Pegasystems Inc (PEGA) 2011 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Pegasystems Inc Q2 2011 earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions on how to participate will be given at that time.

(Operator Instructions)

As a reminder, today's conference call is being recorded. Now, I would like to turn the conference over to your host, Chief Financial Officer, Mr. Craig Dynes.

Good evening and welcome to the Pegasystems 2011 Q2 earnings conference call. With me here in Cambridge is Alan Trefler, Pegasystems's founder 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, forecasts, and could, and other similar expressions identify forward-looking statements, which speak only 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 2011 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 are contained in the Company's press release announcing its Q2 2011 earnings and in the Company's filings with the Securities and Exchange Commission, including its report on Form 10-K for the year ended December 31, 2010, 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.

I was pretty happy when we started the year with a Q1 where license signings for bookings were up 85% from Q1 2010, so I'm even happier now to report that Q2 license signings were above double that of last year's Q2. The growth in license signings was widespread. Every geography was ahead of last year, and every vertical was ahead of last year. The most significant increase was in license signings with new customers. Through the first 2 quarters of the year, the aggregate value of license signings with new customers is approximately 4 times what it was last year. Many of these new customers are coming from new geographies and new verticals; geographies and verticals that previously we were unable to cover.

So I believe that our strategy of growing our sales organization is paying dividends. In addition to covering more customer accounts and verticals, we've been able to dedicate more sales resources to partners, who are also the source for new accounts. Partners were a significant factor in helping us close new arrangements in the quarter, and they continue to represent about 40% of our pipeline. Lastly, while we continue to focus on small, repeatable licenses, increasingly we are being invited into, and winning bigger projects. The increase in bookings can be seen in our backlog. Compared to where we were at the end of Q2 of last year, the license portion of deferred revenue is up $25.5 million, from $5.4 million at June 30, 2010, to $30.9 million at June 30 this year. This the total of $14.1 million current deferred license and $16.8 million non-current deferred license. Similarly, the total of our off balance sheet term and perpetual license payments that we detail on page 25 of the Q is up $23.2 million from $107.4 million last June 30, to $130.6 million at June 30, 2011.

So, this was a great quarter. In spite of the fact that Q2 is typically our weakest quarter, we increased license revenue from Q1, and we filled backlog. Building backlog is important to us. As we have often said, we don't run the business on a quarterly basis, but rather we focus on our ability to grow the Company over a period of years. We've grown revenue at almost 30% a year for the last 5 years, and we are already concentrating on growth in 2012. This backlog is an important part of future revenue growth. The individual components of license revenue for the first six months of the year are as follows. Perpetual license revenue of $44.3 million is up 34% as compared to the first half of 2010. Subscription revenue, which results from subscription accounting applied to perpetual licenses is, as expected, virtually flat for the first 6 months.

To date in 2011, term license revenue is down 9% compared to the first half in 2010, but it's not expected to stay that way. Term license revenue is a function of the aggregate value of term licenses that are outstanding. Page 25 of our 10-Q shows that the aggregate value of term licenses at June 30, 2011, is now $85.9 million, $19.7 million higher that it was on June 30 last year. With this higher balance, a turnaround is coming in term license revenue. On page 25, term license payments and revenue for the rest of 2011 is shown as $14.6 million, 24% higher than the comparable number at June 30, 2010, which was $11.8 million. Maintenance revenue is $28.3 million on a GAAP basis in Q2, up slightly from Q1, but up 39%, or $7.9 million from Q2 last year. Some of the increase is due to the amortization of deferred maintenance agreements acquired from Chordiant last year in late April, while the rest is due to continued growth in our customer installed base.

Just about all of our customers subscribe to, and renew, annual maintenance agreements. Purchase accounting rules give a haircut to maintenance arrangements that are in deferred revenue at the time of the acquisition. This is why we have provided supplementary information on non-GAAP revenues in order to allow investors to more accurately model our maintenance revenue run rates. Professional service revenue of $40.6 million was relatively flat from Q1, but on a year-to-date basis it is up $18.7 million, or 30% as compared to the first 6 months of 2010. While partners are increasingly performing professional services for our license customers, new license signings have been strong for the last 3 quarters, and as a result, we've seen an increase in professional services work in support of our partners and our customers. Demand for partner training continues to be very strong. Many of the training days were given to partners at significant discounts, which has caused training revenue to be flat. This is an investment in our partner organization in order to grow the overall Pega ecosystem.

For the first half of the year, gross margin percentages are about the same as they were last year, other than the larger cost of licensed revenue in our GAAP financial statements. This is due to the amortization of the software intangible asset created as part of purchase accounting. The amortization drops the gross margin on software from 98% to 95% on a GAAP basis. This charge is added back as part of the GAAP to non-GAAP reconciliation. Page 20 of our 10-Q details the amortization of intangible assets. Maintenance gross margins are pretty consistent with the prior year, at 88% for the first 6 months. Professional service margins are down for both the quarter and the first half of the year. With the rapid increase in demand for professional services in support of our partners and customers, we've made a sizeable investment in developing our professional services organization. The investment in advanced training and education associated with our new 6.2 release temporarily reduced our pro serve gross margin.

On a non-GAAP basis, total operating expenses for the quarter, other than the acquisition and restructuring charges, was $57 million, an increase of about $3.7 million from Q1. Just about all of the OpEx increase was in sales and marketing. Since year end we have added 33 employees to the sales and marketing organization. While this accounts for most of the increase on the sales and marketing line, the balance is attributed to commissions on new license signings or bookings, which, as I said, for the first 6 months are running about double what they were last year. Since 2006, we've been investing heavily in R&D as well as sales and marketing. We believe that both the record bookings and activity level that we've experienced so far this year are due to these investments, so we plan to stay the course on this growth strategy. We will continue to grow our sales organization in order to cover more named accounts, geographies, verticals, and partners.

At this point in the year our focus is growth in 2012. While the incremental hires that we make in Q3 and Q4 will not add to bookings or revenue in 2011, they are an investment to drive revenue growth in 2012 and beyond. As I said, since the end of the year, we've added 33 employees in sales and marketing but 27 of the 33 new employees are in the sales organization. During Q2, we held Pegaworld, our largest marketing and sales event of the year. Pegaworld was a great success, and I expect it will drive business through the rest of 2011. We will continue to invest in R&D to lengthen our lead over possible competitors and make improvements in the product that will drive license revenue growth. During Q2 we added only 12 people to our R&D organization. You should expect that there will be a more meaningful investment in R&D headcount growth in the second half of 2011.

G&A expenses decreased slightly from Q1 due to higher professional fees and contractors in Q2. Our FAS 123R charge for stock based compensation for Q2 was about $1.9 million on a pre-tax basis. Note 12 to the financial statement details how this charge is allocated to cost of revenue and operating expenses. This charge is also shown as an adjustment on our GAAP to non-GAAP reconciliation that can be found in our earnings press release. Through the first six months, our revenue from outside of the US has grown from 39% to 46%, as compared to the first six months of 2010. This has created significant accounts receivable and cash balances in Euros and pounds sterling. Given how volatile foreign exchange rates have become, we entered into foreign exchange future contracts to fix the rate of some of these balances. As a result we have a more covered or hedged position, which has taken some of the volatility out of our FX gains or losses. In the first six months of 2011, we had a $1.2 million gain, compared to a $5.6 million loss in 2010.

We continue to work on a tax and operational restructuring plan to further reduce our exposure to foreign exchange rate changes. Our GAAP income tax provision looks a lot more normal compared to what it looked like last year, due to the new purchase accounting rules, where certain items were expensed for GAAP purposes but were not deductible for tax purposes. On a GAAP basis, we show a provision of about 30% for Q2, which is up slightly as our business shifted slightly back to the US as compared to Q1. However, the rate is still down from last year due to higher income enforced jurisdictions with lower tax rates. Overall, we earned $0.16 per share on a non-GAAP basis, a significant increase from Q2 2010. On the balance sheet our accounts receivable balance decreased by $12.2 million from the end of Q1 to $96.5 million at the end of Q2. However, the decrease in trade accounts receivable is actually better.

Note 5 to the financial statement details that trade accounts receivable decreased by $15.8 million, from $91.5 million at the end of Q1 to $75.7 million at the end of Q2. Strong collections in the quarter dropped the DSOs to 59 days from 66 at March 31. As a result, our cash from operations was $25.3 million for the quarter, $17.2 million for the first 6 months, and we ended the quarter with almost $100 million in cash. During the quarter we purchased 28,488 shares for approximately $1 million, at an average price of approximately $36.95. In November, our Board voted to increase the balance available to repurchase our Common Stock to $15 million, and extended the buyback period to December 31, 2011. Therefore, at quarter end we had a balance remaining of approximately $11.2 million available for future repurchases.

Deferred revenue shows up in two places on our balance sheet, short and long term. The sum of the 2, which is $93.4 million increased by $1.2 million from Q1 to Q2. At the halfway point in the year, deferred revenue was up by $18.8 million from the end of 2010. We've been growing revenue at about 30% for the last 5 years. With this growth there has been a significant increase in headcount. This growth, along with increased demand for customer meeting and training, has put a big demand on our existing office space here in Cambridge. During the quarter we executed a new lease for approximately 40% more space for a new corporate head office. The lease terms were very favorable to market conditions, and the new space is located only a few blocks away, so there will be very little disruption to Cambridge based staff and operations.

Lease payments on the new office did not begin until the end of our existing lease, so there's no period of double lease payments. In spite of the fact that lease payments are scheduled to begin when our existing lease ends, the required accounting for leasing can result in double lease expenses and accelerated depreciation. In order to make it easier to understand the ongoing cost of our operations, we will, in future, highlight some of these accounting anomalies. We think the new space will allow for necessary growth and give us a chance to create a more collaborative and productive environment. On our 2010 Q4 conference call we gave our annual guidance. We've always given only annual guidance, and followed a policy of not commenting through the year. We also gave guidance for the first half of the year to provide visibility into the timing of our annual results, so as to provide an additional milestone to chart our progress. We do not comment on guidance during the year for several reasons.

First of all, we sell both term and perpetual license, and a mix between the two can cause quarters to be lumpy and unpredictable. Secondly, guidance pressures have resulted in many software companies providing crazy discounts to meet their quarterly guidance. You hear about the big stack vendors offering end of quarter discounts of 90% plus, but our business model is to sell additional purpose based licenses into our existing accounts. A big discount this quarter will set unreasonable customer expectations for the following quarters when we are selling follow on deals. As a result, we don't give quarterly guidance and we are reluctant to even discuss any guidance during the year. We continue to see our objective of maintaining growth beyond 2011, so we are driven by our long term growth objectives, not individual quarterly or even individual annual results. In fact during the first 6 months we closed license agreements that built backlog, rather than results in quarterly revenue recognition.

As I said, we are already focused on 2012 revenues. So while we don't give our managed quarterly numbers I'd like to point out to those building models, that 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 of approximately 30% in both those years. In addition, due to vacation time in Europe, our professional service business slows in Q3, which depresses our pro serve revenue and gross profit. In summary, Q2 was another great quarter in what is proving to be an exciting year. Q1 seemed look a fast launch out of the starting gates, and in Q2 we saw further acceleration in new license signings. With bookings about double what they were for the first six months of 2010, a bigger backlog and a very strong pipeline, this has been a great first half. With more detail in Q2 achievements, I would like to now turn the call over to Pega's Founder and CEO, Alan Trefler.

Thank you, Craig. You're right, the second quarter of 2011 was usually successful for Pega. Sales performance set another record, significantly increasing the performance over the same quarter last year, the adoption by clients of Pega technology for improved customer centricity and agility at a low cost of operations is expanding across the verticals and geographies. We announced major new product offerings to enthusiastic reception at our record setting Pegaworld conference in June, and in the first half of 2011, the world's premier systems integrators doubled the number of solution architects trained and certified on Pega Technology over the first half of 2010.

Let me delve in a little bit more. Bookings performance for the first half was up significantly from 2010. License business was strong from both the traditional global financial services sector across North America, across Europe, and across APAC, particularly in credit cards and retail banking. We also had very strong performance in the communication sector, and we are seeing significant wins in a number of newer verticals, such as manufacturing, utilities and life sciences. This is an indication that the investment we have been making in sales staff, marketing, and solution frameworks to increase our account coverage and expand beyond the traditional verticals is paying off.

In the second quarter, Pega announced the newest release of our industry leading BPM solution, Pega Rules Process Commander; we call it PRPC. It is the unique capability of our Build for Change technology that enables our clients to become more customer centric, increase agility, and do so with significantly lower costs of operations. Our vision is that business and operations people should be able to use Pega's unified BPM platform to design, create, and evolve their business applications, letting IT do the technically difficult work. This unique approach is one that is resonating extremely well in both business and IT sections of our accounts and prospects. The primary goal of our latest release has been to take the vision, business people being able to design and change their business apps to the next level, with improved user interface capabilities, business friendly process modeling of reporting, and the world's first unified adaptive decisioning and process execution platform. We announced and demonstrated this new release to a phenomenal reception by clients, prospects, partners, and analysts at Pegaworld 2011, and we released the product to markets shortly thereafter.

In Q2, we also released our new service case management framework, with versions specifically targeted at financial services and telecommunications. Service Case Manager integrates with Pegasystems and third party desktop solutions to give organizations visibility, transparency, control, and automation of customer inquiries and requests across all of their channels and operational systems. This solves an enormous problem for launch organizations that are trying to be operationally efficient while handling customer interactions and requests better across multiple back end systems, channels, and multiple legacy environment. Clients who see and use this capability tell us that Pega's ability to put the Service Case Management layer in place around their existing systems gives them visibility, transparency, and efficiency, while enabling organizations to retain their existing investments, and yet still producing staggering business results. This new framework is available for both on-premise and cloud use, as are all Pega BPM and customer service offerings.

We also released in Q2 our newest insurance claims servicing backbone framework for property and casualty insurers, and our life claims framework for life insurers. We're seeing increased adoption at large insurance companies of Pega technology to transform claims operations to be more customer centric, intent driven, and processed based on the exact right rules and the next best actions for every situation. We continue to see increased traction of our Pega cloud for BPM and Pega cloud for customer service offerings. Many existing organizations are buying Pega cloud for development and testing as a way of accelerating time to market of their applications, while still allowing themselves to use on premise facilities for their production deployments. However we are seeing a significant demand, tangible results, and pipeline for the use of Pega cloud for production use as well. Talking for a moment more about Pegaworld, we had record attendance, over 1,600 total attendees. Dozens of customers presented the kinds of returns they are seeing from the use of Pega technology, increasing customer centricity, increasing effectiveness, saving money, and best of all, really, really being able to build for change.

To highlight a couple of the presentations, healthcare client Alere talked about mass personalizations for improved outcomes in care management. Capgemini talked about some interesting work we're doing with them, about the collision of social CRM and BPM for the improvement of customer service. Chase home lending talked about how they quote, Thrive in the turbulent world of mortgage servicing through BPM. Cox Communications spoke about how Cox is turning insight into revenue with Pega technology. HSBC presented on corporate customer self-service through BPM, and I could keep going on and on. Lloyds talking about driving mutually beneficial customer dialogues, ING Group using BPM to manage global risk, and the Mass Mutual Insurance talking about how they put quote, The customer in control. Very exciting presentations from government sectors as well, it was really, really awesomely received by our clients. We also had more partner sponsorships in attendance by far than any prior Pegaworld conference, and partners are increasingly key to our strategy, and it's a strategy that's going very well. In the first half of 2011, I mentioned how our system integrated partners doubled the number of staff trained and certified compared to 2010. This number significantly beat our internal goals, and the momentum is continuing into this quarter.

In addition, the systems integrated partners are now routinely introducing us to new business opportunities that we would not have otherwise even known about, and we are finding increasing opportunities for our partners to deliver multiple phases of significant implementations. This is exactly the sort of win-win relationship that we see providing additional leverage and growth as we look to 2012. To highlight some of the customers who chose Pega Technology in Q2, one of the world's most well known global financial services brands chose Pegasystems as the platform to take their already award winning client service to an entirely new level. This was fiercely competed against some of the world's toughest vendors, and Pega Technology and Solutions came out on top because of our capabilities to dramatically improve customer service processes across channels, and allow agility of lower cost operations.

A premier North America communication company chose Pega as their platform to increase cross-sell and retention using our customer centric next best action technology to implement tailored offers to customers in both inbound and outbound channels. The healthcare business of one of the world's largest global companies chose Pega because the intent-driven experience we offer enables them to best support their sales and marketing efforts, even while dealing with complex regulatory requirements. Pega won several significant opportunities in governments in Q2, one helping a large state government significantly improve their tax agencies' efficiency, and on another helping them improve the transportation department infrastructure and service. We won a large piece of business with one of the world's largest utility companies, another new name account who has chosen Pega for customer service case management to automate multi-channel cross-aisle service, while improving the customer experience. And talking for a moment about Asia Pacific, we had a great win in APAC where we displaced an incumbent competitor in the high-tech manufacturing company. This new Pega customer will utilize our technology to improve numerous internal operational processes.

This replacement of previous efforts at BPM, I'd note, is happening increasingly, with clients seeing that the inadequate first generation BPMs thrown in by the stack vendors can't really meet their needs, while Pega can and does. Now, it's great to win business, but the culture of Pega relishes seeing our technology deployed, and our customer successful. In Q2, we had some terrific highlights outside our traditional financial services and insurance areas. For example, in healthcare, a health plan went live with 6 Pega applications, the majority of which will be used to substantially increase the efficiency of their Medicare processing. In the APAC region, a government regulator went live, using Pega new operations for processing applications for new utility services. In Europe, a leading communications provider went live on a Pega next best action system. This provider is now able to use realtime data to return the best possible sales and service offers or actions to contact center agents.

And also in communications, one of the world's largest providers went live on a solution utilizing our recently developed order fulfillment framework. This solution will help the provider increase efficiency and accuracy of order processing, and improve their time to market. The market in which we offer our distinctive solutions is large and growing, and in general, we are competing against large software stack vendors, rigid applications like SAP, or do-it-yourself programming. But our approach is very different. We really, really are well aligned with our clients challenges to improve customer centricity, to improve agility, and to save money. This means we enable businesses to be able to rapidly design and change how they work with even their existing applications, so that organizations can understand the context of their customers, span those applications, span those silos, and handle work in a way that really radically improves the service experience and operational efficiency. This is what Pega Technology does extremely well, and it's why we are successful in the market.

Now, I have to say a couple words about where we are at this instance in the global economy. The uncertainty in the global economic environment obviously continues. Business is fiercely competitive, and we expect it to remain that way. So far, we're not seeing business being delayed, primarily because the value proposition we provide, that of very very valuable and rapid business returns with lower risk, increased revenue, and improved customer experience continues to be compelling. This is certainly an environment where business agility is critical, and where our tag line, Build for Change, is needed more than ever before. And that's what's been driving our business performance thus far, and what leaves us encouraged, despite what happens in the economy over the next couple of years.

In closing, while it would be happier for us to operate in a world without the financial turmoil we are seeing, I would like to say that we see this future as positive regardless of how the short-term economy shifts. Let me point to our long history and experience in dealing with downturns. We've been around for 27 years. We've seen a lot of them. First of all, I would like to note more specifically that we showed excellent growth in both 2008 and 2009, despite the dismal economy, and actually, if you go back and look at Q3 results of 2008, sort of when the economy was beginning to fall off the rails and compare that to a year later, Q3 2009, you'll see that over that dismal period our license revenue actually increased 58%, grew from $17.9 million to $28.4 million, and our total revenue increased 23%, despite the fact we were selling primarily to banks and insurance companies.

Furthermore over the past five years, we've never had a down quarter in revenue, when compared to previous quarter. Year-over-year numbers have been consistently up. So we've got a lot of history, despite the tough times experienced in 2008 and 2009. And while we like it when it's good, we believe that we can even be good when times are bad. Now, we're much more diversified in new industries. We have an even more powerful technology base, and have outlasted any material pure play competitors, who are unable to grow like us and mostly got sucked into other firms during the downturn. So we're optimistic, and we will continue to drive our business, and make smart investments, consistent with what we see we need to do to take advantage of what is a tremendous opportunity. With that let me say, thank you. And, Operator, you may please open the line for questions.

Thank you. (Operator Instructions) Our first question comes from Laura Lederman of William Blair. Your line is open.

Yes, good afternoon and congratulations a very strong quarter. It's really funny we're analysts, we sometimes are worried about great quarters in that could they have potentially drained the pipeline for the quarter going forward, so if you could talk a little bit about the pipeline. And also separately, can you talk about the deal content in the quarter and were there any whales so to speak?

Hi, Laura. It's Craig. The pipeline actually grew in the quarter which is amazing. Not only did we increase revenue, increase backlog, but we actually increased the pipeline, which is very positive. So no, we didn't drain pipeline at all.

And relative to deal composition, from a revenue point of view, there were no whales and from a bookings and new sales point of view, there was a whalish piece of follow-on business from an existing customer, where we expect to actually be able to sell them more in the future to boot.

Was that in healthcare or financial services, the whale follow-on?

The whalish 1 was in financial services.

Okay, great. Can you talk a little bit about why you think bookings have been so much better this year than last. How much of it was Chordiant distraction, how much of it was draining the pipeline in '09, just as you stand back and look at the first half of '10 over '11, it's starkly different, and I want to understand that dynamic a little bit better.

Well, I think actually, you touched on sort of the 2 of the factors. We had such a really strong close in '09, and I think the pipeline had gotten a little slow. It just took a little while to refurbish it. Obviously, we did a good job in the second half of '10. The acquisition, like all acquisitions are, is a distraction, both after the acquisition closes, and also the diligence and other work that needs to be done to make sure that it makes sense. That's why I'm so glad that historically, we've been such a primary organic grower. We've got confidence that we can be an organic grower, so we can really stick to 1 inning.

And final question for me. Can you talk a little bit about pipeline by vertical market? In other words how much today is still banking and insurance versus the newer verticals, if you could give us some color on that, that would be great.

I don't have the specific numbers in front of me but I will tell you that directionally, the traditional financial services market is quite strong, but what I'm really excited about is that some of the newer verticals that we've been bringing out, verticals such as communications, which is actually having a tremendous both, influx of pipeline and business. Newer verticals like Life Sciences, for example, are doing extremely well, and it's going to manifest itself in our own sort of internal tracking. We're going to have to start referring to some of these things as being more primary verticals from our point of view, if they continue to perform this well through the end of the year.

Thanks so much.

Thank you.

Our next question in queue comes from Nathan Schneiderman of Roth Capital. Your line is open.

Hi, Alan and Craig. Thanks very much for taking my questions. Yes, there was a phenomenal bookings quarter. I want to ask another question about it, though. Craig, that increase in other license backlog really took a jump for that 2013 to 2015 period. Was that highly related to this 1 large follow-on deal that you're talking about, or was that really fairly diversified across a number of deals?

It was actually a couple of deals, Nate. Not just 1. We grew across all verticals, and we grew across all geographies on a 6 month basis, so the increase in the backlog is somewhat widespread, just as the bookings were.

Okay, and then where did you end on total headcount and sales and marketing heads?

Sales and marketing, we ended with 410. That's up 33 from the year-end but of the 33, 27 of those are in the sales organization.

And we've really dialed up our hiring engine. We've actually added several new recruiters in Q2 that are really sort of hitting the ground because we would like to hire good people on board, get them trained. See how well we can do at making sure that 2012 is the strong growth year that we would like it to be.

Do you have a total headcount number too?

We have a number for both headcount and contractors, because we have a lot of contractors in India. I would say, as of today, it's probably pretty close to 2,000, in that we are hiring at a pretty constant basis.

Great, and final question for you, Alan. I know you don't necessarily normally like to talk to this, but just given the dislocation in the financial markets over the past few weeks, can you speak to how the quarter is going so far, that July to kind of mid-August period? Maybe if you can talk about the bookings you've achieved so far and compare it to last quarter year-over-year, just given the dislocation? Thanks very much.

I'm not comfortable, given the way that our whole quarters are lumpy, and being able to talk about partial quarters, it would make it even more so. What I'll tell you is that operating it at an unprecedented level of activity, a lot of good stuff is happening, and like all quarters, lots of stuff will end up coming down to the last couple of weeks, and we're very disciplined about that. We don't do stupid things in the last couple of weeks to make quarters. I feel that, despite what we're seeing in the market, this is no where close to what we saw in the first couple quarters of 2009. As I pointed out in my comments, we were effective at closing business even in the financial services realm during that period. I've got a level of confidence that we've got the skill that we should continue to expect in the future that we'll be able to close business even if the economy is tough, though I'd love it to be easier.

Thanks very much.

Thank you.

Our next question in queue comes from Steve Koenig of Longbow Research. Your line is open.

Hi, gentlemen. Thanks for taking my questions.

Sure.

Maybe if I could squeeze in 2 questions it would be great. First 1 is, just thoughts on how uncertainty in the macro environment could impact the kinds of projects that you're selling. Your value proposition is twofold, both operational efficiency and customer experience, customer centricity. Do you expect any sort of pendulum switch, more to cost savings as we've heard from other companies. Comment on that? That's the first question and just 1 follow-up.

Yes, so when we typically position our business, even when things are better, and to tell you the truth it's not like the last 9 to 12 months have been jubilant. Everybody has had eye level of anxiety. When we position our business, we always try to do it so that people are actually able to obtain good customer related- and effectiveness-improvements with rapid, rapid payback. When times are tough, you change the order of some of the PowerPoint slides to stress the payback a little bit more, but that's not something that we've ever moved away from and that it's easy for us to accentuate. I'll tell you, though, a lot of companies, even companies that are being royaled by the market do have a lot of cash. For companies who are worried about cash, we're also glad to offer business on a term basis too.

And you know, Kevin you mentioned about the high ROI. I just want to -- I think I've told you the story that we sold a pretty good sized license to a major auto manufacturer right at the end of 2008, 2009, probably the worst period ever in the auto industry. But they moved ahead with the big project and a good sized license because the ROI was just so high.

Yes, so there's multiple aspects to your value proposition but in terms of the types or mix of initiatives you're going after, it sounds like you don't really expect those to change a whole lot.

I don't. I think that we're -- certainly any changes would be more little tweeks. No strategy changes. We've never thought that the economy was about to break out. We've always treated this recovery as tentative, and if it is, I think we'll still be okay.

Yes, okay, great. Thanks. Then for my follow-up, just wondering, thoughts on kind of margin trajectory from here. I think you've said in your last call, you intend to hire and grow your hiring, grow your investments at the same pace as your revenues. Should we be expecting margins to improve from here in the near term, meaning next 12, 18 months, or how do we think about your pace of adding cost as you're adding revenues.

Well, as I said in my script, I think that our investment in sales and marketing is really paying dividends. I think 1 of the reasons we are seeing so many deals with so much activity is because of the growth in the sales organization. We're covering more accounts, more geographies, more verticals and more partners than we ever could before. So, I think that we're going to continue to invest. We have been doing this for 5 years and we have a 5 year track record of approximately 30% growth in revenue per year.

Okay, so I'll interpret that to mean that your pace of investment should roughly match your pace of revenue growth at this point.

Well, software companies at some point have the opportunity to become staggeringly profitable, and our margin investment is very conscious and not due to any structural need. It's just expensive to bring on board new staff, get them trained, we invest quite a bit in that, and moving into new geographies, et cetera. We're seeing the results that make us comfortable these investments are prudent, and so we are going to continue to make them. We're going to respect the need to return a level of EPS. But at the end of the day, I've seen few opportunities like this in my professional life, and we want to take advantage of it.

Terrific. Great. Well congratulations on the quarter and thanks for your help.

Thanks, Steve.

Our next question comes from Raghavan Sarathy of Dougherty & Company. Your line is open.

Good afternoon. Thanks for taking my questions. 3 questions from my end. First for Alan. Alan, you talked about the investments you made in sales is helping you with some of the new verticals, such as manufacturing, retail, Life Sciences. Can you talk about what types of problem you're trying to address, or what kind of problems you're trying to solve in those verticals. And then in terms of competition, I would imagine you're seeing the stack vendors. Are you seeing any different stack vendors in the new verticals, such as retail or manufacturing?

So, as you move into new verticals, you see different players. The Telco space you've got companies like Amdocs, which offer a collection of products, some of which they used to try to compete in other verticals, but they've basically been pushed back to their core Telco vertical. But we're pretty excited that we've got a great value prop in places like communications. Some of the things we're doing are really just sort of interesting variations of what we've done before. So, for 1 of the world's largest manufactures of energy related equipment, we've got a multi million dollar implementation of what's, in effect, a quoting and binding system, as you'd refer to in insurance. We helped them put together the quotes, allow all the engineering teams to be able to collaborate, build up the right sorts of elements to try to win the business, and then print out the documents and send it along to the customer to facilitate them being successful.

We're also doing a lot of what you would think of as service management type work. Being able to help in the entire life cycle of service and repair and warranty, which is looking like a great market for us, in exceptions. And another example, I would think, is the whole next best actions. How do you make it so, to the extent that some of these organizations have for example, call center infrastructures and other sorts of things? How do you make sure you're doing the right realtime decisioning, so that you can really help those folks? So, I think there's a very comforting set of analogies to the work that we've done in the past, which I believe is why we've had good uptake in these industries.

And then, a question for maybe Craig. So, 1 thing I notice is revenue from UK went up about 85% year-on-year in the quarter. Is there anything noteworthy there, or maybe Chordiant revenue more in that bucket? Can you help us understand that?

I actually think it was more that the previous was an easy compare. The UK, when we were a little slow a year ago, getting out of the gate, a lot of that was in the UK, and they've really been hitting their stride and actually been doing great the second half of the year, as we've gone into this year.

And 1 final question from my end. So, you had a very strong first half. Obviously you exceeded expectations. I was looking at the model, and look at your guidance, you still need to do $0.75 of earnings from the second half. Historically, second half is a strong half for you, but in terms of linearity, is there anything that we should think about, given the current macro or anything in terms of expenses? Craig, you talked about your tracking of your recruitment machine, anything we should think about for the second half linearity?

No. As you point out, we're, as Alan said, we're trying to increase capacity to sales force. As I said in my script, there's going to be significant number of adds in R&D, in the second half of the year. But the main driver of profitability is license revenue. As we say, license revenue can be pretty lumpy from quarter to quarter, due to the mix between term and perpetual, and our reluctance to do anything stupid at the end of a quarter. We'll just wait for the deals to come in.

And relative to the R&D investment 1 of the things that I mentioned was that, we've put out our new version 6.2 of our core BPM solution, which has very, very powerful capabilities into it. We're now in the normal process of bringing our framework assets and other sorts of assets, including some of the Chordiant ones, on to this environment. Which really, really I think, is going to allow us to come into next year with a very, very strong product line that takes another major step forward. So I think that these investments in areas that have paid dividends historically looks prudent, and with the capacity to do that, we should continue to do that. Frankly, as a business, we should focus on working to have a good year but also working really hard to build backlog for 2012, so that we can continue to race along towards our goals of getting much larger.

Great. Thank you.

Thank you. Our next question is from Kevin Buttigieg of Collins Stewart.

Thank you. Looks like your sales hiring significantly accelerated this quarter. Looks like it was, you said 27 this quarter, and I think you had about 12 or so in the previous 3 quarters combined. So, do you foresee hiring remaining at those levels or do you think it will even increase from here?

Yes, we hope we can continue to hire salespeople at this level. Without them we can't grow. We just don't have the capacity. We can't cover new accounts. We can't cover new geographies. And we need salespeople to cover partners and work with the partners, so we're going to continue to grow the sales force, as we have for the last 5 years.

And part of making sure these guys are effective is also making sure that, since we're a vertically oriented company, we don't just call them IT. We actually want to be able to call them the business people. We need the right marketing and framework assets to make it so that, when we call and say, hi, we can really help your order management. We've got a way to make that clear to a customer that we can do that. That coupled with, also, the Alliances' [depth] which we've placed a bet on, which looks like it's a great bet -- means that we are intending to continue hiring at a good clip.

And outside of the new sales additions, how are you trending in terms of sales force productivity of people that have been there for a little while?

So, it's better the first half of this year than it was the first half of last year, and I don't think it's an accident. I think we've take in a lot of steps to try to improve education, and just make sure we're bringing people on and making them effective better.

But as I said, it does take a long time to get salespeople up to speed and build a pipeline and close deals. So, the people that we hire in sales for the rest of this year were really not expecting them to have any impact on revenue for this year.

Right. Okay, and then just, I know that you've been pushing a little bit further into the government for a little bit of time. Just wondering, how much of that makes up of your business today and does the changes you think influence that 1 way or the other in terms of, you talked about earlier on the call about Pega being used as an efficiency tool. Do you think that you have some incremental opportunities, or do you think that it's the budget situation is going to be something that tempers your move into that industry.

So, we actually have some pretty good results selling to some agencies that you might have been shocked actually would purchase, given that they were in the press, because we can actually help organizations really deliver on cost savings and efficiencies. So, I think it's the same old story where it's a challenging sale, but I think it's possible. In aggregate the government space is still in single digits from a percentage point of view, contribution to revenue. I think it's a place that merits additional investment on our part, and I think we can do more there, based on the results. And we're good at selling into industries that are trying to save money.

Or generate revenue, because a lot of the government applications actually are about collecting taxes and generating cash flow, both in Europe and in the US. I guess it depends on your politics then what you think about that.

I guess it depends on your politics, then, what you think about that. Thanks very much.

Well, I would say that regardless of your politics, 1 would believe that if somebody owed taxes that they should be paid -- (multiple speakers)

We help collect it.

Collected. It's not really a political statement.

Okay, thank you.

Thank you. Our next question comes from Brian Murphy of Sidoti & Company. Your line is open.

Thank you for taking my question. Most have been answered. Alan, you mentioned that you're increasingly displacing competitor installations, and I'm wondering if you can just give us some color on that. Is this mostly shelf-wear that was maybe bundled into larger deals, or are these really painful rip and replacements of operating systems. If so, what's driving those decisions?

Well, I think its been less painful rip and replace, because it's mostly stuff that was intended to do something that turns into a science project, and never actually really delivers on what the customer needed. Customers are pretty good at figuring that out. So, for the last couple of years there's been a lot of thrown in BPM, and it's going to continue, but at the end of the day, we're still meaningfully differentiated from our competitors. We're, obviously, still able to show our clients that there's a difference, particularly if they try it. Our competitors hate it when our customers actually try something with us, because so much of our business, well over 70% of our business is follow-on sales to existing customers. Every single 1 of them has at least 2 or 3 more competitors in them often claiming they're using the BPM, but in fact not really.

Okay, great, and just 1 more, Craig. The R&D headcount additions, will most of those be in the US?

Actually most of them will be in India.

Okay, that's it for me. Thanks.

Thank you. The next question in queue is from Edward Hemmelgarn of Shaker Investments.

Yes, hi, Alan. My congratulations, also, on a great quarter. I wanted to just follow-up on your comment that the orders -- or the number of new customers, were up fourfold over last year. Can you give us a sense of magnitude? Is that like 5% of the total orders that you had, and you went from 1% to 5%, or is it like going from 5% to 20%, or is it going from 10% to 40% or something of --

So, Craig is digging through the papers, but what I will tell you is that consistent with the fact that more than 70% of our business comes from existing customers. It's great and it sets the stage for awesome follow-on business, but the new clients don't move the needle as much as being successful with the existing ones.

Well I understand that, but I was just trying to get some idea of the magnitude of new customers, in terms of thinking about the future. So, I realize that most of your dollar value is coming from existing customers. But kind of thinking in terms of the number of new customers -- are the number of, how does that measure as a percentage of all your orders?

Well the most important thing is that it broadens our base, and these are accounts that we hadn't covered before. So, as Alan said, 70%, 75% of the revenue comes from existing accounts. So, we look at each customer as an annuity over the next few years. So, any time we can broaden that base we're pretty happy about it.

But I think the way we look at it is that the number of new customers that we're adding tells you that our entree into new verticals is working. Because in fact, we're already in just about all of the financial services companies, we can't count much of their business the same way. So that's indicative of, from what our point of view, folks who now will become repeat business customers, but that are more often than not in a new vertical.

Well, let me ask it another way. Did you go from like 10 new customers to 40 new customers, or 5, that's what I'm trying to get an idea of, number of new customers that were added.

So we added -- I think, the right way to think about it is we went from single digits to several times -- to a couple times that.

Okay, that's what I was trying to get an idea. Appreciate that.

Sure.

Thanks.

Thank you. Our last question comes from Laura Lederman of William Blair. Your line is open.

Thanks for letting me back in the queue. Earlier in the call you mentioned your bookings were up 100% year-over-year, yet when we calculate the first half, we get closer to 150%. So, I was just trying to understand the difference in that. Is some of that Chordiant? Just trying to understand our math versus yours.

I'd check your math, Laura. We're up about double from where we're were in the first 6 months of last year. If you just look at the change on page 25, the revenue we've booked and the change in deferred revenue, you'll get to that number.

We'll talk about it offline. Thanks again.

Okay, thanks.

Thank you. I'd like to turn the call back to our presenters for any concluding remarks.

So, let me thank everybody for staying with us this evening. I just want everyone to know that we're working very hard. We are sensitive to, but undaunted by some of the royaled economy that all of us are living in these days, and we think this continues to be a great opportunity, and we're going to push forward. Thank you very much for your support.

Ladies and gentlemen thank you for joining today's conference. This does conclude the program, and you may now disconnect.