Pegasystems Inc (PEGA) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Pegasystems third-quarter earnings call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. I would like to turn the call over to your host, Beth Kurth. Please go ahead.

Thank you. 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 (technical difficulty), risks and uncertainties. Actual results for the fiscal year 2013 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 Q3 2013 earnings and in the Company's filings with the SEC, including its report on Form 10-K for the year ended December 31, 2012 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. And with that I will turn the floor over to Alan Trefler.

Yes, thank you, and good evening. Q3 was a terrific quarter for Pega, year to date we have grown license revenue materially, quite an achievement in these challenging times. For much of the last several weeks I've spent considerable time visiting customers, prospects and partners in North America, Europe and India. There is tremendous excitement about our Pega 7 release. This is the latest major version upgrade of our unified model driven platform and a significant step in our goals of both improving power and ease of use.

One recent example of the excitement was from the attendance and reaction to our first Pega developer conference held October 27 and 28 in Hyderabad, India. Responding to demand by our customers and partners in India, we decided to hold this conference with only eight weeks advanced notice. Yet the conference was way oversold with over 1,700 attendees from 52 organizations all there to learn about the powerful market leading Pega 7 software.

Here were two telling quotes from conference attendees. The head of a partners global BPM practice said, quote, everyone here, their eyes are lighting up when they see what they're able to do with the new technology. And from a customer vice president, he said, quote, Pega 7 is going beyond boundaries; it is giving a different perspective to the development and building of applications. These are representative of the comments we now hear about Pega 7 which brings speed and simplicity to the building of serious [build] business apps.

Key among new capabilities in Pega 7 are -- a so-called responsive UI, a user interface which allows you to have your business application respond automatically to whatever device you run it on. For example, shrinking from a desktop to an iPad or resizing itself for a smartphone. This dramatically reduces the time and skills needed to build world-class case management user interfaces while dramatically improving the user experience.

Something really novel that we call case lifecycle management, which allows business people to graphically layout their reusable business processes and context without having to awkwardly glue them together. Then the Pega 7 engine automates the software creation so that is the way the application will work in practice. This really enables reuse and speed to change.

And finally, simplified data transformation, which we call live data, which makes it significantly simpler for business applications to access enterprise data where it resides in whatever format it is in. This is one of the most challenging aspects in building agile applications and putting this in really will significantly speed time-to-market and business responsiveness. These are just some of the very powerful capabilities that are generating excitement and buzz among customers, prospects and partners about our new release.

Also, however, very exciting are some of the changes we see occurring in the enterprise software market. For some time now we've been explaining that Pega 7 in our solution frameworks addresses about a $30 billion market in the combination of business process management, case management and various vertical application segments. We are seeing these emergent into a new category. And as I talk to customers, partner executives and industry analysts there is increasing evidence and momentum that this evolution is speeding up as it takes place.

Organizations increasingly realize the traditional approaches to case management and customer centricity simply do not provide the agility and responsiveness required to effectively compete in a continuously changing environment. Both business and IT organizations know they need something different. But until now the enterprise software market definitions have not given them a name for this new requirement.

Now we're seeing industry analysts, pundits, systems integration firms and customers asking aggressively for this new approach. Some call it, quote, systems of differentiation, unquote. Some call it smart process applications. We can sometimes hear it referred to as dynamic case management or systems of agility. But regardless of the label, this confluence of market segments for a new type of business application is upon us. And increasingly customers, partners and analysts are recognizing Pegasystems is the market leader and the best solution to this new emerging set of needs.

Evidence that the market's needs and acceptance of this emerging categorization is the excellent performance of Pega in Q3. We had three different international telecommunications companies choose Pega for order management and next best action marketing to improve efficiency and increase cross sell for new customers. The combination of business responsiveness at the moment of truth for the customer with analytics for improved outcomes and our vertical frameworks for rapid development and deployment really shows how we are pulling together these different markets into the new approach that I mentioned above.

We also won significant business in the healthcare segment in Q3 as healthcare organizations are dealing with the need to save money through personalized healthcare and clinical programs. And they have to be able to readily and easily change their business practices based on new products, new processes and all of the regulation that is hitting that business.

We also did well in the financial services sector in Q3 and we're seeing financial services companies under cost pressure and needing to really streamline the way they do business. And true to form, that is something that Pega's combination of technology is uniquely positioned to be able to address.

I was also pleased with the public sector segment in Q3. We actually had the highest number of quarterly orders in public sector segment in our history with wins in both federal and state governments. Public sector organizations are beginning to acknowledge that their traditional approaches to business apps cannot get them through the tough challenges they're now experiencing with lower budgets and higher demand by stakeholders. So they are turning to the newer model that Pega represents.

So in Q3 we saw major wins in the public sector for licensing applications, citizen service delivery and exceptions management. So you can see across the segments the combination of business process automation, cross channel customer experience, dynamic case management and vertical solutions really helps organizations improve agility and responsiveness and these are all the things that Pega software is at its core.

Let me close by discussing our acquisition of Antenna Software in October. We see mobility as a critical element of what clients want and need in business software and it's a fast-moving and rapidly changing market. And our philosophy of the organization is to be agile and efficient, mobility has to become a core capability of the business applications and core to their processes. It is not a separate thing that is distinct from the way they want to run their business.

It's interesting because a recent analyst study showed that 75% of mobile applications either do not reach expected return or have any return at all. We think that this is because they've been overly simplistic, have not been fully and properly integrated with the core elements of the business. And of course that is a tremendous strength that Pega has and Pega brings.

And we see the introduction of the 250 very skilled resources from Antenna and being able to fit in their approach with their model driven architecture as making it possible for us to both improve capabilities for the existing excellent Antenna customer base and also make mobility a key and core differentiator for Pega as we move forward. The clients and partners we've talked with are very excited about this combination and they see it as really taking mobility applications to where they need to go.

So in closing, it has been a strong 2013 for Pega. And with that let me welcome Rafe Brown, Pega's new Chief Administrative Officer and CFO, to his first earnings call. Welcome, Rafe.

Thank you, Alan. I am thrilled to have become part of the Pegasystems team. Given the Company's best-in-class technology, leading customers and track record of growth, this is truly a fantastic opportunity.

With a little more than a month behind me I want to thank the entire Pega team for the warm welcome and for their hard work these past few months. I especially want to acknowledge Max Mayer for his leadership and dedication these last few months, in particular for covering our most recent earnings calls.

Q3 was another great quarter for Pegasystems in terms of license revenue growth, bookings, earnings and cash flow. Our pipeline is robust and, though we have a tremendous amount of work to do to close 2013, we are looking forward to a strong finish to the year. Let me begin by taking you through our third-quarter results starting with revenue.

Q3 revenue was $122 million, up 20% from the year prior. Within that number Q3 license revenue was $45 million, that is up 57% over Q3 of last year. On a year-to-date basis, which normalizes quarter-to-quarter volatility in our business, license revenue was up an impressive 34% over the prior year with total revenue up 12% over the same period last year.

Year to date we continue to see higher mix of license and maintenance revenue relative to professional services revenue versus the same period last year. This change in our mix of revenue is consistent with the Company's strategy to focus on growing the number of implementations performed by our partners and clients with Pega providing expert services.

Looking at year-over-year growth on a regional basis, year-to-date revenue in the United States grew 9% to $189 million. Revenue from the European continent has improved nicely growing at 47% to $66 million on a year-to-date basis, reflecting our sales team's growing traction on the continent and early signs of business recovery in the sectors we serve.

In the third quarter license signings increased significantly in total value terms when compared to the third quarter of 2012. Notably our Q3 2013 results were achieved without reliance on a small number of very large transactions, or whales as we often call them. This said, our fourth-quarter pipeline does contain a few very large transactions that are important to our achieving our bookings target for the year.

In terms of the mix of license deals signed year to date, the percentage of perpetual licenses wherein revenue is recognized in the quarter the deal is signed has ticked up. The mix between perpetual and term licenses is to a great extent dictated by the needs of our customers though the Company does somewhat prefer term license deals. And remember, due to the disparate short-term accounting results for perpetual versus term license deals, small changes in relative license mix can have a significant effect on both revenue and margin in a given quarter.

Turning to the income statement -- the Company posted a GAAP gross margin of 69% in the third quarter, up from 63% in the third quarter of last year. This improvement is largely the result of the relative decrease in professional service revenues versus license and maintenance revenue as discussed earlier.

Operating expense dropped over $2 million in Q3 compared to Q2 of this year. The overall reduction in expense is a result of the fact that our annual user conference, PegaWORLD, occurred in the second quarter. Overall we saw both sequential and year-on-year improvement in our operating margins.

You can expect that we will continue to focus on building operational efficiencies, but we will be investing in areas that propel our growth, principally our sales and product development departments. For example, the acquisition of Antenna will require additional investment. However, much like the Chordiant acquisition in 2010, which ultimately accelerated our call center business and development of our next best action product, we believe the Antenna acquisition accelerates our mobile strategy.

Turning to earnings -- we posted third-quarter non-GAAP earnings of $0.33 per share. On a year-to-date basis our non-GAAP earnings total $0.88 per share compared to year-to-date earnings of $0.45 per share in 2012. Our GAAP earnings were $0.22 per fully diluted share for the third quarter, $0.58 per share on a year-to-date basis.

License backlog, computing by adding deferred license revenue as detailed on page 11 of our third-quarter 10-Q filed earlier today, and future cash receipts from license arrangements as detailed on page 22, totaled $268 million as of the end of the quarter, up $42 million or 19% from Q3 of last year.

As the Company has discussed in prior quarters, our business tends to be backend loaded in the year in terms of both the number and value of our license signings. As such, the Company tends to consume backlog in the early part of the year. Consistent with last year backlog is down year to date as of the third quarter.

In support of our land and expand sales strategy, year to date more than two-thirds of the value of or licenses have been executed with existing customers. The conclusion here is that our software works, our clients like the results and they're willing to continue their investment in our technology.

Turning to cash flow, operating cash flow for Q3 was $90 million, year to date operating cash flow was $83 million of 187% over the same period last year and in part the result of strong collections year to date. We ended the quarter with $188 million of cash on hand. Our days build outstanding now stands at 50 days.

Year to date the Company has repurchased 313,000 shares for $9.2 million at quarter end we had a balance of $5.6 million available for repurchase this year. We finished the quarter with a total headcount of approximately 2,300 employees, up 7% from the same point last year. Of course, this figure jumped significantly shortly after quarter end with the acquisition of Antenna adding an additional 250 employees to our headcount figures.

Turning to the impact of the acquisition on our Q4 results, we expect that Antenna's operations will have no material impact on our 2013 revenue. We do expect Antenna's operations will reduce non-GAAP earnings in the fourth quarter by $0.03 to $0.05 per share. As a reminder, a complete GAAP to non-GAAP reconciliation can be found in our earnings press release we issued earlier today.

In summary, Q3 was a great quarter and we are looking forward to a strong finish to the year. I feel privileged not only to report these results but to be part of such a great management team. With that, operator, we will open the call to questions.

(Operator Instructions). Richard Davis, Canaccord.

Quick question. Do you just -- I mean you kind of talked about it at a high level, but each of the last couple years Q4 you guys have made like retailers look like [pikers] because you do 50% to 60% of your bookings in one quarter. Does it feel like it will be similarly backend loaded or just order of magnitude or we're just trying to kind of triangulate around that.

And then the second kind of tactical question is on Antenna. The purchase price looked pretty darn low, I mean it was a great buy because a member they were trying to go public at one point. But are there any earn outs at all in that figure at all or is it just straight up kind of a mid-20s purchase price?

So, on the Antenna, it was a straight up purchase. I think we are pretty careful acquirers. And we really like some of the work they have been doing in the last particularly I would say 12 to 18 months. But the business has struggled for a little bit. But we were very, very impressed and we think it is both an excellent team and obviously a really, really important area for us to be investing in. So we feel pretty good about that.

In terms of the backend loading, I think we did get some nice business closed in Q3 that in past years might have drifted off to Q4. But we are still expecting and looking to do a strong Q4. And as Rafe said, there are even a couple of whales in there. We have a sort of a whale free year, which is not a bad thing, to tell you the truth. But we are working and we think we might be able to get a couple of big deals in the quarter as well.

And then, lastly, with regard to Antenna expectations. Should we just figure 50-50 license service split or is that roughly about right or when we are trying to model it out?

I think there might be a touch more in service than in license -- service and maintenance there. So I think they are a little more heavily weighted towards that.

Perfect, thank you.

Raghavan Sarathy, Dougherty & Company.

Sorry if you already talked about this, can you give us some sense for the revenue run rate of Antenna Software? I know you talked about expenses. Can you give us some sense of the revenue run rate of this business? And then are you going to be continuing to sell the development platform or is it going to be assumed in your platform?

Yes, the revenue run rate for Antenna is around $5 million on a quarterly basis. So we don't think it is going to have a big impact on Q4 as noted.

And in terms of what we are doing, so they have got a pretty, pretty interesting set of mobile first development platform capabilities they call AMPchroma. And we are continuing to sell that and we are in the process of also integrating their capabilities in with we already did in mobile, which we think is going to make our mobile offerings even stronger.

So it is a combination of continuing to let them do what they have been doing. And also as we look probably towards the PegaWORLD timeframe, middle of next year, we think we could have some really very, very exciting things to be able to put forward.

Okay, and then my second question is around bookings. If you look at the fourth quarter I think -- and, Alan, you just talked of a couple of (inaudible) deals. But when I look at the license comparison, you do have a tough comparison for the fourth quarter. How should we think about the license revenue growth of the quarter because I think the perpetual license is a big swing factor.

Yes, it is. And as you well know, we live in a world of high adventure when it comes to figuring out exactly what is going to come in term and what is going to come in perpetual. I will tell you that what we call the working set, which is the collection of deals that have either closed or that we are working, looks quite good. However, there is still a lot of work to do between now and the end of the year. And I guarantee you we are all highly focused on it. I wish I could give you some better guidance, but in the reality you know what we know.

Just one final question. Were there any -- I mean you talked about (inaudible) across the board. Are you -- was it driven by sort of -- I mean is it Pega 7 product you talked about or is it too early for customers to migrate to Pega 7, how does the upgrade work, is it part of (inaudible) maintenance, would that mean in terms of revenue for you going forward?

Sure. So Pega 7 would be available to existing maintenance paying customers under their arrangements. And so it is not just a movement to Pega 7 is not going to lead to massive springs of new revenue. But we see having Pega 7 available and being able to really get customers excited about the product as being a very, very good harbinger especially for next year. Anything we did in Q3, though, was not materially driven by Pega 7 -- maybe a little.

Okay, thank you.

(Operator Instructions). Kevin Ikeda, Wedbush Securities.

Congrats on the quarter. Just wanted to get a little more color on the Antenna acquisition. What is the initial target for cross-selling? Will you be selling Pega into the Antenna base or selling Antenna into the Pega base? Thanks.

We think it can go both ways. And part of what is interesting is that I think one of the challenges that mobile apps have had historically is they have been great for like displaying a little bit of data, but in terms of actually doing real work the great majority of them don't actually do that. And that is part of that industry analyst quote that I read that said, boy, companies have been doing them but they are not sure exactly, necessarily what they are getting.

We obviously have an absolutely terrific, terrific platform for being able to sit behind a mobile app. And there is this whole concept of what is called mobile backend as a service where you actually put up a system on the cloud and use that as an intermediary for people to be able to build and deploy mobile apps.

We see that system on a cloud being a Pega system as offering the Antenna customer base and actually new clients some really, really terrific opportunities to have a model driven architecture there when everybody else is writing [tug]. So I think there is going to be some great opportunities into the Antenna customer base and I think it's going to be really appealing as a next year at sort of thing across the board.

Okay, thanks. And just one more. Given that many other software vendors are adopting a mixed model or transitioning to pay as you go model. Do you expect to see any sort of mix shift towards term or perpetuals or away from the other? Thanks.

Well, you know, I think of that Rafe pointed out that our perpetual mix had picked up somewhat this quarter, obviously good for short-term revenue. The reality is we like term, the when the Company was started actually we only offered term licenses that was it. And so the fact that there has been a push by some companies to really, really want to buy perpetuals frankly driven any material way I think by the acquisitive nature of companies like Oracle and IBM, and I am not wanting to be in the situation where they have got a term license with one of those firms, they feel better when they have a perpetual license.

Though that's obviously not something that we are looking to have happen to us. The predilection of the clients can be very strong. We made the decision that if the business was good business we would be prepared to offer perpetuals as well as a term. But you should be aware that we do favor terms and we really try to encourage the sale when there is really a choice.

Okay, thanks very much. I appreciate all the color there.

Raghavan Sarathy.

A quick follow-up on this expense that she talked about related to Antenna Software. So you said on a non-GAAP basis it is going to be dilutive $0.03 to $0.05. Do you -- will there be any -- you said there is minimal revenue but I want to make sure that is actually on a non-GAAP basis you are not going to -- there is not going to be much revenue. And it seems to me that if it is about $0.03 to $0.05 the expense rate is roughly $2.5 million for this business on a quarterly basis? I want to make sure I am looking at this the right way.

So their expense run rate for the quarter is probably around $7.5 million a quarter. And keep in mind, so the revenue numbers, as I just mentioned, will be around $5 million. As they're just coming into the Company we are still getting our arms around the business and making sure we are investing to see them off to a good start. On a GAAP basis it of course gets quite a bit more complicated because there is the haircut to GAAP revenue that will be determined as the valuation work is completed.

But you will recognize roughly $5 million on a non-GAAP basis?

Correct.

Okay, that is it, thank you.

(Operator Instructions). We don't show any other questions in queue. I will turn it back to Alan Trefler for closing remarks.

Well, thank you to everyone who joined the call. We are obviously very pleased about how we have done year to date, 34% year-on-year license revenue I think has been quite an accomplishment for the team. And we feel quite excited. And we know we have a lot of work to do between now and the end of the year and we are going to get back to it. So, with that, thank you very much, everyone.

Ladies and gentlemen, thank you for participating in today's program. This concludes the program. You may all disconnect.