Pegasystems Inc (PEGA) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your Pegasystems Inc. quarter one 2010 earnings call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder this is being recorded.

I would know like to introduce your host for today's program, Mr. Craig Dynes. Please go ahead.

Good morning and welcome to Pegasystems 2010 Q1 earnings conference call. With me here in Cambridge is Alan Trefler, Pegasystems' Chairman and CEO. Before I introduce Alan I will start with our Safe Harbor statement and then provide my commentary. You have to excuse me, I have a cold today so if I cough that is what is going to happen.

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, forecasts, and could 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 2010 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, among others, variation in demand and the difficulty in predicting the completion of product acceptance, and other factors affecting the timing of our license revenue recognition; the mix of perpetual and term licenses and the level of term license renewals; our ability to develop or acquire new products and evolve existing ones; the negative global economic trends and the ongoing consolidation in the financial services and healthcare markets; our ability to attract and retain key personnel; reliance on key third-party relationships; the potential loss of vendor-specific objective evidence for our professional services; management of the Company's growth; our ability to successfully integrate our acquisition of Chordiant Software; 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, 2009, and other recent filings with the SEC. The Company undertakes no obligations to revise or update forward-looking statements as a result of new information since these statements may no longer be accurate or timely.

Q1 was one of the most significant quarters in Pegasystems' 25-plus-year history. It was our 11th consecutive quarter of record revenue. We added more employees, especially more sales and marketing staff, than in any other quarter in our history and we negotiated the largest acquisition in our history. These are meaningful milestones in our plans to become a $1 billion a year player in our space.

Revenue in Q1 was $75.1 million, up 20% or $12.7 million from Q1 2009. Revenue is also up by $2.1 million from Q4. Revenue growth from a Q4 to a Q1 is pretty rare in the enterprise software business as Q1 is typically the weakest quarter in our industry. Q1 bookings are always down to the end-of-year budget spending that is often part of Q4 bookings. So as a result enterprise software companies typically eat backlog in Q1.

In our case in comparison to Q1 2009 we actually grew our backlog and the consumption of backlog from Q4 to Q1 was less in this year's Q1 than it was during last year's Q1. In Q1 2009 the aggregate of future payments for term and non-term license payments, these are the off-balance-sheet future payments that we detail in this quarter on page 18, decreased from Q4 2008 to Q1 2009 by 15.8 whereas in Q1 2010 the net backlog used was only $13.8 million.

In addition, the total balance of these future payments grew from approximately $103 million at the end of Q1 2009 to $119.6 million at the end of Q1 2010, an increase of about 16%. In Q1 our new license signings were up from Q1 2009 in both Europe and Asia Pac. This appears to be an indication that the economy is improving in these regions.

New license signings in the US in Q1 2010 where less than those in 2009 due to the anomaly of one deal. Q1 2009 included one large deal which was actually signed in a previous quarter but had a contingency that didn't clear off until Q1. Given our conservative nature, we held the deal out of bookings until the contingency was cleared. If that deal had been counted in the previous quarter when it was actually signed, US bookings in Q1 2010 would have been up from 2009.

Looking at the verticals, all verticals with the exception of healthcare showed an increase in new license signings in Q1 2010 over 2009. Maintenance revenue was $15.1 million for Q1, an increase of $3.1 million or 26% from Q1 2009. As noted in our 10-K, the increase in maintenance revenue is a function of continued growth in the installed base of our software.

Our maintenance renewals exceed 95% as almost every customer renews each year.

Professional services revenue of $29.7 million was up about $4.1 million from $25.6 million in Q4 and was also up $5.7 million from Q3 2009. There are several reasons for this increase over the last few quarters; overall demand for consulting services is higher, demand for training seems to have really taken off. This might have been the biggest training quarter in our history.

In addition in Q1 we had two fixed-price projects reach completion. When these projects finish they tend to pull more revenue out of deferred revenue on the balance sheet. We expect the demand for professional services to remain at these levels for the foreseeable future.

Lastly, we have no 10% revenue customers in the quarter.

Gross profit for the quarter was $48.6 million, up $6.8 million or 16% from Q1 2009. While most of the increase is attributed to higher license and maintenance revenues, ProServ margins improved from 15% to 17%. With the improvement in the economy realization rates were better in all geographies.

In addition, we did slightly less internal training in Q1. While our ProServ margins are higher the primary goal of our professional services organization is not to maximize margins but rather to complete successful implementations that drive follow-on license sales and to enable our customers and partners.

Total operating expenses for the quarter were $40.1 million, an increase of about 36% from Q1 2009. The increase in OpEx reflects the strategy of investment that we have been following since 2006 with the goal of growing the Company to become a $1 billion player in our space. Just like last year, almost two-thirds of the increase in operating expenses is in sales and marketing.

The increase in Q1 is primarily due to headcount. We added 41 people to the sales and marketing organization in Q1. Of the 41, 30 were in sales. The increase in sales headcount was timely. Many of the new sales employees started early in January just in time for our sales kick off, thereby allowing them to jumpstart their training and on-boarding process.

In order to grow revenue we need to cover more accounts and lay-off more quota. This is a sizable investment in future revenue growth as it takes several quarters to train new sales staff, have them assigned to accounts, build pipeline, and close deals. So adding them so early in the year is a real bonus.

In addition to the investment in sales and marketing we added 26 people to our R&D organization. While we are the undisputed leader in the BPM market, we strive to lengthen our lead. Improvements to our product lead to customer success which drives follow-on sales.

Our FAS 123R charge for stock-based compensation was about $1.5 million in the quarter, down slightly from $1.7 million for Q1 2009. Note 7 to the financial statements details now this charge is allocated to cost of revenue and operating expenses.

This quarter we recorded on the P&L foreign exchange translation loss of $3.1 million. Pega's operating and tax structure is not friendly to swings in foreign exchange rates. Foreign exchange translation gains and losses are recorded in two places, on the P&L or in comprehensive income, which is part of shareholders' equity.

While we recorded translation loss of $3.1 million on our P&L, we recorded a loss of only $332,000 in comprehensive income as detailed in note six. This is the opposite of most companies where the majority of the translation gains and losses are not recorded on the P&L. As a result of our structure we show unusual swings in translation gains and losses.

In 2009 we had translation gains of $2.1 million while in 2008 we had translation losses of $4.5 million. In Q1 the sudden fall in the sterling and the euro gave rise to these losses. We are working to move to a more typical international structure where these external swings will not go through our P&L but will go directly to equity like other companies.

This translation gain or loss does not reflect any change in our business condition which is why when we gave guidance we specifically stated we assumed a constant US dollar to exclude large accounting charges caused by factors such as the liquidity crisis in Greece. Our business is no worse due to the situation in Greece nor is it any better now that the sterling is up from March 31.

The application of the new purchase accounting rules to the Chordiant acquisition are starting to impact our GAAP earnings. Expenses associated with the acquisition are no longer treated as part of the acquisition cost but now are immediately expensed to the P&L. As a result, we have recorded $1.5 million of acquisition expenses in Q1.

I am not sure who thought up these new rules but they have a crazy impact on our financial statements. While these costs are treated as GAAP expenses, most of them are treated as part of the acquisition costs for tax purposes and are therefore not deductible for tax purposes. This causes our effective tax rate to look very strange at 38.8%.

The application of new purchase accounting rules is similar to the impact of foreign translation accounting in that nothing has changed in our business but we take two significant accounting charges on our P&L that together end up impacting EPS by about $0.10. So while we would like to report only on a GAAP basis, to make our financial statements more useful to our shareholders when we report in Q2 we will start to include non-GAAP results and present a reconciliation to GAAP.

Even after adding back these two accounting charges to get to a non-GAAP measure of our business, the earnings for the quarter are slightly down from Q1 2009. This is not a surprise but a result of our efforts to invest in sales, marketing, and R&D to continue to grow our business.

On our Q3 and Q4 investor calls I indicated that we had throttled back a little bit on growth investment in early 2009 due to our concerns over the economy and that we would step up our investments as part of our growth plan. As part of this plan since 2006 have doubled our R&D resources and more than doubled our quota-carrying sales reps. These are both key elements of driving growth beyond 2010.

Q1 bookings increased our [AER] balance by $2.9 million from $39.4 million at the end of Q4 to $42.3 million at the end of Q1, but the days [sales] outstanding is still an amazing 35 days. We had another great quarter of collections which resulted in a $4.8 million cash flow from operations and we ended the quarter with $202 million in cash and investments.

During the quarter we purchased 44,299 shares for $1.6 million at an average price of $35.22. Our Board replenished the buyback program in Q4 and we still have a balance remaining of about $14.2 million available for repurchases during the remainder of 2010.

Deferred revenue of $42.1 million was up by $9.3 million from December 31 due to increases in deferred license revenue and annual maintenance billings.

Wednesday we closed on the acquisition of Chordiant. As a result we would like to give some initial guidance. We were only able to give guidance update on revenue given that we have a lot of work to do in finalizing our purchasing accounting.

Part of the purchase accounting includes taking a reduction or haircut on Chordiant's deferred maintenance revenue that is on their books at the time of acquisition. Again, this is only an accounting anomaly and doesn't reflect a drop-off in their maintenance business. In fact, we believe that their maintenance revenue is very sticky since customer applications are important, mission-critical type apps.

In addition, we have met some of the Chordiant customer base and they are excited about the enhancement that adding PRPC can have to their existing applications. We are formulating a detailed product plan that we believe will be synergistic as the technologies can be very complementary.

But bringing the two companies together and implementing the strategy will take some time. We believe that the acquisition will be slightly accretive this year and very accretive in 2011. On a non-GAAP basis we now expect 2010 revenues to be approximately $360 million. I say non-GAAP because I am adding back the purchase accounting haircut on deferred revenue to get to a truer run rate business.

The haircut represents about $12 million so GAAP revenue should be approximately $348 million. We have provided a reconciliation in our press release and will update these estimates when we report Q2 results.

With regard to earnings, however, we are not yet able to present a reconciliation due to the complexity of other purchase accounting items. So the GAAP versus non-GAAP split on earnings is not yet possible, however, we see no change in the overall profitability of Pegasystems.

Our earnings estimates will, in fact, probably become non-GAAP estimates but we just can't do the GAAP to non-GAAP reconciliation until we finish the purchase accounting work. This will be done in time to file our Q2 results.

As a reminder, our guidance is always annual guidance. We don't give quarterly guidance for two reasons. Our customers, not us, determine whether they will buy a term or perpetual license and a change in the mix can make our quarters extremely lumpy.

In addition, we don't give crazy discounts at the end of the quarter to make guidance numbers because our business is built on follow-on sales to existing accounts. Big discounts would ruin our business just as it has ruined many other software companies.

So while we don't give or manage quarterly numbers, I sometimes try to give some advice to those building models. Historically, there have been quarters where revenues have not grown sequentially. In fact, in the high-growth years of both 2006 and 2007 we had down quarters during the year but on an annual basis still put up growth numbers for approximately 30% in each of those two years.

In addition, in our 2009 annual call I gave the guidance that our profitability would be somewhat back-end loaded as we will have high expenses in the first half of the year. This was to account for our planned investment in sales, marketing, and R&D in Q1 and Q2.

Once again we do not manage to quarterly numbers. We are managing the company with a goal of becoming a $1 billion software company and owning our space. While this seems like a lofty goal, our progress to date has been amazing and this quarter we have made some significant investments towards this objective. We have added a record number of new employees and we have now completed the acquisition of Chordiant.

It was only in 2008 that we barely surpassed $200 million in revenue and now with non-GAAP guidance of $360 million I look forward to continued progress toward our goal.

With more detail in Q1 achievements I would now like to turn the call over to Pega's Chairman and CEO, Alan Trefler.

Thanks, Craig. I am glad your voice held up. Mine is under a little stress as well so if I start coughing no one take that to mean anything special.

Good morning to all. I thought the start of 2010 was remarkable for Pegasystems and had felt really good about it till I read the overnight report from Bangalore that condemned our Q1 miss. As I find this judgment pretty ironic I would like to take a few moments to talk about our approach to the opportunity that we see before us and how we manage the Company.

I am not going to try to convince anyone that our approach is correct. There are people who might reasonably say that we should bet less on future growth and seek to return more current profit. So let me simply try to be transparent about Pega's goals and strategy, which is one of pursuing aggressive but well considered growth even if it requires significant investment.

We believe that the opportunity we have could be enormous. The transformational capability of BPM is just beginning to be understood and it requires meaningful effort to establish it in the minds of buyers. So this is how we see it.

In 2007 we had $51 million in license revenue. In 2009 we grew that to $116 million, a 127% increase over two years. But sales and marketing expense grew from about $52 million to $74 million, a 44% increase. So let me ask a hypothetical question, if license is growing at a particular rate in a market that is a sell to the customer market as opposed to a fulfill order market, would you expect sales and marketing expenses to grow at a rate somewhat more proportional to the license growth especially as hiring, training, and on-boarding staff is costly and paying that level of commissions is expensive?

The reality is that by being prudent in the face of the dire economic environment we saw in 2008 and 2009 we invested less than I now wish we had. And the fact that we are growing our top-line numbers so well, 11 record revenue quarters despite the economy, is a tribute to the effectiveness of the team despite what I now consider a hiring gap in 2008 and 2009.

Now we understand that this is riskier than banking the profits but it is true to our mission and all we can do is be transparent with this way of thinking and the inherent lumpiness of our business. We are not running Pega for short-term profit or for quarter-to-quarter consistent GAAP results.

We think there is a very big opportunity here that we have worked 27 years to prepare for and we are going after it despite the potential risks and potential misunderstandings about our need to invest to bring sales coverage into alignment with growth and to continue the R&D that BPM requires to be operationalized to the next level and to be used by a broader audience and in new verticals.

We think the potential is exceptional but to draw on a chess metaphor, our approach is much more king's gambit than Ruy Lopez. And while only investors who believe in the vision of this market should be signing up with us, I would say that Pega is very thoughtful in making investments and committed to critical thinking and continuous improvement in looking for the investments to be wise.

So why have I been feeling great? Well, in Q1 we achieved our 11th consecutive quarter of record revenue. We announced our newest release of our industry-leading business process management platform, SmartBPM 6, which is spectacular. We won significant business, not only in our core verticals, traditionally financial services, insurance, and healthcare, but also in newly targeted sectors including life sciences and the public sector.

I feel much better about the federal business. We have actually started to get some traction, something I have spoke of about wanting to do for a couple of years. Feelingly like that is heading in the right way absolutely.

We announced the largest acquisition in the Company's history. We dramatically advanced our work with systems integrators in global alliances. For the first time we were recognized as a leader in Gartner's CRM customer service contact center's Magic Quadrant.

We invested in growth in Asia Pacific, opening offices in Singapore and Hong Kong. In Q1 we committed resources and engaged an external expert firm to help us seed our entry into Japan and I am pleased to report that in April we hired Pegasystems first country manager for Japan. We have existing international clients to give us leverage as we move into this region though we understand it will take a while and further investment to build that business. We think it's going to be a great opportunity for us.

And we received a record pace of registrations for our upcoming PegaWORLD user conference, now at over 1,000 which makes PegaWORLD the largest BPM conference in the world. As Craig mentioned, our total revenue exceeded $75 million in the first quarter of 2010 with quarterly license revenue of over $30 million.

Pega addresses the needs of the pragmatic buyer by very quickly developing ROI and enabling the business to achieve unprecedented agility using our build-for-change technology. The benefits of our technology have been considerably advanced with our newest release, SmartBPM 6.

The capabilities include faster time to market, further increases in collaboration between business and IT groups, new capabilities for clients to transform their business and move beyond the constraints of how software has been manually written for the last 40 years. Really letting our customers achieve agile and rapid benefits in a business-lead approach to applications.

In regard to Q1 wins we achieved successes across the board in financial services, healthcare, insurance, and life sciences. I am particularly pleased with the government team. As I mentioned it scored wins and has built an exciting pipeline.

We continue to see companies using Pega technology to enable business growth, improve the customer experience, and transform their back offices. For example, we have received a large win in a leading bank that selected us as their services backbone to automate processes throughout the back office. A Blue Shield organization organizes us to manage claims and to automate the claim repair process. And the government agency is also going to be using us in the area of claims and in support of the health business.

So it has been good across the board, I would say, in terms of the industries. I am also pleased to say that in Q1 the work that we have been doing to let us launch into new industries also moved forward very, very substantially.

We had many system go lives in Q1 -- healthcare organizations, banks. A large bank opened a PRPC initiative to really change the way that they add customers and open new accounts. We have a large P&C company who went live with a customer experience service platform and a leading health insurer launched a national desktop for member and provider services.

I am also pleased to announce that we just closed the acquisition of Chordiant and this is a very strategic deal from our view. It adds decision management technology to our already strong intent-driven process approach. It will let us improve the customer experience, brings assets in the area of retention, cross-sell, and upsell while letting clients reduce the cost of sales and the cost of service.

Chordiant has a very impressive, large, extremely important customer base. We have had a chance to meet with a number of those customers and we are extremely pleased that we are going to be able to engage well with them. I think they are also excited that they are going to have a larger company that is committed to their success and is in a position to be able to invest as we go forward.

We are very pleased to have their strong employee base with deep technology experience and customer experience and decision management experience join the family. In terms of the verticals that they are in they actually have very, very good presence in two specific verticals where we weren't as deep.

The telecom vertical, which I had mentioned was going to be an important area for us this year. We had one client in telecom and they have got over 10 significant organizations. Also, they bring important relationships in consumer banking where they have got literally hundreds of thousands of seats that are being used across some of the world largest institution.

So we think it's exciting. We think we are going to be able to help our customers take advantage of some of the new Chordiant technology. We think we are going to be able to help revitalize some of the Chordiant technology by incorporating PegaRULES Process Commander. And I can say that the potential from this move is at least as strong as we believed when we first engaged with them.

In Q1 our partner relationships also advanced at a faster pace than ever before. Our partner-sourced pipeline activity increased approximately 75% from the same period in 2009 and we conducted business development training for over 500 partner delivery resources. Approximately 30% of the total PegaWORLD attendees are expected as a result of these partners, representing a three X increase from the last one.

We also launched a new Pegasystems web-based partner portal and have had almost 1,000 partners sign up at pegapartner.com.

We are also expanding geographically. As I mentioned, we have been really growing in the Asia-Pacific region and we think that that has a lot of potential for us because, frankly, we have already seen in the last six or nine months that region perking up and actually have seen purchases come from it.

So overall we feel the quarter and the year to date has been remarkable; record revenue growth, SmartBPM 6, the closing of the acquisition, exceptional partner traction, a leadership position in CRM, and geographical and vertical expansion.

You are going to be able to see a lot of this if you happen to be at PegaWORLD next week in Philadelphia, next Monday and Tuesday. We are going to have leading businesses from around the world present on how they are using Pega technology to win two business agility. We have over 30 clients scheduled to present to this audience and we welcome you to join the excitement and the dynamic opportunity offered by the BPM market.

With that let's open the line for any questions.

(Operator Instructions) Laura Lederman, William Blair.

That one deal that didn't close as you thought, has it closed now? And if not, when do you expect it to and what is it contingent upon?

Then I will follow up with more questions. Thank you.

I think you misheard; there was no one deal that didn't close. What he was talking about was a deal going all the way back to 2008 that had slopped over to hit the first-quarter 2009 numbers.

Oh, so it's -- I see. Got it. Can you talk a little bit about the pipeline for this quarter as we sit in Q2 over Q2?

I would say the pipeline overall continues to grow and it has continued to grow quite nicely. We are in a position where, like most software companies at this point, you are not sure exactly what is going to happen this quarter versus Q3.

But I will tell you that historically PegaWORLD, what we have done it in the past, has been a very, very effective galvanizing event for both additional purchases from existing customers and new customers making decisions. So going into PegaWORLD next week I would say overall we are pretty excited.

Can you also talk a little bit about, and I guess this is a Craig question, changing the way you deal with FX so you don't have as much earnings variability? When will that be in place so there is not as much a swing on the earnings line?

It's a long-term process; there is a bunch of things we have to do. First of all, we are upgrading our accounting systems to allow more operations offshore, more licensing and more transactions offshore.

Essentially what it does is it pushes a lot of the operational aspects of G&A and accounting out of the US into the subsidiaries. Once you do that the translations gains and losses are in the subsidiaries and that goes through comprehensive income rather than P&L. So it's a bit of a process, lots of consulting fees involved, lots of tax restructuring and we are working on that.

Actually the acquisition of Chordiant is very timely because we will use some of their offshore operations and weave that in to the whole plan.

If you look at -- final question for me and I will pass it on. If you look at the revenue guidance you gave and you take out Chordiant was the revenue guidance for core Pega the same or up or down? If you could address that, thank you.

Same, no change. There has been very little change to our business outlook. As I said, in spite of crazy accounting charges or non-tax-deductible acquisition fees and the crisis in Greece causing foreign exchange accounting entry nothing has changed.

I meant on the revenue line.

Same thing.

Okay. Thanks a lot.

Nathan Schneiderman, Roth Capital.

Thanks very much in advance for taking my questions. A first one for you on Chordiant. The guidance that that acquisition on a pro forma basis should give you about $45 million of lift on revenue, just looking at the consensus estimates for the April through December on Chordiant it looked to me like it was a lot closer to $65 million.

So I understand you miss a few weeks of the quarter. But would you just describe that as conservatism or is there another reason why you wanted to haircut that $20 million?

Well, remember that $20 million wasn't our $20 million nor based on statements that we were making. I think if you take a look back at the history of Chordiant -- now I am going to do this from memory -- but for the last reported fiscal years the revenue had gone over I believe two years from about $126 million to around $77 million and was extremely choppy.

So I am not exactly sure how the analyst community arrives at that particular set of numbers, but they have not been numbers we have endorsed. And I don't think we are changing any of what our expectations were of what Chordiant would provide.

And there is a bit of a transition when you do an acquisition. You have to reposition salespeople; there is customers that get confused. Do I buy Chordiant, do I buy Pega and you have to go and visit all those people. So you do have some things that impact your revenue.

It's a possibility that their sales organization and our sales organization could have been forecasting the same deals and only one of them is going to close. So you do have that aspect as well.

Got it. The 10-Q referenced it looked like significant prepayments from three customers that boosted term licenses. What was the cumulative value of those prepayments and can you explain why the customers were prepaying? Did you give them financial incentives or other reasons to get them to prepay?

We don't give customers any sort of meaningful incentive to prepay. Sometimes customers want to do it because frankly they have got money available relative to their fiscal year. And sometimes it's just random and it shows up the end of one quarter as opposed to the beginning of the next.

A lot of times it has to do with their budgeting and their funding and their political situation. If they were in a situation where they borrowed money from some government or whatever, they don't want to have a lot of cash sitting on their balance sheet because it looks bad.

Got it. When you add those three prepayments together what was the benefit? How much additional revenues did that give you?

I don't have those numbers in front of me right now but I can get back to you. But it's a common occurrence; it's not a one-time event. In fact, I think if you look back at prior Qs and Ks you will see the same thing.

Final question for you, the 10-Q detail that you had $31 million of other license payments that you would recognize in the remainder of 2010 in that famous table of yours. What was the year-ago number, so coming out of Q1 2009 what would that $31 million have been for the balance of 2009?

The balance of 2009, I am not sure where you are getting the $30 million from. Are you talking about the term or the non-term?

We give three columns. Are you talking about the last column on the right or the middle column?

(Operator Instructions)

Hello?

Nate, I think we lost you but I can answer that off-line or I can give the numbers that at -- the page 30 numbers for non-term future payments at 12/31/08 were $30.3 million, at 3/31/2009 were $18.6 million, at 12/31/2009 were $57.1 million, and at 3/31/2010 on page 18 was $51.6 million.

Operator, are we still connected?

Yes, we are connected. His line is still open.

Craig, I was just talking about that third column over. It was 31.035. I was just curious what that number was in the year ago period because you didn't disclose it then.

Okay. So let me get through this again, at 12/31/08 that number is $30.3 million, at 3/31/09 that number was $18.6 million, at 12/31/2009 it was $57.1 million.

But let me -- I think there is a disconnect. Are you asking what that table looked like in the year ago Q?

No, it wasn't -- you didn't disclose it in the year-ago Q.

But we gave the total numbers in the text of the K and the Qs as we have been going along.

Okay. Why don't we discuss off-line? I will drop off so others can ask questions. Thanks very much. Bye.

Okay, give me a call back.

Steve Koeing, Longbow Research.

Good morning. Just a couple of quick questions. I am wondering -- back to Craig, your comments about the integration of Chordiant. In terms of the sales forces how will you bring those sales forces together or not?

So we have -- so just literally one day into it we have already begun the integration of the sales forces. We are going to operate the Company as an integrated unit. It may lead to a little more disruption day one but it means that customers will be called on by Pega as a consistent entity as opposed to potentially having different parts of customers called on by different parts of Pega. And I think that that transition is going to go quite well.

Okay. Also, can you give any color on how long will the hiring spree, the hiring strategy continue? Is it mostly just a Q1 occurrence or should we expect much heavier hiring than normal over Q2 or even beyond?

I am not really prepared to characterize it as a spree but I will tell you that we are expecting to hire quite assertively through the first half. To some degree the Chordiant acquisition will actually fill some of those slots, but we want the acquisition to be accretive so we can't undo the fact that additional hiring will be necessary.

Basically what we are going to do is continue to push in Q2 pretty hard and, frankly, we reevaluate it every month.

And will that mix, Alan, of R&D, sales and marketing, do you think it will resemble the Q1 hiring or have you gotten more of the sales hiring out of the way?

No, we still are covering fewer than half of the Fortune 100 companies. Part of the realization we had when we took a look at where BPM could be used, which is very, very broadly, and we took a look at the massive, just completely uncovered accounts, as I said frankly at the start of year call and I also said it in Q4, we decided we needed to meaningfully ramp it up.

We have closed a bit of that gap but we have got a long way to go. I think the major constraint to our hiring is our belief that we can effectively on-board and train and manage the new staff as opposed to, frankly, the short-term financial considerations. Because as we know, if we start hitting on all cylinders with the sales force and the software the results are extremely, extremely positive.

And that is why it was really important to us that a lot of the guys started before sales kick off. It was a great opportunity. We literally had a lot of new guys walk in here and really in some sense they were drinking from a firehouse, but it was a great opportunity for them to get jumpstarted on their on-boarding and training.

Can you all characterize or generalize about where those folks came from, the variety of places you hired from?

We are a pretty popular place to come work these days because there aren't a lot of companies whose market share is increasing. There have been a number of acquisitions, as I talked about on the last call, in the last six months and, frankly, when companies get acquired by one of these large aggregators, I would say, their best salespeople typically find that they lose their customers.

Those large organizations already have people who are taking care of the big customers and the salespeople very quickly become disenfranchised. Generally within six months to a year an awful lot of them, shall I say, become available or actively pursue us. So we have had a lot of, frankly, ex-FileNet people who IBM bought a couple of years ago. Some of the more recent acquisitions are now also pushing forward.

We have got folks who are coming out of places like Adobe and other sorts of places that, frankly, have had a different strategy than we have had about how to go after markets. We are very vertically oriented and not all companies appear to be following or pursuing that strategy.

Companies like Global 360, some of the private companies that may have been struggling a bit. We are getting a good mix and, frankly, we are in a position to be quite selective.

Rahgaven Sarathy, Dougherty & Co.

Good morning. Thanks for taking my questions. Can you guys hear me? I have got two questions for Alan and then a few for Craig here.

First, on your new product, SmartBPM 6. So Alan, can you talk about the feedback you are getting from your customers? And then in terms of product roadmap, do you plan to provide a free upgrade for customers who have maintenance agreement signed? And then if customers buy term licenses going to be selling the new version on sort of the transition there?

Yes, whether customers are term license or perpetual customers we take things that are enhancements to the core product and generally those are released as part of the maintenance and update fees that they get. There are additional pieces and add-on bits that we will be able to sell but we are expecting that this is going to be adopted very broadly by our customer base, which once again we think is a good thing.

As I have said in the past, even in our top five customers I would say that the level of adoption of Pega still has a lot of legs and we still have tremendous opportunity to sell additional seats and sell additional business operations. So we want them using our new stuff because it frankly helps more parts of that organization see it like that and take it on. And that is where we get a lot of that return from.

The features have been, I think, warmly embraced by customers. We have made a lot of changes in this release and they include very significant changes that impact ease of use and significant changes that improve the way that businesspeople can take control of their destiny.

These are themes we have had for a while and, frankly, this sort of work is never done. I have never seen us, though, take this big a step in a single release of the product and the initial feedback we are getting is extremely positive.

And then can you talk about the selling environment? The economy -- the license signings, like (inaudible) evaluate your company on a quarter to quarter basis. So can you talk about the selling environment [with the back of an] improving economy? Also can you talk about the competitive environment, has there been any change there?

Yes, so the selling environment I actually think is improving. The problem with gauging some of these things quarter to quarter at our size is if you look at this stuff from a statistical basis, you got a sample size problem here. But the pipeline is up, the sales force is very enthused, and I think the selling environment is starting to perk up.

But, frankly, we did so well last year a lot of these compares are tough compares, particularly since we didn't grow the sales force that much over the last year or two which is exactly what we are trying to rectify.

What was your other question? I am sorry you sort of cut in and out again.

In terms of competitive environment given these acquisitions recently.

I think the competitive environment, from my perspective, continues to improve. Customers are very skeptical about acquired companies continuing to pursue the BPM vision. Frankly, they are skeptical for all the right reasons and to some degree I think some customers are resenting the fact that there are some large aggregators that are trying to drive their choices out of the equation.

And BPM is one of those places where a customer can actually still get competitive advantage. They don't want to all have the exact same stuff as their neighbors, which is frankly why they use the technology. So we were actually thrilled by the acquisitions that have been announced over the last year.

All right. And then in terms of Chordiant you said Gartner has actually ranked you in the leadership of the CRM. I looked at the report, too. Chordiant obviously -- when I looked at the report Chordiant isn't really in the leader category.

So my question is going forward do you plan to continue selling your product instead of Chordiant product in the CRM situation? How do you transition those customers? Give us some color.

The good news is that BPM, our technology, is pretty good at adding muscle to existing call center implementations. So for the existing Chordiant customer base we have got some very, very good ideas about how we are going to be able to use Pega technology and frankly license them Pega technology to be able to give them an improved value proposition from their existing Chordiant investment. Not just letting them support it but letting them actually grow it and at the same time introducing some of these customers to Pega.

I am actually pleased to say that at PegaWORLD next week we are going to be demonstrating five different sets of interactions between the Pega and Chordiant technology live including one that I think will be of great interest to -- for Chordiant's CRM customers.

On a go-forward basis strategically obviously as Gartner has pointed out the Pega product is meaningfully stronger and is a leader. And I see us frankly being able to offer that more advanced product to the Chordiant sales force, which I know they are pretty excited about.

Okay. Then one final question for Craig. Previously after this Chordiant acquisition you had indicated that Chordiant would be earnings and $0.20 for next year's earnings on a non-GAAP basis. I know that you haven't finished your purchase but does your previous outlook still hold?

Yes, we have not changed our attitudes in regard to the business conditions and the profitability. It's just that with all of these crazy purchase accounting things essentially what is going to happen is that the earnings will become more non-GAAP earnings and we can't give non-GAAP earnings unless we can do a detailed reconciliation. Since we just closed this Wednesday night, believe it or not we are not finished with the purchase accounting yet.

But my question is your previous outlook on a non-GAAP basis will hold?

Yes, we still believe that the Chordiant acquisition will be slightly accretive this year and strongly accretive next year.

Okay, great. Thank you.

(Operator Instructions) [Greg Spiker], [Moss Creek].

Can you give us an update on your platform as a service approach? Has there been quick uptake, are people looking at it, will there be some conversations at the user conference about it?

Yes, we are actually going to be showing it at the user conference. It has gotten pretty positive responses. We have traditionally used it to primarily for QA and development because our customers traditionally, given who they are, have wanted to run their production systems internally. And it has been very, very positive.

It has also been taken out by several of our partners who are now running in some cases dozens of platforms and service instances to help them do development for their customers internally as well. The thing that is interesting is that as we go into the second half of this year we are going to be offering a managed service full-blown, you can run production environment, and we are right now just putting those contracts into place. We are going to be discussing it with our clients at PegaWORLD.

I think we are going to start to see some uptake and we can start to talk about revenue for that probably, meaningful revenue from that as we go into next year.

Okay, great. Interesting. So with the new sales hires what -- out of the total market coverage you would like to have how far along are we now? Where does this get you on a scale of one to 10 or however you want to phrase it?

Well, I kind of believe we should be calling on every one of the Fortune 100. I don't think that is a very radical thought. And today I would say, I don't have the hard number in front of me, but I would say we sort of just crossed the 50% or so threshold.

So if you buy into the value prop that BPM is applicable across industries and if we attack this in an industry by industry basis so we can do it somewhat more reliably by showing up with things that make sense to people in an industry, I want to continue to grow this until we have got, frankly, coverage deeper into the Fortune 300 and 400 as opposed to just the Fortune 100.

Now you can cover the smaller companies with a very different ratio of salespeople. We actually have in some cases two, three salespeople tied to literally one organization because the organizations are just massive. Obviously the ratios are not going to be the same but we have got to continue to grow.

As I say I view us as being primarily constrained by our ability to onboard and make sure we are supporting them in the verticals.

Great. Thank you very much.

Richard Davis, Needham.

Thanks. The pushback that I hear from corporations against these aggregators, maybe they are headquartered in New York State somewhere, but in any case is that they come in and they go, hey, look, we have got a Chinese menu of stuff. Sorry it doesn't really work together but we have got these great global services guys that will glue gun the thing together.

So the question I have for you is can you go in to your clients and go, listen, they may have a couple of the modules that we have but the fact of the matter is you are not going to spend a bunch of money on services. So it's really a question is can you come in with a lower total cost of ownership? And if so, can you give us orders of magnitude how much better that is because to me it seems like a competitive advantage if you are able to do that.

Well, I think we can come in with a lower cost of ownership but the thing that we can do that these frankenstack vendors we sometimes refer to them as can't remotely do is we actually improve the return on investment and the value by improving the return. So whether it's making it much, much faster for an insurer to do a quote and buying process or whether it's making it so that they can do the same work with far fewer people because one of the things we do is automate the work so much better than these cobbled together solutions even if they use services.

We routinely see clients who get 50 and 60% reductions in staff in meaningful operations because the stuff can be automated with our technology and it cannot be automated in remotely the same way. All that can be done is sort of feed to people.

So the return is better both on our lower cost of ownership basis but also, frankly, on a much, much better return on investment basis, which is the only recently were successful the last two years. Because clients would buy it, install it, get a return, and buy some more.

Got it. Perfect, thanks a lot.

Brian Murphy, Sidoti & Co.

Thanks for taking my questions. I have a quick one on the pricing environment. Alan, I know you try not to play the quarterly earnings game here. Can you maybe just give us a little bit of color on how that might be helping you prevail in pricing negotiations? And also maybe to the extent that it may cause some deals to get pushed out into future quarters?

I don't think that the way most software companies price is very rational, which is frankly why these aggregators keep scooping up these companies that are unable to grow sustainably. Because most software companies, I think, are -- well, they panic in pricing negotiations.

We are very, I would say, stable and very commercially disciplined in terms of the way that we do these things. We will sometimes have customers, particularly new customers, try to hold us up at the end of the quarter. But once people see that doesn't work then they stop being tempted to do it and it's actually just a much, much better relationship to have.

So I think that often with a new client, and obviously we are adding a number of new clients and you will see that occur, but we tell them we don't [manage] to the quarters. We give some copies sometimes of these call transcripts so they have a reason to believe it. And to be honest, I think it works well and I think other companies should do it too.

Okay, great. Alan, also you touched on the additional adoption potential in the installed base. I know you guys get a very high percentage of sales through existing customers.

Can you give us a sense for what the ramp looks like after you get to a certain sort of critical mass? With some of these large customers, what is the typical sort of annual increase that you see from this land and expand strategy?

You know, it is significant. It's not uncommon to see adoption go up 50%, 60% year after year in some of these customers. Still though I will tell you it requires some sales effort. I think it's lands and expand, not land and sort of automatically happen, so we do continue to need to invest sales effort in those. It's just a lot easier when a customer is internally referenceable, particularly in organizations where they are doing meaningful things with the technology.

So I would say on average it would be sort of 50% to 100% growth rate in these customers once we have gotten in after the first year.

You will see with PegaWORLD you will have a chance to talk to some customers that will tell you that they started with one application, two applications. Now they have six, seven, eight, 10, 12 applications they are building at the same time.

Also, if I can just sneak in one more. Craig, historically the maintenance gross margin in the high 80s. You guys are layering in a pretty significant maintenance stream here. As you go to support the Chordiant customers how, if at all, might that affect the maintenance gross margin? Thanks.

It's a little early to determine exactly what the margin is going to be but I can tell you Chordiant does about $9 million a quarter in maintenance and we are doing about $15 million. So you are looking at a company that is doing pretty close to $100 million in maintenance, that is pretty impressive.

As those groups grow, there is generally the opportunity to improve margins.

Edward Hemmelgarn, Shaker Investments.

Actually my question was answered, thanks.

Laura Lederman, William Blair.

Thank you. A few follow-up questions. Can you talk a little bit, and I realize you just got Chordiant, how the pipeline looks? Did it totally or largely disappear because of position or is it starting to grow? Any sense you can give us of that.

Finally, -- sorry the phone kept going in and out because I am in a taxi and there were some areas where the phone wasn't working. Can you give that same sort of bookings growth you gave us last quarter? It was like 30% last quarter. Can we get it for this one as well? Thank you.

So relative to the Chordiant pipeline I will tell you that it definitely has not evaporated; I think some customers are waiting to talk to us. But at this point we have had the chance to talk to several customers and frankly Chordiant had some good business that was in the pipeline that is going to persist and I expect is going to close over the next couple of quarters. So we feel pretty good about that.

And I think, frankly, the customers in some cases are more likely to buy because Pega is a larger firm so I think that will be positive as well.

Relative to bookings growth I don't have a [quarter to quarter] number there but --

Q1 is pretty tough quarter to measure; it's the weakest quarter. You clean out all our pipeline in Q4. In Europe and Asia-Pac it was up.

In the US if you put that one big booking back when it was signed, it was up. If you sort of leave it, and we do to our conservative nature because of the contingency, it was down slightly. In all verticals with the exception of healthcare bookings were up as well.

Okay. Sorry for having to repeat, but can you talk a little bit about that deal that swung? When was that, how big was that? I am sorry, once again traveling makes listening to calls hard I apologize.

So this was a deal back in Q4 2008 and Q1 2009. The deal closed in Q4 2008, typical end of quarter kind of budget flush deal, but it had a kind of contingency. And we are so conservative until the contingency gets cleared off we held it off and we moved it into Q1.

And it was a big deal. If I recall it was over $4 million, maybe close to $5 million so it makes that sort of an unfair compare because frankly all the work was done in Q4. The commission was accrued in Q4 it just didn't hit our own internal record until Q1.

And once again that is not this quarter. That is 2008/2009; it's a year ago so it has nothing to do with our go-forward position at all.

Final question for me is if you look at your bookings this quarter were they below or in line with what you had expected? And obviously it was a Q1, but how was it versus what you thought it would be?

There were more clients, there were more deals than we expected and a punch of new customers, much more from new clients than we had had a year ago. But the average number was like a little lower. Some of that is because we are frankly very, very happy with the land and expand strategy so that is not at all troubling. And as I said, the sample sizes are somewhat small.

And we have one deal that slipped out and we had one deal that we actually got the paperwork on April 1.

But that always happens.

That always happens.

Can you tell us about the one deal that slipped out though?

Deals always slip out. A lot of time sales guys have happy eyes, things are going to close, they are not going to close. This happens all the time; some deals come in, some deals slip out.

It's a great disservice, Laura, to this market to have sent as much time as we just have talking about any single deal in any single --

Sorry.

I kind of feel like I have slipped back into just a whole position that is just not consistent with what people are going to see a PegaWORLD next week when they actually talk to the client.

Thank you so much.

Thank you.

I am not showing any other questions.

Well, with that let me thank everybody. We are working hard here. We are very excited about the prospects and we are going to continue to work as hard as we can to grow this company terrifically. Thank you very much.

See you all at PegaWORLD.

Ladies and gentlemen, this does conclude today's programs. You may now disconnect and have a wonderful day.