Pegasystems Inc (PEGA) 2014 Q3 法說會逐字稿

Greetings and welcome to the Pegasystems Third Quarter Fiscal 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded. It's now my pleasure to introduce your host, Rafe Brown. Please go ahead, sir.

Good evening, ladies and gentlemen.

Certain statements contained in this presentation, including but not limited to, statements related to future earnings, bookings, revenue and mix of license revenue, 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 only speak as of the date the statement was made.

Because such statements deal with future events, they are subject to various risks and uncertainties, actual results for fiscal year 2014 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 2014 earnings and in the Company's filings with the Securities and Exchange Commission, including its quarterly report on Form 10-Q for the quarter ended September 30, 2014, its annual report on Form 10-K for the year ended December 31, 2013, and other recent filings with the SEC. Although subsequent events may cause the Company's view to change, the Company undertakes no obligation to revise or update forward-looking statements, whether as a result of new information, future events or otherwise, since these statements may no longer be accurate or timely.

And with that, I'll turn the call over to Alan Trefler, Founder and CEO of Pegasystems.

Thank you, Rafe.

I'm going to talk a little bit about what we've seen going on in the quarter, as well as how we're thinking as we sort of enter our planning process 2015 relative to where we are thinking of investing and what we think is going to be important going forward.

Relative to Q3, it was a solid quarter, continuing what has been a strong performance here for Pega. I note that [Q3s are] often a challenge because business can slowdown in the summer leaving tremendous amount to get done in September. And this year, the mood across Greater Europe was rather sour, though we've seen some lightening of that mood in October. I'll talk about that a bit more in a second.

Overall, we continue to be very optimistic about how our software is being adopted and our long-term growth opportunities. As discussed on previous calls, we continue to position our business beyond the traditional tech categories like BPM and other alphabet soup into instead being a basis for strategic digital transformation. We see digital transformation initiatives as being increasingly important to our customers and actually central to the growth of our business.

This quarter, we've seen new wins and meaningful increases in our relationship with companies including those from our original banking and insurance markets like AIG, which continued its broad investment in Pega as part of their enterprise strategy for global clients putting a single backbone sort of architecture across [14] countries around the globe. (inaudible) initiatives are strategic to their business that they regularly talk about it in their Investor Presentations and the perfect example of the meaningful work we do with clients. Or Charles Schwab which is going to be using us to provide case workers the user experience they need to more efficiently complete client requests.

But I'm always excited about the expansion into the markets we've been going into more and more in recent years. With the business for example like extensions at Cisco for order scheduling and backlog management in the supply chain order management area providing visibility to the business and their partners to ensure on-time deliveries and increased customer satisfaction. Or General Motors' OnStar. This is another sort of Internet of Things type opportunity, I'll talk about in a moment, where if you have a GM car and it's a tree or something unfortunate happens, it calls the Pegasystems and we do that, not just in North America, but for them in China as well. Yes, they're expanding their relationship with us to prepare to -- deal with how they intend to deliver new services in 2015 is another example of exciting extensions. Or brand new clients like Amazon showing the applicability of our technology well outside those original financial services markets.

And the ultimate test of our software is out upwards in real life and we saw important new go lives at many clients. Now, to pick out a few that are sort of interesting, the Transport Management Centre in Australia, which is another interesting Internet of Things use case, where they are using the Pegasystems to be an interface to change incidents occurring on their road networks and helping them both monitor what's going on in the various highways and interoperate with existing motorists around the incidents and making sure that both information exchange and the incident management process is optimized. Or a major, major outsourcer of medical claims who in Europe went live with our customer process management technology using the system to manage insurance claims on behalf of travelers when there has been a medical emergency. Or Rabobank which has rolled out a commercial sales and servicing platform put right into the Internet environment that allows small and medium enterprises to apply for credit online and to initiate service processes on their loans. Or one of the nation's -- US' massive wireless carriers for an omni-channel solution that standardize offers and guides interactions across retail and call center agents for retention, prioritization, compliance. The system was rolled out to over 25,000 care agents and over 20,000 retail agents on iPads. So that is exciting to see both the new clients and the existing customers continuing to deepen their investment in Pega technology.

Now, as I mentioned at the outset, our sales and service business in Europe had a particularly challenging quarter. Even markets such as Germany, which have been strong for years, seem to slow down. We continue to have some macroeconomic concerns about the global economy, particularly in Europe. However, we do have a robust pipeline of work and in October, saw progress on some of the UK and EMEA business that have stalled a bit in September. Despite the challenges in Europe, we are pleased to be showing year-to-date 21% license revenue growth increase and the backlog has grown in addition 18% over Q3 of last year.

Looking elsewhere internationally, I've just returned from a trip to Asia and I was particularly impressed with the progress we're making in Japan. We opened our office several years ago at a particularly unfortunate time. It was immediately before the earthquake and tsunami, obviously a difficult time, we worked through, and we continued to invest. And now, the results coming in are very exciting. We held a very successful digital transformation summit while I was there and got tremendous enthusiasm from both clients and prospects. It's clear to me this will be a very strong market for us going forward.

We also recently announced that in Turkey, we acquired a local partner that we've worked with in recent years. This will help us provide additional local sales, delivery and support resources and it's sort of interesting because Turkey has become a real hot bed of digital transformation. We actually recently had half a dozen executives of Isbank, Turkey's largest commercial bank, come to Cambridge and they were doing one of the most interesting transformation projects that I have seen as they are looking to really try to digitize and take advantage of what they can do in that growing economy.

So overall, we think that international will be important and that we can show traction. I'll be in Europe both later this month and in December as part of our digital transformation road show and making sure that we're really investing time with clients and prospects, just see what we can do about making that area as strong as possible. And though we expect challenges in Europe to persist for the remainder of the year, we feel we are well positioned for both weak and strong economies, as we've traditionally been able to offer our clients both the ability to drive new revenue in good times and improve efficiency and cost savings in bad times. You can remember how well we weathered the 2008 and 2009 recession. We did extraordinarily because we're able to move on messaging in a more difficult economy to really show the importance of simplification and cost saving and we are actually rejiggering our message to make sure that we can stress some of those things in the economies that may be struggling a bit as we go forward.

Relative to where we're going, we are going to be continuing to invest in our product and our marketing to take advantage of what we think are extraordinary opportunities and the investment will continue through the end of the year and as we're thinking about planning for 2015, we think it's important to make sure that we continue to be a leader in these key areas, because we are confident it will pay off. We're going to continue to build on our strong offerings in key horizontal areas of customer service and support, sales and onboarding, marketing in what we call next best actions, as well as the operations that are automated by our core Pega 7 platform, and where it makes sense, we're verticalizing our applications to help our customers [with a see, touch] and understand the value proposition. For example, in this past quarter, we launched a new commercial underwriting capability for the insurance industry and an Equifax connector for the financial services industry.

We, continue to see interest from our customers in the core areas of technology, which I call SMAC, social, mobile analytics, cloud and the Internet of Things and we're seeing good uptake and enthusiasm around how these technologies are served by and with the Pegasystems. Now, the cloud is becoming increasingly more important to our customers as they look for increased flexibility, agility, and speed as well as decreased cost, and especially as we think of opening up our markets, we believe that this will be increasingly important to us. We're seeing excellent demand and increasing our capability in this area and think it will be increasingly important in 2015 and already showing rapid growth as Rafe will talk about it in a bit.

We think that our ability to offer both on-cloud and on-premise offerings is bringing a great level of flexibility and benefits to our clients for their strategic applications. We're also integrating the technologies we acquired earlier this year core into our application, really unifying them. So it plays to the strength of this single model that is what differentiates us from a lot of our competitors within the [go and] lots of stuff together and frankly not having that worked terribly well.

We recently announced a major new release of our customer service app that unifies the technology we have around social from MeshLabs and around what's called co-browsing user interface technology to help operating centers work with their clients over the phone and over the web. And we are seeing a lot of interest in these capabilities. Our Pega customer service technology engages customers, while maintaining context and visibility and gives them traction across channels and across devices unifying the social media, the mobile apps, live chat, co-browsing and in person service.

And I'll tell you, the new interface that we've released is beautiful to work with and yet extremely powerful to support the important applications and complexities of significant organizations. Its intelligent guidance takes CSR step by step through recommendations to deliver personalized service experiences appropriate for each customer. So, in addition to this product work, which we're excited about, we're also continuing to invest in marketing to improve awareness among key audiences.

We really want to deepen the skill set of our marketing staff and aligned our team to better deliver programs that will contribute to pipeline and we've been working to update our messaging. You should see as we roll into the new year, some important new releases on our website, as the team is working hard to make us enter 2015 with a very strong and highly refined set of messages. Our new positioning that I talked about, applications engineered for evolution, is resonating well with customers and we're going to be continuing to pitch this message. I mentioned in the last call that we had sort of thought about a difference between the types of applications that people want to address with their technology and with their software. On one hand they will we call conforming business applications. These are ones that while may have significant impact on the business, but don't really have to be differentiated. They allow a business to sort of change the way they run, so that it matches the software and frankly a lot of the SaaS players in the space are being successful offering this sort of technology.

But by contrast, what we want to specialize at what we call strategic business applications are those that organizations will use to differentiate that will need to be different and need to be well frankly able to allow them to offer their clients what they need, where they need it and are going to have to be able to evolve to deal with the needs of markets, products, regulations, competition. Now, well, out of the box features are important to these applications and we're working hard to make sure we're adding them the ability for an organization to imprint itself rapidly in the software and most importantly change is absolutely critical. And given the increased importance of software for organizational success, we see these strategic applications as frankly creating a [$30 billion] plus industry that allows companies to really take advantage of our technology and apply it to drive better business outcomes and business success.

Our strategy is to be the leader in enabling strategic business applications using our unified model driven software that Pega 7 architecture we talked about. Model driven means delivering a straightforward development environment that I mean enables business people to directly generate and change the strategic business applications even while working more efficiently with their IT brethren. Benefits include faster time to market, increased business differentiation and continual business and organizational agility. Now Pega will deliver strategic applications for sales, service and marketing based on Pega 7 as well as supporting clients who wish to further extend Pega 7 as a platform across the enterprises.

So in summary, though the current economic climate is challenging, we're very optimistic about the future. We continue to be inspired by the great work that our clients are doing to transform their businesses and very excited about the role our software is playing in these strategic initiatives, and we think we've got great prospects as we go forward.

To provide more color on the financial results, let me now turn this over for additional discussion by our CFO, Rafe Brown.

Thank you, Alan.

For the third quarter of 2014, please note, we are reporting both GAAP and non-GAAP results. A full reconciliation of all GAAP to non-GAAP measures is provided in the financial tables of the press release issued earlier today and is available on the Investor section of our website. As we discussed in the past, quarter-to-quarter comparisons do not necessarily reflect the underlying momentum of our business as the timing of a small number of large transactions can significantly impact our results. To provide the best look at how our business is performing, let me run through the results on a year-to-date basis.

Year-to-date non-GAAP total revenue was $424 million, up 19% year-over-year. Year-to-date non-GAAP license revenue was $157 million, up 22% year-over-year. And year-to-date non-GAAP cloud revenues stood at $13 million, up 135% over the prior year, though approximately a third of that revenue growth is from Antenna, which we acquired in the fourth quarter of 2013. As a percentage of year-to-date non-GAAP revenue, license cloud and maintenance revenue stood at 72% of total revenue, up from 69% for the same period of 2013. This is a direct result of our stated strategy of growing our higher margin revenue items faster than growth of professional services and training.

Looking at our results on a geographic basis, non-GAAP revenue in North America grew 25% to $255 million on a year-to-date basis and stands at 60% of total revenue. Revenue from EMEA was approximately $139 million on a non-GAAP basis, up 11% year-over-year and year-to-date Asia-Pacific business was up 16% year-over-year. It should be noted that our European sales were below our third quarter targets. We believe that this is attributable to a combination of factors, including timing of a number of larger transactions which we believe will land in coming quarters, as well as the macroeconomic factors, which have resulted in some of our customers taking a more cautious approach to license commitments.

The contribution to non-GAAP revenue recognized from term or subscription licenses for the nine months of 2014 was 45%, up from 38% for the same period of 2013. This contribution percentage varies quarter-to-quarter based on the mix of revenue recognized from term versus perpetual licenses in a given period. On a year-to-date basis, non-GAAP professional service revenues were $114 million, up approximately $8 million from the same period last year. While we are pleased overall gross margins have remained strong, professional service margins faced significant headwinds in Q3. The net result being that non-GAAP gross margins stand at 69.2% on a year-to-date basis compared to 70.2% for 2013.

And taking a closer look at our professional service margins, there are a couple of key points to understand. First, as discussed above, business in Europe was particularly challenging this past quarter. These challenges impacted both license and professional services revenue. And while there is significant focus on our professional service utilization rates, we are still trending below our targets. Secondly, while margins for implementations of Antenna offerings have improved, they remain below the margins of our core professional service business. We continue to incur higher costs with inherited Antenna customer projects. And while we anticipate steady improvement in this area, we expect this to be a source of pressure on professional service gross margins for several more quarters.

Now, turning to the rest of the income statement. We posted year-to-date non-GAAP operating margin of 11.8% compared to 14.7% for the same period of 2013. Year-to-date non-GAAP operating expenses were approximately $244 million, up 24% from 2013. As we discussed in our Q2 call, we are making a number of significant investments in our technologies. You may recall that our year-over-year R&D run rate jumped as a result of both the Antenna acquisition, which was principally a technology and technologist acquisition, and as we discussed in Q1 a reclassification of cost for marketing into engineering. As Alan mentioned, our sales and marketing efforts continue to ramp with additional investments supporting enhancements to our digital marketing presence and brand positioning. We believe these investments will drive continued growth yielding both deeper relationships with existing customers and extending our reach to new users.

Turning then to earnings. On a year-to-date basis, we posted non-GAAP earnings totaling $32.1 million. On a non-GAAP fully diluted EPS basis, this totals $0.41 a share. It should be noted that our earnings were impacted by an FX charge of $2.5 million or $0.02 during the quarter.

Now to discuss license and cloud backlog. We compute license and cloud backlog by totaling two elements, deferred license and cloud revenues as posted on our balance sheet and off-balance sheet license and cloud commitments that are signed, but is yet unbilled. As a reminder, you can find detail of both elements in our 10-Q and a summary table in our press release, both of which were filed earlier today. We finished the quarter with $334 million of total license and cloud backlog. For year-over-year comparison purposes, this total backlog as of Q3 2013 was $283 million. Thus, as of the end of Q3, backlog has increased $51 million or 18% over the prior year.

Turning now to cash. Year-to-date, the Company has produced $98 million of operating cash flow, an increase of 18% over the prior year. Free cash flow, which we defined as operating cash flow less CapEx, was $93 million, up 17% over the prior year. And we finished the quarter with total cash and marketable securities of $229 million. Year to date, the Company has repurchased [608,000] shares for $12 million and at the end of the quarter, we had a balance of $2 million available for repurchases for the remainder of the year. On headcount, we finished the quarter with approximately 2,900 employees, up approximately 26% from the same point last year.

In summary, we are pleased with our results for the first three quarters of 2014. This said, we're working hard to meet our targets for the year and are looking forward to updating you on what is traditionally our biggest quarter in just a few months.

With that Operator, we will open the call to questions.

Thank you. At this time, we'll be conducting a question-and-answer session. (Operator Instructions) Steve Koenig, Wedbush Securities.

I'd like to, if I may, just decompose or gauge your thoughts with a little more granularity on the miss this quarter, how much of that you think was -- it sounded like even since (inaudible), how much of that was on from those deals and did any of them close, whether any execution issues or anything that can be tweaked on execution and what's their lightness in specific industries?

So, a couple of things. So there were a couple of things [that rushed] in the quarter sort of bounced out that could have just easily bounced in some which have already. And in terms of a miss, it wasn't a disastrous miss obviously, we were not sounding enormously enthused up in quarter one. I think the weakness was really very much concentrated in some of the European areas and we have made some changes there, though I think that some of it was -- just it was a tough September frankly in some of the European continent -- in UK and Europe in general. The mood was just pretty sour is the way that I would -- the way I would describe it.

So yes, I think what sort of really happened -- really underlies with the quarter is there is a lot of business in the pipeline for Q4 and we're out there pushing to make sure that we do every little bit that we can.

Yes, okay. And if I can just follow up on, Alan, on that particular topic, you provided a little color last quarter that -- given this thought, given the strength in the first half, your guidance was unchanged for your usual policy, but you thought probably, you'd likely -- you'd come in ahead of it for the year, which seem pretty plausible. Is that still your feeling now? Can you comment on your thoughts last quarter?

I think that from a revenue point of view, at least I think we'll likely to modestly exceed what we had talked about at the beginning of the year. The reality is that we are a lumpy business. We were extremely enthused that we will get to pulling a lot of revenue in the first half, Q3, I think, as I look at this, compared to where we are historically, compared to guidance at start of year, if you go back to last several years, I think historically compared to your guidance, we're further ahead than we've been in any of the recent years. Once again, still a lot of business to close, because Q4s are always big for us.

Yes. Okay, great. I'll leave it at that, guys and thanks a lot for your help.

Thanks again, Steve.

(Operator Instructions) Mark Schappel, Benchmark.

Rafe, starting with you, Antenna revenue in the quarter, I think, you give it your date. What was the specific Antenna revenue for the quarter?

So yes, thank you for that. One of the things that is going on with Antenna is we are rapidly working to integrate Antenna into the rest of the company and due to that integration of both the products and the sales force, other than really maintenance and hosting revenue, which are discrete and easily be tracked, it's really not feasible for us to identify the revenue from new arrangement solely attributable for Antenna and you'll see some discussion of that in the 10-Q.

Now, I will say I did break out quite a bit of detail of this in the second quarter. So you can kind of extrapolate from that and be very, very close and at that time, we are on track to have Antenna total revenue at around $22 million for the year. So if you use that figure, you're going to be terribly close. So it's just that we can't get that discrete detail at this point.

Okay, great, thanks. And then with respect to operating cash flow, I'm kind of remote at the moment. Just wanted, if you could just give us the quarterly operating cash flow and free cash flow quarter?

Sure. So for the operating cash flow on year-to-date basis was $98 million and then the free cash flow was $93 million.

How about for the quarter, though? I don't have them.

So operating cash flow for the quarter was $24 million. Free cash flow for the quarter was $21 million.

Great, thank you. And then with respect to foreign exchange, I mean obviously there was a big hit toward earnings, but what about the [role play] in the top line?

We've looked at that closely. It's relatively small, largely because we take a good chunk of our revenue off the deferred revenue, which is captured as deferred revenue at its historical rate and then amortizes in at that historical rate. So it tends to provide a delayed effect whenever there is any sharp FX movement. It's less than a 1% impact on overall growth.

It is the bottom line impact is most difficult.

Right. And the -- yes.

Okay, great. Alan, turning to you here with respect to Europe. Did you maybe just go into a little bit more detail where you are seeing the particular weakness in Europe. I mean what's your big deals in particular, was it in certain verticals and certain industries?

I think it was sort of in general, I think that there was just an anxiety that settled up Europe as you can remember there's been a lot of debate about what's going to be happening in terms its slowness in interest rates, etcetera. And it was sort of a bit of a pause, having said that, we've seen some energy return in October. So we're not calling out the alarm bells. But I think that we're not the only company that's in Europe has been weak this quarter, I think it's actually fairly, I would expect you'll see that and we'll continue to see that from lots of firms.

Having said that, we know what to do. We slip back to cost savings, we stress the ability to simplify operations and things to pay for itself. And so you can still get even pretty meaningful deals, you don't get generally whales to pay for themselves, but you can get some of the marlet and tuna which can be in the sort of sub $10 million category, but still can be somewhat meaningful, you can still do things in the $3 million, $5 million, $7 million category. One times are tough, you're just not going to do the super big deals in that environment. I'm not sure whether we're really counting on any of them from Europe anyway now, which I think is the truth.

And with respect to that slowdown, I mean, did you see it evenly in the quarter or was it in the last week or two?

In Q3, the visibility of the slowdown is always in September. I mean, basically, things are intrinsically pretty slow, especially in Europe in July and August. And so it's all about when people coming back from their vacations, getting back engaged etcetera. So we should -- I think also we had a couple of customers where they had some management changes and other things that I think ultimately going to be very, very good for us. But anytime you get some of those changes, the bunch of big announcements, executive changes at some of the UK banks that hit over the summer and I think ultimately that is going to be very positive and we have every reason to believe it's going to be positive. But inevitably, anytime we have those changes is always (technical difficulty).

Okay, great. Thank you, that's all from me.

Brian Murphy, Merriman Capital.

Alan, so with some of these transformational projects that you are going after obviously messaging is important and it certainly requires a large complex communications effort. You guys have been focusing on that pretty acutely this year. When I look at your website now, I see a big difference from the past just in terms of the volume of the resources that you have up there, and the way that they are organized, I think it's really well done. And my question is, I'm wondering if you're seeing any interest in the pipeline yet in terms of lead generation, [off course sales sides of it], any early indications that those initiatives are working?

So I'll tell you that we've made some changes and I'm glad you like what you've seen. There is a very, very substantial pipeline changes, that's the new marketing team has broadened. We've actually made very, very significant introductions of new talent into the marketing team, and they've been working extremely hard. But you should expect that wave to hit at the beginning in January, and that's really what we've been planning. When we dealt with the marketing team, I think we decided we were open to really stepping back and thinking what it would take to get our game up to the whole next level. So I think what you've seen so far, my CMO actually describes as lipstick on a pig, to quote him. So you should have very high expectations for what is expected to do in January.

Okay, sounds great. Thank you.

Thank you. We've reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments.

So I'll just say that folks, we are working hard, the opportunity is actually tremendous and we get a very strong reinforcement of that. And as we think about the things we're looking to do next year in terms of both the meaningful improvements in broadening of our marketing presence, what we've talked about in the past is opening the aperture of being able to go after many more accounts than we've historically gone out which is again traditionally been the sort of Fortune 400. And as we see the client successes and customers' willing to come to the transformation summits or the case studies for us, I'm very excited that we have a highly differentiated product and technology. We have the capability to deliver it. We have an increasing partner ecosystem that's helping us get good visibility and we're very, very excited and going to work hard to close the year and look forward to telling you about our 2015 plans on our next call. Thank you.

Thank you. That does conclude today's teleconference. You may disconnect your lines, it's time and have a wonderful day. We thank you for your participation today.