Pegasystems Inc (PEGA) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your Pegasystems Inc.'s Q2 2010 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions)

As a reminder, today's conference call is being recorded. I would now like to introduce your host for today's conference call, Mr. Craig Dynes. You may begin, sir.

Good morning. Welcome to the Pegasystems 2010 Q2 earnings conference call. With me here in Cambridge is Alan Trefler, Pega's Chairman and CEO.

Before I introduce Alan, 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, believes, estimates, targets, forecasting, could and other similar expressions identify forward-looking statements which speak only as of the date the statement is 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 the forward-looking statements include, among others, variation in demand and 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 and 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 obligation to revise or update forward-looking statements as a result of new information, since these statements may no longer be accurate or timely.

Q2 was a history-making quarter for Pegasystems. We worked hard on the largest acquisition in our history and at the same time reached a new milestone. For the first time, the Company exceeded $80 million in revenue in a single quarter.

A lot of work went into the integration of Chordiant, so let me give you an update. We moved very quickly on integrating the two companies. The cash tender offer closed on April 21. Four days later, on April 25, PegaWORLD, our annual user conference, started, and we had Chordiant employees, customers and partners in attendance, [where we're] already meeting new customers, presenting initial product roadmaps and demonstrating product integration.

As of today, all of the organizations and systems are pretty much integrated. As an example, there is not a separate Chordiant sales organization. We have one sales team selling into their assigned accounts.

It is the norm to see a sales team comprised of Pega and ex-Chordiant staff working together on opportunities, and we are already seeing deals where the customer is [licensing a] mix of products. While this level of integration makes it very difficult to separate the deals and products, approximately $7.8 million of Q2 GAAP revenue can be directly attributed to Chordiant.

Most of the integration cost is reflected in the Q2 restructuring charge of $6 million. This charge is primarily for severance payments. We expect that there will be additional restructuring charges of approximately $1.7 million in Q3, as there are additional severance payments scheduled and facility work to be done.

The restructuring charge is not a catchall for all costs. There are still many Chordiant employees who are in transitional roles whose salary costs are not in the restructuring charge. So in our Q2 financial statements, there is approximately $1 million of personnel costs in the operating expense line for staff who are employed on a temporary basis. During Q3, these transitional roles will wind down, and so we expect these OpEx costs to drop to about $400,000 in Q3 and be gone in Q4.

In addition to the restructuring costs, during Q2, we recorded $3.4 million of acquisition-related expenses, such as banker and legal fees, which are directly related to the transaction. This is in addition to $1.5 million of acquisition-related expenses that we recorded in Q1. In total, through the first six months, we recorded over $10 million in restructuring and acquisition expenses.

Just to size the numbers and the impact they have on our GAAP bottom line, we have provided a non-GAAP financial information in our press release. Like other software companies, we've excluded these large acquisition costs, amortization of intangible assets created as a result of purchase accounting, as well as FAS 123(R) charges. This allows an easier comparison to other software companies, as well as to analyst's model who use these non-GAAP measures.

Lastly, we've provided guidance on a non-GAAP basis for easier comparison.

GAAP or non-GAAP, Q2 was our 12th consecutive quarter of record revenue. As I said, it is also the first time in our history that quarterly revenue has ever exceeded $80 million. License revenue on a GAAP basis was up $2.5 million from $25.7 million in Q2 2009 to $28.2 million in Q2 this year. Very little license revenue is directly attributed to Chordiant. License revenue is slightly down from Q1 2010, but this is a very common trend for us. In fact, Q2 license revenue has been less than Q1 license revenue every year since 2004, as new license signings or bookings are typically much lower in Q1 and Q2.

New license signings were higher in Q2 this year as compared to last year's Q2 in both Europe and Asia. They were also higher in every vertical other than US healthcare, which I suspect may be caused by the temporary uncertainty related to federal health care reform.

As a result, new license signings were just slightly lower in Q2 2010 compared to Q2 2009. However, 2009 is a tough compare as it was far less backend loaded than normal. In fact, 2009 was the only year in the last five years that at the halfway point, bookings were more than 30% of the annual total. Our customers buy software from annual, not quarterly budgets, and so they tend to save their budgets and evaluate products through Q1 and Q2 before spending in Q3 and Q4.

Maintenance revenue was $20.4 million in Q2, an increase of $8.2 million over Q2 2009. About half of this increase was directly attributed to Chordiant. The acquisition-related increase in maintenance revenue is calculated only from April 21, so there will be a further pickup in Q3.

Purchase accounting rules give a haircut to maintenance arrangements that are in deferred revenue at the time of acquisition. So on a non-GAAP basis, maintenance revenues were $22.8 million for the quarter.

Professional Service revenues are up 31% on a year-to-date basis over last year. The Chordiant acquisition contributed $3.9 million to Professional Services revenue in the quarter. But even if I take out the acquisition pickup, Service revenue would still be up by 23%.

Demand from customers and partners for training is especially high. Training revenues are up 67% for the first six months of the year in comparison to last year.

At the halfway point in the year, gross margins are about the same as they were last year. Professional Services are at 18% versus 19%, and maintenance is at 87% versus 88%. You should know that we have a much larger cost of license in our GAAP financial statements. This is due to the amortization of the software intangible assets created as part of the purchase accounting. This charge is added back as part of the GAAP to non-GAAP reconciliation. Page 20 of our 10-Q details amortization of intangible assets.

Total operating expenses for the quarter, other than the acquisition and restructuring charges, were $50.6 million, an increase of about $20.2 million or 66% to Q2 2009. Approximately $6.5 million of the increase is due to increased staff and costs from Chordiant employees. The balance represents the strategy of investment that we've been following since 2006, with the goal of growing the Company to become a $1 billion a year player in our space.

Sales and marketing expenses are up substantially, as this is the major area of investment for us. On a year-to-date basis, sales and marketing expenses are up $19.7 million from $32.1 million in 2009 to $51.8 million in 2010.

While marketing programs such as PegaWORLD accounted for $2.1 million of the increase, the vast majority is due to increased headcount. In the first six months, we've added 112 people to the sales and marketing group, of which 89 are in the sales organization. We've been investing heavily in the sales organization, partly because investment last year was tempered by concerns over the economy.

At June 30, 2010, we had 58% more account executives on board than we did at June 30, 2009. However, we estimate that on average, it takes about nine months for a sales rep to become productive, as it takes time to onboard, train, assign accounts and start building pipelines. So while we have 58% more reps on board June 30 this year than last, the number of reps that have been on board for more than nine months is up only 15%. This means that more than 40% of the sales reps may not be fully productive until late this year or early next year. So this is clearly an investment to drive revenue growth in 2011, even though we bear the cost in 2010. We plan to continue to add more people to the sales organization during the rest of 2010, but at a reduced pace.

In addition to the investment in sales and marketing, during the quarter, we added 99 people to our R&D organization. Approximately 61 were added as a result of the Chordiant acquisition. Of the remaining 38, 30 were added in India.

The headcount for G&A is up by 32 from last quarter. However, 20 of these people are Chordiant employees in transitional roles which will end by the end of Q3.

Our FAS 123(R) charge for stock-based compensation was about $2.2 million in the quarter, up from $900,000 in Q2 2009. Note 11 to the financial statements details how this charge is allocated to the cost of revenue and operating expenses.

This quarter, we recorded another foreign exchange translation loss of $2.5 million due to changes in the value of the pound sterling and the euro. Pega's current operating structure is not very foreign-currency friendly since most of the changes in foreign currency hit our P&L, as opposed to comprehensive income, which is an equity account.

However, with the acquisition of Chordiant, we were able to balance our foreign cash, and the result is a partial hedge on currency movement. This should moderate the impact to the P&L for the rest of the year.

On a year-to-date basis, we've recorded foreign exchange loss of 5.6. This represents a charge of $0.13 to EPS. Because translation gains or losses do not reflect any change in our business condition, they are beyond our ability to control or forecast. In February, when we gave guidance, we ignored the potential and unpredictable foreign exchange gains and losses by stating that we assumed a constant US dollar. Our business is no worse due to the liquidity and currency situation in Europe.

Even after adding back the purchase accounting charges as part of the reconciliation to get the non-GAAP measures of our business, our non-GAAP earnings of $0.10 per share are down slightly from non-GAAP EPS of $0.17 for Q1. Q2 is usually our toughest quarter in the year, and since last year was an anomaly, it is a difficult compare to 2009. The comparison is even tougher when you consider that in Q2 last year, we had a foreign exchange gain of $2.9 million, or about $0.06 a share, while in Q2 this year, we recorded a foreign exchange loss of $2.5 million, or about $0.05 a share. That is a quarter-to-quarter swing of $0.11 on something that has no significant impact on our business.

On April 21, we picked up $14.2 million of Chordiant Accounts Receivable. Our ending accounts receivable balance of $65.9 million is an increase of $23.6 million from March 31, 2010, or $26.5 million from December 31, 2009. Adding in Chordiant Accounts Receivable, which resulted from sales in pre-acquisition periods, causes the DSO calculation to generate a higher, but still respectable, days sales outstanding of 49 days.

During the first six months, we purchased 99,603 shares for $3.3 million at an average price of $33.08. Our Board replenished the buyback program in Q4 last year, and so we still have a balance remaining of approximately $12.5 million available for future purchases.

Deferred revenue of $53.8 million was up by about $20.9 million from December 31. The increase is due to deferred maintenance revenue as a result from our Chordiant acquisition.

In addition to providing non-GAAP financial statements, we've provided an update to guidance on both a GAAP and non-GAAP basis. We expect revenue to be $348 million on GAAP basis and $360 million on a non-GAAP basis, the largest difference being the $12 million reduction or haircut that we take on maintenance for the next year.

In addition to this revenue, we've added back the acquisition-related expenses, restructuring charges, amortization of the intangible assets created as a result of the purchase accounting and equity compensation charges [to] estimate a non-GAAP earnings per share of approximately $1.02.

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 or timing can make our quarters extremely lumpy.

In addition, we don't give crazy discounts at the end of a quarter to make guidance numbers because our business is built on follow-on sales to existing accounts. Big end of quarter discounts would ruin our business line.

Consistent with the guidance that we gave in February, this is going to be a backend-loaded year, but we have a very strong and large pipeline, which we think will continue to drive record revenues for the rest of the year.

With more detail on Q2 achievement, I would now like to turn the call over to Pega's Chairman and CEO, Alan Trefler.

Thank you, Craig, and good morning, all. Overall, the second quarter was very successful for Pegasystems. Despite a difficult economy, we had our 12th consecutive quarter of revenue growth. Very different from other firms who have claimed 2010 successes on easy compares, after having retrenched in 2008 and 2009.

We achieved license wins across a broad spectrum of our targeted verticals. We crushed our prior attendance record for PegaWORLD, our user conference. And we had over 25 systems go live in leading organizations around the world. We closed the largest acquisition in the Company's history and continued to deepen relationships with key partners, contributing to a record level of pipeline and sales activity with the world's leading organizations.

But before I talk more about some of that good stuff, let me acknowledge that there were challenges. And we've chosen to make significant investments at a time when conservativism is the norm, when economies are in distress. We've said many times before that we don't manage the business on a quarterly basis, but instead focus on the huge market opportunity in front of us and on the long-term business value growth of the firm.

Despite a stressful economy and despite the fact that software is a lumpy business at best, the returns we see from our clients in the adoption of our technology is so significant that we are convinced that the right action was and is to continue to invest for long-term profitable growth. Let me give some color on our thinking about the business.

First, the use of the BPM technology is a very big market opportunity, and we have a very excited, highly differentiated product line. We have a leading technology that is really pretty revolutionary in providing a level of agility to our clients that has kept them buying.

When we looked at the last year or so, large portions of even our target markets were uncovered. Let me remind folks that we have a target account strategy. What that means is unlike some of the companies that sort of do a lot of general-purpose marketing and hope that leads come in that they can respond to, we actually pick companies that we think would be the appropriate uses of our technology, and we assign sales reps to them. And it is not this sort of lead-generation fulfillment model. It's really a get in, understand the organization, focus, collaborate and dig.

So we are in fact tied to the number of sales reps we have, and making the decision to increase the sales reps we think was very, very critical to allowing us to increase capacity. Now there are ways we can augment them, and I will talk about partners and other things that we can do as well. But at the end of the day, we took a look at it and we decided we had not meaningfully increased the sales force in the 2008 post-crash environment in 2009.

The reason for that is we've been terrified, like everybody else, at what had been going on in the market and sort of the drumbeat of bad news. So we were pretty modest. But if you take a look at the license revenue for the two years from the end of 2007 to 2009, we had a staggering increase in license revenue. License revenue grew 127% from $51 million in 2007 to $116 million last year. But total sales and marketing staff increased at only 65% across those two years, only about half that rate.

We significantly increased hiring and made the Chordiant acquisition this year, thus bringing sales capacity more in line with our actual historical growth and facilitating future growth.

Fourth, Chordiant has consumed a lot of our energy, but it will clearly be worth it. Craig points out that it was our largest -- actually more than 10 times larger -- than what we had done before. And I think we appropriately focused a lot of management attention to the integration. It was as hard as we expected, but with even more potential. We have not only spent time internally on integration and alignment, but have had dozens of meetings with senior executives of Chordiant clients, understanding what they were seeking so we could incorporate their needs into our plans. And we've seen favorable responses, I'll touch more on in a little bit.

Fifth, we are confident that we will achieve a significant return on the significant investments we are making. They give us the capacity we need to grow the business to take advantage of the opportunity. But investment involves upfront expense and comes with all the attendant upfront costs and challenges that rapid growth entails. However, I will say it's been a good time to be looking to hire, and we are very pleased with the talent we've found, not just in sales, but in building out our solutions and development capabilities to attack complementary verticals that need our technology, and making it so that we could reach out to areas like public sector, life sciences and communication with stronger teams.

We are also fortunate to have a well-structured and highly-regarded onboarding program for our staff, as well as experienced cadre of first level managers. That made it sensible for us to frontload these investments early in 2009 -- I'm sorry -- early in 2010 to make sure that we would build the capacity, particularly as we went into next year.

One advantage we have is that we are doing things that are familiar. We are extending and deepening our target account model, rather than contemplating any sort of massive change in approach. We are entering the verticals where the problems they are trying to solve are similar to the problems we solved so well in our existing verticals. New business acquisition processes, customer service processes, fulfillment processes, things we call the servicing backbone, these sorts of things we find highly, highly applicable in areas like communications. Or, for example, in life sciences, with adverse event reporting and case management.

We also see, with great enthusiasm, a lot of energy in our systems integration partners. We've invested significantly to make sure we have a capacity to work with these partners to make them both want to but able to build Pega practices and allow them to really create their own differentiated solutions using our technology. The fact that there is that level of enthusiasm from world-class organizations like Accenture, Capgemini, Infosys, Cognizant, IBM, Tata, these all demonstrate that there is a lot of enthusiasm in the market for building on and increasing the Pega ecosystem, that ultimately, I think, is what we need to do to get to that next plateau, that next level of growth.

Obviously, the proof of these investments we are making in sales staff, solution frameworks, partner support, will only be shown as we see our end of year performance and put forward our plan for 2011. Nonetheless, we are confident enough about our prospects to target our being a $360 million company this year, something that would have appeared inconceivable just three years ago.

So let's understand a little bit more about what we did achieve in the quarter. We have named accounts across a lot of verticals -- life sciences, government, telcom, energy, financial services,, healthcare insurance choose to deploy new product or increase their product use. We added names across the world -- North America, Europe and Asia. And we continue to expand the benefits of our business with, well, just demonstrated agility time and time again, shown by our clients as they deploy the products.

Our product advances have been recognized as well. With the release of SmartBPM 6, we've taken a dramatic step forward in meeting the needs of the pragmatic business buyer. In April, we hosted a record over 1200 attendees at our PegaWORLD Conference, and we had dozens of clients choose to speak and share how they were using this technology. The level of enthusiasm and the level of pipeline that we saw come out of this was unprecedented. They were able to present successes in achieving rapid returns on investment through the technology, how they automated the programming and how they now automate work, enabling them to quickly open new revenue opportunities and control costs.

We were able to demonstrate also first-hand how the Chordiant and Pega integration would work. Some highlights. We were selected by a very large insurance company based in the UK to support new business transformation, starting with quotes and driving it in to the entire revenue system.

Another UK win was with a large global banking organization that is using us to support their global service request backbone, a groupwide servicing backbone to manage service requests over hundreds of thousands of employees in 70 countries.

In Australia, we continue to radiate at a large bank (inaudible) has multiple uses of our SmartBPM technology to drive their lending processes across multiple channels and multiple lines of business.

We actually achieved a win with our new decision management technology resulting from the Chordiant acquisition, and a large new-name North American telecom that will be using the technology to enable intelligent cross-sell and upsell to help manage churn. This marks a milestone in enabling Pega to extend into the telecom vertical here in the US.

And we continued our radiation in the North American insurance vertical, with wins at two very large insurance companies, one using Pega to enable the customers to deploy web self-service using our Internet application composer framework that brings matchup technology to the web.

So I would say all in all, it was pretty exciting from a sales perspective. From a go-live perspective, it was unprecedented. Over 25 systems going live, with -- well, one of the largest credit companies in the world launched a cardmember case management system and a disputes management system, and we've become their standard for case management as they deal with customer service going forward.

We had another major insurer launch a new Workmens' Compensation system, leveraging their existing backend technology, but making so they could be far more effective and competitive and both save money and write more new business.

And we launched a new mortgage application management system that enabled a leading bank to triple the volume of mortgage originations without adding any headcount, and allowing them to do a much better job of reviewing the loans to ensure greater reliability.

The list goes on and on. It was actually really very, very exciting from a go-live perspective. And one of the things we like is that we had a very strong mix of new name customers, as well as existing. In fact, we had far more new name customers in the first half of this year than we did last year, when, frankly, people were reeling a bit from the economy. This is a good sign, given that so much of our business is follow-on sales, and we think that is a real good indication of client success.

To touch back on Chordiant, in late April, we announced its closing. And since then, we've made significant progress in integrating the organization, as Craig discussed. In addition, we visited with numerous customers in the past month and seen general excitement with regard to the combination. Most customers understood that Chordiant was likely to be acquired, and I think Pega is seen as one of the best alternatives that they could envision here.

We've also begun communicating a unified product roadmap to customers, to provide them with guidance and visibility on how we plan to meet their needs by bringing the offerings together. It's really pretty exciting to think about bringing the Chordiant decision management technology to Pega clients, and then bringing some of our advanced BPM technology to the Chordiant client family. It's being well-received by the organizations we are talking to.

In the Q2, our partner relationships continued to rapidly advance, and partner-sourced pipeline continues to grow at a record pace and ahead of plan. Partner enablement is a key indicator of partner confidence, and also continues to grow at a rate well above our 2010 targets, with both the delivery and sales organizations within our partners spending a lot of time to become enabled.

Through the Chordiant acquisition, we gained several additional key executive sponsors at a number of our partners, as the advent of our decisioning and analytics capabilities represents a good strategic initiative for them to talk to their clients about. And several of our partners have begun to develop their own frameworks on our PRPC SmartBPM technology, and will be announcing products throughout the year in varying verticals.

In Q2, we also saw a significant uptake of our new Pega Cloud BPM offering, which we offer in conjunction with Amazon on their Elastic Compute Cloud. And we've now got over a dozen customers who are making material use of the cloud environment and the fact that we've got a nice thin client development environment that is uniquely suited for running on the cloud to be able to make their development and deployment faster. We think this is very, very positive and are looking forward to continue to have many, many more client customers as we go forward.

So all in all, I think Q2 was a success. Significant wins across target verticals, major go-lives, blockbuster PegaWORLD, closing of our largest acquisition and significant traction and a record level of pipeline, both independently and with our key partners.

We think that this investment we've made in the first half is appropriate, it adds needed capacity and, frankly, is the right thing for us to do and see no reason to believe that we won't get the returns we expect from it.

With that, let me thank you and turn it over to questions.

(Operator Instructions) Nathan Schneiderman, Roth Capital.

Hi, Alan and Craig. Thanks very much for taking my questions. First one for you. As far as the Chordiant contribution goes, do you still feel comfortable that Chordiant is going to contribute $45 million to your pro forma revenue this year?

Yes. Part of the increase in Chordiant revenue or directly attributed to Chordiant is on a GAAP basis in the queue, so the non-GAAP basis is significantly higher.

We gave guidance of $348 million on a GAAP basis and $360 million, so we are confident that they will contribute. And that is just this year. Once we get going and we start really capitalizing on synergies, we expect better things for next year.

Given that you are still thinking $45 million would be the Chordiant contribution, that would imply $33 million of Chordiant contribution in the second half. How backend-loaded do you envision that for Q4?

I don't think the Chordiant contribution is terribly backend-loaded. Frankly, I think that, as Craig said in his presentation, we've worked very, very hard to try to make it so the, quote, Chordiant contribution and the Pega contribution have both sort of come into the same stream. I assume you are getting the $45 million number from the fact that we originally were at $315 million and we now are at $360 million. Is that --?

Correct.

I don't know that we are going to be in a position to tell you exactly how much of that at the end of the year was Chordiant or not. But obviously, as I said, we feel comfortable the $360 million continues to be the right target for us.

I have a couple of questions related to the guidance, Craig. I wanted to clarify -- is your guidance for the $1.02 based on fully-diluted share count, or is it basic share count?

Fully-diluted.

And does it include the negative impact of this $0.13 penalty for FX that you experienced during the first half?

Yes, it does. I mean, originally we didn't want to forecast that. I mean, who can forecast that, right? But it is what it is. We've taken the hit for Q1 and Q2. And we think that we have some measures in place to greatly reduce the fluctuations in that for the rest of the year.

Okay. And final question for you. On the $360 million of guidance for the year, what approximately do you see as license -- your license -- software licenses as a percent of total revenue? Just pretty approximately there.

I don't believe we gave that indication right now.

Okay. Thank you very much.

Laura Lederman, William Blair.

Several things can cause a slowdown in the market. Obviously, you mentioned not adding sales capacity. You mentioned the difficult comparisons with last year. But other things that could impact a company's results obviously would be competition or markup penetration. So can you talk a little bit about those and why you thin the slowdown in new customer billings doesn't relate to those two factors? Thank you.

Sure, Laura. A couple of things. In terms of market penetration, even in our traditional markets, like financial services, we are far from having sort of penetrated that market to the level where there is not a lot of opportunity. And in fact, we are adding staff in those existing markets to both better cover and cover additional accounts. So I would say that even in our oldest market, financial services, I don't think we are more than 20% penetrated of where we could be, as we take a look at just the very, very large organizations that are out there.

Relative to competition, I actually think the competitive environment is better than it was a year ago from our perspective. We've had a number of our competitors sort of get sucked up by other companies. And customers have a pretty cynical view of what ends up happening, particularly since inevitably the management turns over and the sort of aggressive entrepreneurial culture tends to become a little more staid and a little more corporate.

So it was a very competitive environment. It continues to be a competitive environment, but I haven't seen any meaningful change in the competitive dynamic.

Any major losses to the competitors this quarter that surprised you?

I think our win rates have continued to be around the same. We do have tough competitors. The biggest challenge I'd say we have with our competitors is inevitably they will go in and, having perhaps lost the business, will offer to let clients try it for free.

One of the really cool things that happened this quarter is a customer that had made a decision with one of the very, very large competitors actually came back to us this quarter, having discovered that there was a reason it was free.

So no, I am not seeing anything that is particularly difficult, but it was a tough -- it has been a tough and a challenging market all along. I'm actually quite pleased, however, that some of these smaller companies were acquired. I think that is actually long-term helpful for us.

If you look at how you did in the quarter, it sounds like it was below what you thought. What was different? Did deals slip? The pipeline wasn't as mature as you thought? In other words, why was it less in terms of a bookings quarter than you would have expected? Because you knew what you were sales headcount was, et cetera.

It's interesting, because once again, we still -- until we get to be, I would say, even double the current size that we are, you still get a level of statistical anomaly [if you] have something of a small sample size. We had a lot more new clients come on board, which is great, new name customers, but they tended to come on for somewhat smaller purchases.

So I would say our average deal size was down because some of the huge, huge purchases that some customers have come on board with, they actually wanted to sort of do a $1 million purchase instead of a $3 million or $4 million purchase, which we had a couple of those happen in the first half of last year.

I am not at all unhappy about that, because as we do that, we are actually preserving what is ultimately going to be a good and, I think, lucrative relationship. Because generally, when clients spend a lot more upfront, they sometimes have unduly lofty expectations about discounts and things of that type. So I think what I would describe as sort of the lack of [wales] would be the one thing that was -- I can't say it was surprising, because we can't statistically expect [wales] -- but is the thing that made the comparison also a little difficult.

Final question for me and then I'll pass it on. If you look at the pipeline, can you give us a sense of how much bigger it is year-over-year, how mature versus immature the pipeline is, coverage to revenue? In other words, something to give us comfort in the $360 million in revenues.

It is up very significantly, I would say, year-over-year. Craig is looking for the numbers, but off the top of my head, I would say that the pipeline is up 40%, 50% over -- Craig just checked -- yes, it's in the -- it's in about the 50% range of increase. Obviously when the pipeline increases that much, more of it is early stage than late stage. But we think that the pipeline is generally of extremely high quality.

I'm sorry. Go ahead.

(multiple speakers) bookings were less, which would be healthcare. We have a very strong pipeline for the remainder of the year.

Thank you.

Raghavan Sarathy, Dougherty.

Thanks for taking my questions. Start out with a clarification question, Craig. So your full-year guidance of $1.02 includes about $0.10 or so FX loss. So you did $0.27 in non-GAAP EPS in the first half. So you are implying that your full-year guidance implies $0.75 non-GAAP for the second half. Did I understand that correctly?

As I said in February and as I said today, that this was always going to be a backend-loaded quarter when it came to profitability. (Multiple speakers) a backend-loaded year, not quarter.

So the number we are looking at, $0.75 for the second half, as implied by your guidance --- that's all I wanted to make sure.

Yes.

All right. So in terms of -- I think, Alan, you kind of talked about the new customer wins are up year-over-year. The ASPs are down. Can you give us some color on why customers are buying in small chunks this year versus last year, when it seems like macro economy is improving and there seems to be more spending on IT.

Yes, I think -- remember, we sell more to the business people than we sell to IT. So most of our projects are justified in the business. I'm hearing a bit of an echo on the line. I'm not sure if the operator could address this.

It seems like you are echoing off of the current questioner's line.

If you could mute yourself, that would be good. So -- still getting it. So I would say that the ASPs where what I would describe as kind of the lack of [wales] were due to the sort of individual circumstances of the customers. They were customers that could've made much larger purchases, but wanted to sort of take it a bit slower, which I don't think there is anything particular wrong with. In fact, I would generally prefer working with our clients that way.

So there was nothing macro. The reality is we had three [wales] in the first half of last year, and it was different this year.

All right. And then in terms of healthcare vertical, Craig, you kind of touched upon that. Do you see the reform actually holding up things and do you expect that to change in the second half of the year?

I think that what we are seeing is some temporary sort of uncertainty in that market. I think people are now getting over that. They are starting to think about purchase decisions, and the pipeline is actually very strong for healthcare for the rest of the year.

And by the way, I've always found historically that healthcare has been much of a backend-loaded business. And again, we're looking at a tough compare, where last year -- it was last year we closed significant healthcare deals in Q2 and significant healthcare deals in Q3. So last year was an anomaly.

Then one final question and I will pass on. This question was asked before, so let me ask it a little differently. If I look at the license revenue growth for the first half, it was about 11%. I know you have not provided guidance on license revenue growth in the past. That said, when you look at again the revenue growth in the first half, you are looking at low teens from mid-40s that we saw recently. And also you have (inaudible) effect on EPS in the second half. So things are a lot different now than in the past. We haven't seen this kind of backend-loaded year. So given this backdrop, can you give us some color on how to think about license revenue growth in the second half?

I think the right way to think about the license revenue growth is to realize that we only had a little additional capacity of experienced sales reps in the first half of the year. So if you take a look at the first half of this year compared to previous years, our growth in sales force, which is directly tied to license revenue, was modest. Very, very modest. I think Craig cited only 15% more than it was a year ago in terms of experienced reps.

Now we've brought on a lot of reps who have much shorter tenure, but will be hitting the sort of nine months that we look at in Q4 and going into 2011. So we have a very material increase in the sales force that -- it is not a slam-dunk, but it is our job to get those guys productive, and you can see it in the headcount numbers that we talked about and that we report in the Q, that we have actually jumped up the sales force and the support for that salesforce. So that is why -- I don't think it is actually very complicated -- that is why I would expect that the year will be backend-loaded.

And as I said, it is very typical for us to -- license revenue to go down from Q1 and Q2. In fact, it has done that virtually every year since 2004.

Steve Koenig, Longbow Research.

Good morning. Thanks for taking my questions, guys. Let me start with some housekeeping questions and then move on.

Craig, in going through your Q last night, what -- we found commentary that -- we were looking at the contribution from Chordiant, and we found commentary that -- this is on GAAP basis -- that Chordiant maintenance added $3.9 million, and Pro-serve from Chordiant added $3.9 million. So that gives me $7.8 million contribution from -- on a GAAP basis. And that is even -- so assuming no licenses, that number is higher than the $7.2 million contribution you mentioned on a GAAP basis. So I am wondering, can you help us with that calculation?

As I said, there was very little contribution from Chordiant on license revenue. It was primarily in maintenance and in professional services.

Okay, so the Chordiant maintenance and professional services contribution was at $7.8 million -- was it $7.8 million or was it $7.2 million?

It should be $7.8 million, I believe. I will look at the Q. I don't have it in front of me, but it's $7.8 million, I believe.

Okay. Okay, thanks. And then can you remind us, the licenses that Chordiant has typically generated, are those mostly perpetual, term or subscription, or are you accounting for them differently than Chordiant did?

Historically, I would say their licenses were very, very significantly standard, traditional, perpetual licenses. And actually, if you look back on their history, they were also really quite lumpy in terms of when they would hit. We are planning to offer them in a variety of mechanisms more consistent with how Pega licenses.

And we will not be changing the accounting. I mean, the accounting is what the accounting is according to the terms of the license agreement.

Okay, and the deferred revenue writedown haircut that you took on licenses, that would relate to the perpetuals then?

No, that refers to the maintenance. Part of the craziness of purchase accounting is that if somebody was to renew $1 million maintenance agreement on April 19, we would probably only be able to report something like $600,000 of that maintenance revenue, as opposed to a very similar maintenance renewal on April 25, after the acquisition, where we would get the full $1 million. So that is why we add that back, to give people a true run rate.

Okay, but the thing that confuses me is in your reconciliation in your print, you have also have a haircut on the license line as well, in the Pro-serve line. So where do [the writeoffs] come from?

We have a small -- there was a small amount of license revenue and a small amount of Pro-serve revenue that fits in deferred, and we do take a small haircut on that. But for the most part, most of it is in maintenance.

Okay. Great. And then move on to maybe last housecleaning questions here. When I look at what kind of -- how you need to generate the EPS in the second half that you are targeting, assuming no big FX gain or losses and assuming no big change to the other income line, I come up with you need an operating margin around a 20% level. Am I thinking about that the wrong way or is there something very wrong with my calculation? Or if not, what is going to get us to that kind of operating margin?

As we said, the bookings for this year are going to be very much backend-loaded, as our customers' buy out of annual budgets. And those bookings, especially the license piece, are virtually 100% margin and fall right to the bottom line.

So we will be adding additional staff, but we will be adding additional staff at a reduced rate in Q3 and Q4, and there are some Chordiant staff that are on board and they are in the OpEx line, their transitional roles will end and their costs will fall out during Q3 and Q4.

Okay. And Craig, did you say earlier those are more G&A-weighted than in the other OpEx lines?

There's about 20 of them in the G&A line. You could imagine that once the acquisition closes, they have to help us take off their stub year, and then they have to help us pick up any balances into our accounting systems and do a lot of work. So yes, there are a lot of G&A people that are going to fall off by the end of Q3.

Okay, and then just two last questions. On the 89 addition to the sales organization, can you guys talk about what kinds of roles were those hired into? I assume heavily weighted towards quota carriers.

Absolutely. But when we hire a quota-carrying sales rep, they also need -- they need what we call sales engineer or sales consultant that needs to be able to work with them. So you're kind of buying these guys almost in pairs, as it were.

Okay. Got you. Great. And last question, Alan, as you're going out and talking to the Chordiant customers, especially you mentioned over the last month or two, and you talk to them about the roadmap, the kind of a two-part question there is can you give us a flavor for some of the highlights on the integrated product roadmap that you are talking about with them? And secondly, how are they responding to that?

I think the response is really overall quite favorable. We've come up with ways that we can preserve the clients' investments, I think, quite well. That was one of the things they were worried about.

I think we are also going to increase the investment in, for example, well, in just pragmatic things that the customer ends up getting in both the decisioning and in some parts of the foundation products, which were the predominant products that customers were worried about.

And frankly, the customers have seen -- Chordiant's revenue had declined pretty precipitously over the last two years, as they went through the tough 2008 and 2009 period. They went down from sort of mid-120s to in the 70 something sort of range. And so I think most clients anticipated that Chordiant was going to be acquired, as did a lot of the staff, frankly, too.

Having Pega acquire them was viewed as like wonderful compared to alternatives like Oracle or other sorts of firms. And I think we've lived up to that expectation with both the customers and the staff, as we've worked hard to really bring them together. So I would say that overall it has been quite positive.

Terrific. Thanks so much for your answers.

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