Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Pegasystems Inc. (NASDAQ:PEGA)

Q1 2010 Earnings Call Transcript

April 23, 2010 9:00 am ET

Executives

Craig Dynes – SVP & CFO

Alan Trefler – Chairman and CEO

Analysts

Laura Lederman – William Blair

Nathan Schneiderman – Roth Capital Partners

Steve Koeing – Longbow Research

Raghavan Sarathy – Dougherty & Company

Greg Spiker – Moss Creek

Richard Davis – Needham & Company

Brian Murphy – Sidoti & Company

Operator

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

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

Craig Dynes

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

Certain statements contained in this presentation may be construed as forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. The words anticipates, projects, expects, plans, intends, believes, estimates, targets, forecasts, could, and other similar expressions identify forward-looking statements which speak only as of the date the statement was made.

Because such statements deal with future events, they are subject to various risks and uncertainties. Actual results for fiscal year 2010 and beyond could differ materially from the company’s current expectations. Factors that could cause the company’s results to differ materially from those expressed in forward-looking statements include among others variation and demand and the difficulty in predicting the completion of product acceptance and other factors affecting the timing of our license revenue recognition, the mix of perpetual and term licenses, and the level of term license renewals, our ability to develop or acquire new products and evolve existing ones, the negative global economic trends and the ongoing consolidation in the financial services and healthcare markets, our ability to attract and retain key personnel, reliance on key third-party relationships, the potential loss of vendor-specific objective evidence for our professional services, management of the company’s growth, our ability to successfully integrate our acquisition of Chordiant Software, and other risks and uncertainties.

Further information concerning factors that could cause actual results to differ materially from those projected is contained in the company’s filings with the Securities and Exchange Commission, including its report on Form 10-K for the year ended December 31, 2009 and other recent filings with the SEC. The company undertakes no obligation to revise or update forward-looking statements as a result of new information since these statements may no longer be accurate or timely.

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

Revenue in Q1 was $75.1 million, up 20% or $12.7 million from Q1 2009. Revenue was also up by $2.1 million from Q4. Revenue growth from Q4 to Q1 is pretty rare in the enterprise software business, as Q1 is typically the weakest quarter in our industry. Q1 bookings are always down to the end-of-year budget spending that is often part of Q4 bookings. So, as a result enterprise software companies typically eat backlog in Q1. In our case, in comparison to Q1 2009, we actually grew our backlog and the consumption of backlog from Q4 to Q1 was less in this year’s Q1 than it was during last year’s Q1.

In Q1 2009, the aggregate of future payments for term and non-term license payments vis-à-vis off-balance sheet future payments that we detailed in this quarter on page 18. Decrease from Q4 2008 to Q1 2009 by 15.8, whereas in Q1 2010, the net backlog used was only 13.8 million. In addition, the total balance of these future payments grew from approximately $103 million at the end of Q1 2009 to $119.6 million at the end of Q1 2010, an increase of about 16%.

In Q1, our new license signings were up from Q1 2009 in both Europe and Asia-Pac. This appears to be an indication that the economy is improving in these regions. New license signings in the US in Q1 2010 were less than those in ’09, due to the anomaly of one deal. Q1 ’09 included one large deal, which was actually signed in the previous quarter that had a contingency that didn’t’ clear off until Q1. Given our conservative nature, we held the deal out of bookings until the contingency was cleared. If that deal had been carried in the previous quarter when it was actually signed, US bookings in Q1 2010 would have been up from ’09.

Looking at the verticals, all verticals with the exception of healthcare showed an increase in new license signings in Q1 2010 over 2009. Maintenance revenue was $15.1 million for Q1, an increase of $3.1 million or 26% from Q1 2009. As noted in our 10-K, the increase in maintenance revenue is a function of continued growth in installed base of our software. Our maintenance renewals exceed 95% as almost every customer renews each year.

Professional services revenue of $29.7 million was up about $4.1 million from $25.6 million in Q4 and was also up $5.7 million from Q3 2009. There are several reasons for this increase of last few quarters. Overall, demand for consulting services is higher. Demand for training seems to have really taken up. This might have been the biggest training quarter in our history. In addition, in Q1, we had two fixed price projects reach completion. When these projects finish, they tend to pull more revenue out of deferred revenue on the balance sheet. We expect the demand for professional services to remain at these levels for the foreseeable future. Lastly, we had no 10% revenue customers in the quarter.

Gross profit for the quarter was $48.6 million, up $6.8 million or 16% from Q1 2009. While most of the increase attributed to higher license and maintenance revenues, ProServ margins improved from 15% to 17%. With the improvement in the economy, realization rates were better in all geographies. In addition, we did slightly less internal training in Q1. While our ProServ margins were higher, the primary goal of our professional service organization is not to maximize margins but rather to complete successful implementations that drive follow-on license sales and to enable our customers and partners.

Total operating expenses for the quarter were $40.1 million, an increase of about 36% from Q1 2009. The increase in OpEx reflects the strategy of investment that we have been following since 2006, with the goal of growing the company to become a $1 billion player in our space. Just like last year, almost two-thirds of the increase in operating expenses were in sales and marketing. The increase in Q1 is primarily due to headcount. We had 41 people for the sales and marketing organization in Q1. Of the 41, 30 were in sales. The increase in sales headcount was timely. Many of the new sales employees started early in January, just in time for our sales kick up, thereby allowing them to jumpstart their training and on-boarding process.

In order to grow revenue, we need to cover more accounts and lay off more quotas. This is the sizeable investment in future revenue growth as it takes several quarters to train new sales staff, have them assigned to accounts, build pipeline and close deals. So, adding them so early in the year is a real bonus. In addition, in the investment sales and marketing, we added 26 people to our R&D organization. While we are the undisputed leader in the BPM market, we strive to lengthen our lead. Improvements to our product lead to customer success which drives follow-on sales.

Our FAS 123R charge for stock-based compensation was about $1.5 million in the quarter, down slightly from $1.7 million for Q1 2009. Note 7 to the financial statements details of this charge is allocated to cost of revenue and operating expenses. This quarter, we have recorded on the P&L, foreign exchange translation loss of $3.1 million. Pega’s operating and tax structure is not friendly to swings and foreign exchange rates. Foreign exchange translation gains and losses are reported in two places on the P&L or in comprehensive income, which is part of shareholders’ equity. While we have recorded translation loss of $3.1 million in our P&L, we recorded loss of only $332,000 in comprehensive income, detailed in Note 6.

This is the opposite of most companies where the majority of the translation gains loss are not recorded under P&L. As a result of our structure, we show unusual swings in translation gains and losses. In 2009, we had translation gains of $2.1 million, while in 2008, we had translation losses of $4.5 million. In Q1, the sudden fall in Sterling and the Euro gave rise to these losses. We are working to move to a more typical international structure where these external swings will not go through our P&L, but will go directly to equity like other companies. This translation gain or loss does not reflect any change in our business condition, which is why when we gave guidance, we specifically stated we assumed a constant US dollar to exclude large accounting charges caused by factors such as the liquidity crisis in Greece.

Our business is no worse due to the situation in Greece, nor is it any better now that the Sterling is up from March 31. The application of the new purchase accounting rules for the Chordiant acquisition are starting to impact our GAAP earnings. Expenses associated with the acquisition are no longer treated as part of the acquisition costs, but are now immediately expensed to the P&L. As a result, we have recorded $1.5 million of acquisition expenses in Q1. I am not sure who thought up these new rules, but they have a crazy impact on our financial statements. While these costs are treated as GAAP expenses, most of them are treated as part of the acquisition costs for tax purposes and are therefore not deductable for tax purposes.

This causes our effective tax rate to look very strange at 38.8%. The application of new purchase accounting rules is similar to the impact of foreign translation accounting, in that nothing has changed in our business. So, we take two significant accounting charges on our P&L that together end up impacting EPS by about $0.10. So, while we would like to report on a GAAP base system, to make our financial statements more useful to our shareholders, when we record in Q2, we will start to include non-GAAP results and present reconciliation to GAAP. Even after adding back these two accounting charges to get to non-GAAP measure of our business, the earnings for the quarter are slightly down from Q1 2009. This is not a surprise but a result of our efforts to invest in sales, marketing and R&D to continue to grow our business.

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

Q1 booking increased our AER [ph] balance by $2.9 million from $39.4 million at the end of Q4 to $42.3 million at the end of Q1, but the days sales outstanding is still an amazing 35 days. We had another great quarter of collections, which resulted in a $4.8 million cash flow from operations, and we ended the quarter with $202 million in cash and investments. During the quarter, we purchased 44,299 shares for $1.6 million at an average price of $35.22. Our Board replenished the buyback program in Q4 and we still have a balance remaining of about $14.2 million available for repurchases during the remainder of 2010.

Deferred revenue of $42.1 million was up by $9.3 million from December 31, due to increases in deferred license revenue in annual maintenance billings. Wednesday, we closed on the acquisition of Chordiant. As a result, we would like to get some initial guidance. We were only able to give guidance update on revenues given that we have a lot of work to do in finalizing our purchasing accounting. Part of the purchase accounting includes taking a reduction or haircut on Chordiant’s deferred maintenance revenue that is on their books at the time of acquisition. Again, this is only an accounting anomaly and doesn’t reflect a drop-off in their maintenances. In fact, we believe that the maintenance revenue is very sticky, since customer applications are important mission-critical type apps.

In addition, we have met some of the Chordiant customer base and they are excited about enhancement that adding PRPC can have to their existing applications. We are formulating a detailed product plan that we believe will be synergistic as the technologies can be very complementary. But bringing the two companies together and implementing strategy will take some time. We believe that the acquisition will be slightly accretive this year and very accretive in 2011. On a non-GAAP basis, we now expect 2010 revenues to be approximately $360 million. I say non-GAAP because I am adding back the purchase accounting haircut and deferred revenue to get to a truer run rate business. The haircut represents about $12 million, so GAAP revenue should be approximately $348 million.

We have provided reconciliation in our press release and will update these estimates when we report Q2 results. With regard to earnings however, we are not yet able to present reconciliation due to the complexity of other purchase accounting items. So, the GAAP versus non-GAAP split on earnings is not yet possible. However, we see no change in the overall profitability of Pegasystems. Our earnings estimates will in fact probably become non-GAAP estimates, but we just can’t do the GAAP to non-GAAP reconciliation until we finish the purchase accounting work. This will be done in time to file our Q2 results. As a reminder, our guidance is always annual guidance. We don’t do a quarterly guidance for two reasons. Our customers not us determine whether they will buy a term or perpetual license, a change in the mix can make our quarters extremely lumpy.

In addition, we don’t get crazy discounts at the end of the quarter to make guidance numbers because our business is built on follow-on sales to existing accounts. Big discounts would remain our business, just as it ruined many other software companies. So, while we don’t give or manage quarterly numbers, I sometimes try to give some advice to those building models. Historically, there have been quarters where revenues have not grown sequentially. In fact, in the high growth years of both 2006 and 2007, we had down quarters during the year, but on an annual basis, still put up growth numbers for approximately 30% in each of those two years.

In addition, in our 2009 annual call, I gave the guidance that our profitability would be somewhat backend-loaded, as we will have high expenses in the first half of the year. This was to account for our planned investment in sales, marketing, and R&D in Q1 and Q2. Once again, we do not manage quarterly numbers. We are managing the company with a goal of becoming a $1 billion software company and owning our space. While this seems like a lofty goal, our progress to date has been amazing. In this quarter, we have made some significant investments towards this objective.

We have added a record number of new employees and we have now completed the acquisition of Chordiant. It was only in 2008 that we barely surpassed $200 million in revenue and now with non-GAAP guidance of $360 million, I look forward to continued progress toward our goal. With more detail on Q1 achievements, I would now like to turn the call over to Pega’s Chairman and CEO, Alan Trefler.

Alan Trefler

Thanks, Craig. I am glad your voice held up, mine’s under a little stress as well. So, if I start coughing, no one take that to mean anything special. Good morning to all. I thought the start of 2010 was remarkable for Pegasystems, and I felt really good about it till I read the overnight report from Bangalore that condemned our Q1 miss. As I find this judgment pretty ironic, I would like to take a few moments to talk about our approach to the opportunity that we see before us and how we manage the company.

I am not going to try to convince that our approach is correct. There are people who might reasonably say that we should bet less on future growth and seek to return more current profit. So, let me simply try to be transparent about Pega’s goals and strategy, which is one, pursuing aggressive but well-considered growth even if it requires significant investment. We believe that the opportunity we have could be enormous. The transformational capability of BPM is just beginning to be understood, and it requires meaningful effort to establish it in the minds of buyers. So, this is how we see it.

In 2007, we had $51 million in license revenue. In 2009, we grew that $116 million, a 127% increase over two years. But sales and marketing expense grew from about $52 million to $74 million, a 44% increase. So, let me ask a hypothetical question. If license is growing at a particular rate in the market that is a sell to the customer market as opposed to a fulfill order market, would you expect sales and marketing expense to grow order rate somewhat more proportional to the license growth, especially if hiring, training, and on-boarding staff is costly and paying that level of commissions is expensive. The reality is if by being prudent in the face of the dire economic environment we saw in 2008 and 2009, we invested less than I now wish we had. And the fact that we are growing our top line numbers so well, 11 record revenue quarters despite the economy is attributed to the effectiveness of the team despite what I now consider hiring gap in ’08 and ’09.

Now, we understand that this is riskier than banking the profits, but it is true to our mission and all we can do is be transparent with this way of thinking and the inherent lumpiness of our business. We are not running Pega for short-term profit or quarter-to-quarter consistent GAAP results, we think there is a very big opportunity here that we have worked 27 years to prepare for, and we are going after it despite the potential risks and potential misunderstandings of our need to invest to bring sales, coverage and to alignment with growth and to continue the R&D that BPM requires to be operationalized to the next level and to be used by a broader audience and new verticals. We think the potential is exceptional, but to draw on a chess metaphor, our approach is much more king’s gambit than Ruy Lopez. And while investors who believe in the vision of this market should be signing up with us, I would say that Pega is very thoughtful in making investments and committed to critical thinking and continuous improvement in looking for the investments to be wise.

So, why have I been feeling great? In Q1, we achieved our 11th consecutive quarter of record revenue. We announced our newest release of our industry-leading business process management platform, SmartBPM 6, which is spectacular. We won significant business not only in our core verticals, traditionally financial services, insurance and healthcare, but also in newly targeted sectors, including life sciences and the public sector. I feel much better about the federal business. We have actually started to get some traction, something I spoke to them about wanting to do for a couple of years, feeling like that is heading in the right way absolutely. We announced the largest acquisition in the company’s history.

We dramatically advanced work with systems integrators and global alliances. For the first time, we were recognized as a leader in Gartner’s CRM Customer Service Contact Centers Magic Quadrant. We invested in growth in Asia Pacific, opening offices in Singapore and Hong Kong. In Q1, we committed resources and engaged in external expert firm to help us seal our entry into Japan, and I am pleased to report that in April, we hired Pegasystems’ first country manager for Japan. We have existing international clients to give us leverage as we move into this region, but we understand it will take a while on further investment to build that business we think is going to be a great opportunity for us. And we received a record pace of registrations for our upcoming PegaWORLD User Conference, now at over 1,000, which makes PegaWORLD the largest BPM conference in the world.

As Craig mentioned, our total revenue exceeded $75 million in the first quarter of 2010, with quarterly license revenue of over $30 million. Pega addresses the need to the pragmatic buyer by very quickly developing ROI and enabling the business to achieve unprecedented agility using our build-for-change technology. The benefits of our technology has been considerably advanced with our newest release, SmartBPM 6. The capabilities include faster time to market, further increases in collaboration between business and IT groups, new capabilities for clients to transform their business and move beyond the constraints of how software has been manually written for the last 40 years, really letting our customers achieve agile and rapid benefits in a business-lead approach to applications. In regard to Q1 wins, we achieved successes across the board of financial services, healthcare, insurance and life sciences.

I am particularly pleased with the government team. As I mentioned, it scored wins and has built an existing pipeline. We continue to see companies using Pega technology to enable business growth, improve the customer experience and transform their back offices. For example, we have received a large win in a leading bank that selected us as their services backbone to automate processes throughout the back office. A Blue Shield organization organizes us to manage claims and to automate the claim repair process and the government agency is also going to be using us in the area of clients and in support of the health business.

So, it’s been good across the board I would say in terms of the industries and I am also pleased to say that in Q1, the work that we have been doing to let us launch into new industries are also moving forward very, very successfully. We had many systems go live in Q1, healthcare organizations, banks, a large bank opened a PRPC initiative to really change the way that they add customers and open new accounts. We have a large P&C company who went live with a customer experience service platform and a leading health insurer lost their national desktop for member and provide services.

I am also pleased to announce that we just closed the acquisition of Chordiant. And this is a very strategic deal from our view. It adds decision management technology to already strong intent-driven process approach. It will let us improve the customer experience, brings assets in the area of retention, cross-sell and upsell, while letting clients reduce the cost of sales and the cost of service. Chordiant is a very impressive large extremely important customer base. And we have had a chance to meet with a number of those customers and we are extremely pleased that we are going to be able to engage well with them. I think they are also excited that they are going to have a larger company that is committed to their success and is in a position to be able to invest as we go forward. We are very pleased to have the strong employee base with deep technology experience and customer experience and decision-management experience joining the Pega family.

And in terms of the verticals that they are in, they actually have very, very good presence in two specific verticals where we weren’t as deep. The telecom vertical which I had mentioned was going to be an important area for us this year. We had one client in telecom and they have got over 10 significant organizations. And also, they bring important relationships in consumer banking where they have got literally hundreds of thousands of seats that are being used across some of the world’s largest institutions. So, we think it’s exciting, we think we are going to be able to help our customers, take advantage of some of the new Chordiant technology we think we are going to be able to help revitalize some of the Chordiant technology by incorporating PegaRULES Process Commander, and I can say that the potential from this move is at least as strong as we believed when we first engaged with them.

In Q1, our partner relationship also advanced at a faster pace than ever before. Our partner-sourced pipeline activity increased approximately 75% from the same period in 2009, and we conducted business development training for over 500 partner delivering resources. Approximately 30% of the total PegaWORLD attendees are expected as a result of these partners, representing a 3X increase from the last one.

We also launched a new Pegasystems Web-based partner portal and have had almost 1,000 partners sign up pegapartner.com. We are also expanding geographically. As I mentioned, we have been really growing in the Asia-Pacific region, and we think that, that has a lot of potential for us, because frankly, we have already seen in the last six or nine months that region perking up and actually have seen purchases come from it. So, overall, we feel the quarter and the year-to-date has been remarkable. Record revenue growth, SmartBPM 6, the closing of the acquisition, exceptional partner traction, our leadership position in CRM and geographical and vertical expansion.

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

And with that, let’s open the line for any questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Laura Lederman from William Blair.

Laura Lederman – William Blair

Thank you. I am sorry if the call is not good quality, I am in the taxi. That one deal that didn't close as you thought, has it closed now? And if not, when do you expect it to and what is it contingent upon? And then I will follow up with more questions. Thank you.

Alan Trefler

I think you misheard. There was no one that didn’t close. What he was talking about was deal going all the way back to 2008 that had swopped over to hit the first quarter 2009 numbers. So –

Laura Lederman – William Blair

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

Alan Trefler

I would say the pipeline overall is continues to grow and has continued to grow quite nicely. We are in a position where like most software companies at this point, you don’t show exactly what’s going to happen this quarter versus Q3, but I will tell you that historically PegaWORLD, what we have done in the past has been a very, very effective galvanizing event for both additional purchases from existing customers and new customers making decisions. So, you are going into PegaWORLD next week, I would say overall we are pretty excited.

Laura Lederman – William Blair

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

Craig Dynes

It’s a long-term process; there is a bunch of things we have to do. First of all, we are upgrading our accounting systems to allow more operations offshore, more licensing and more transactions offshore. Essentially what it does is it pushes a lot of the operational aspects of G&A and accounting out of the US into the subsidiaries. And once you do that, the translation gains and losses are in subsidiaries and that goes to comprehensive income rather than P&L. So, it’s a bit of a process, lots of consulting fees involved, lots of tax restructuring, and we are working on that, and actually, the acquisition of Chordiant is very timely, because we will use some of their offshore operations and leave that into the whole plan.

Laura Lederman – William Blair

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

Craig Dynes

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

Laura Lederman – William Blair

I meant on the revenue line.

Craig Dynes

Same thing.

Laura Lederman – William Blair

Okay, thanks a lot.

Operator

Our next question comes from Nathan Schneiderman from Roth Capital.

Nathan Schneiderman – Roth Capital Partners

Hi, Alan and Craig, thanks very much in advance for taking my questions. First one for you on Chordiant, the guidance that, that acquisition on a pro forma basis should give you about $45 million uplift on revenue, just looking at the consensus estimates for the April through December on Chordiant, it looked to me like it was a lot closer to $65 million. So, I understand you miss a few weeks of the quarter. But would you just describe that as conservatism or is there another reason why you wanted to haircut that $20 million?

Alan Trefler

Remember, that $20 million wasn’t our $20 million nor based on statements that we were making. I think if you take a look back at the history of Chordiant, I am going to do this for memory, but for the last couple of fiscal – reported fiscal years, the revenue had gone over I believe two years from about $126 million to around $77 million and was extremely choppy. So, I am not exactly sure how the analyst community arrives at that particular set of numbers, but they are not the numbers we have endorsed, and I don’t think we are quite changing any what our expectations were of what Chordiant would provide.

Craig Dynes

And there is a bit of a transition when you do an acquisition, you have to reposition salespeople, there’s customers that get confused, do I buy Chordiant, do I buy Pega and you have to go and visit all of those people. So, you do have some things that impact your revenue and it’s a possibility that their sales organization and our sales organization could be forecasting the same deals and only one of them is going to close. So, you do have that aspect as well.

Nathan Schneiderman – Roth Capital Partners

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

Alan Trefler

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

Craig Dynes

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

Nathan Schneiderman – Roth Capital Partners

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

Craig Dynes

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

Nathan Schneiderman – Roth Capital Partners

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

Craig Dynes

The balance of 2009 for, I am not sure where you are getting the $30 million from. Are you talking about the term or the non-term? We give three columns. Are you talking about the last column on the right or the middle column?

Operator

One moment, I will open his line. Can you please press star then one?

Alan Trefler

Hello?

Craig Dynes

Nate, I think we lost you, but I can answer that offline or I can give the numbers that at page 30 numbers for non-term future payments at 12/31/2008 were $30.3 million, at 03/31/2009 were $18.6 million, at 12/31/2009 were $57.1 million, and at 03/31/2010 on page 18 was $51.6 million.

Alan Trefler

Operator, are we still connected?

Operator

Yes, he’s connected, his line is open.

Nathan Schneiderman – Roth Capital Partners

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

Craig Dynes

Okay, so let go through this again. At 12/31/2008, that number was $30.3 million; at 03/31/2009, that number was $18.6 million; at 12/31/2009, it was $57.1 million.

Alan Trefler

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

Nathan Schneiderman – Roth Capital Partners

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

Craig Dynes

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

Nathan Schneiderman – Roth Capital Partners

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

Craig Dynes

Okay, give me a call back.

Operator

Our next question comes from Steve Koeing from Longbow Research.

Steve Koeing – Longbow Research

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

Alan Trefler

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

Steve Koeing – Longbow Research

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

Alan Trefler

I am not really prepared to characterize it at the spree, but I will tell you that we are expecting to hire quite assertively through the first half, and to some degree the Chordiant acquisition actually fulfills some of those slots, but we want the acquisition to be accretive. So, we can’t undo the fact that, that additional hiring will be necessary. Basically, what we are going to do is continue to push in Q2 pretty hard, and frankly we reevaluated every month.

Steve Koeing – Longbow Research

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

Alan Trefler

No, we are covering fewer than half of the Fortune 100 companies. Part of the realization we had when we took a look at where BPM can be used, which is very, very broadly, and we took a look at the massive, or just completely uncovered accounts. As I said frankly at the start of the year call and I also said in Q4, we decided we needed to meaningfully ramp it up. We have closed a bit of that gap, but we have got a long way to go. I think the major constraint to our hiring is our belief that we can effectively on-board and train and manage the new staff as opposed to frankly the short-term financial considerations, because as we know, you start hitting on all cylinders with the sales force and software, the results are extremely positive.

Craig Dynes

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

Steve Koeing – Longbow Research

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

Alan Trefler

Yes, we are a pretty popular face to come work these days, because there aren’t a lot of companies whose market share is increasing. There have been a number of acquisitions as I talked about on the last call in the last six months, and frankly, when companies get acquired by one of these large aggregators I would say, their best salespeople typically find that they lose their customers. Those large organizations already have people who are taking care of the big customers, and the sales people very quickly become disenfranchised. Generally within six months to a year, an awful lot of them should I say become available or actively pursue it. So, we have had a lot of, frankly ex-FileNet people who IBM bought a couple of years ago. Some of the more recent acquisitions are now also pushing forward. We have got folks who are coming out of places like Adobe and other sorts of places, but frankly have had a different strategy than we have had about how to go off the market.

We are very vertically oriented and not all companies appear to be following or pursuing that strategy. And in terms of like Global 360, some of the private companies that may have been struggling a bit, we are getting a good mix and frankly we are in a position to be quite selective.

Operator

Our next question comes from Raghavan Sarathy from Dougherty & Company.

Raghavan Sarathy – Dougherty & Company

Good morning. Thanks for taking my questions. Can you guys hear me?

Alan Trefler

Yes, Raghavan.

Raghavan Sarathy – Dougherty & Company

All right. I have got two questions for Alan and then a few for Craig here. First, on your new product, SmartBPM 6, so Alan, can you talk about the feedback you are getting from your customers for this? And then in terms of product roadmap, do you plan to provide a free upgrade for customers who have maintenance agreement signed? And then if customers buy term licenses going to be selling the new version while on sort of the transition there?

Alan Trefler

Yes, whether the customers are term license or perpetual customers, we take things that are enhancements to the core product, and generally those are released as part of the maintenance and update fees that they get. They are all additional pieces and add-on bits that we will be able to sell, but we are expecting that this is going to be adopted very broadly by our customer base, which once again we think is a good thing. As I said in the past, even in our top five customers, I would say that the level of adoption of Pega still has a lot of legs and we still have tremendous opportunity to sell additional fees, sell additional business operations.

So, we want them using our new staff, because it frankly helps more parts of that organization, set that and take it on, and that’s where we get a lot of that return from. The features have been, I think warmly embraced by customers. We have made a lot of changes in this release and they include very significant changes that impact ease-of-use and significant changes that improve the way that business people can take control of your destiny. These are themes we have had for a while, and frankly, this sort of work is never done. I have never seen us though taking this big a step in a single release of the product and the initial feedback we are getting is extremely positive.

Raghavan Sarathy – Dougherty & Company

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

Alan Trefler

Yes, so the selling environment I actually think is improving. The problem with gauging some of these things quarter-to-quarter at our side is, if you look at this stuff from a statistical basis, you got a sample size problem here, but the pipeline is up, the sales force is very enthused, and I think the selling environment is starting to perk up, but frankly, we did so well last year. A lot of these compares are tough compares particularly since we didn’t grow the sales force that much over the last year or two, which is exactly what we are trying to rectify. What was your other question? I am sorry; you were sort of cutting in and out a bit.

Raghavan Sarathy – Dougherty & Company

In terms of competitive environment given these acquisitions recently.

Alan Trefler

I think the competitive environment from my perspective continues to improve. Customers are very skeptical about acquired companies continuing to pursue the BPM vision, frankly that’s skeptical for all the right reasons, and to some degree, I think some customers are resenting the fact that there are some large aggregators that are trying to drive their choices out of the equation. And BPM is one of those places where a customer can actually still get competitive advantage, and they don’t want all have the exact same stuff as their neighbors, which is frankly why they use the technology. So, we were actually thrilled by acquisitions that have been announced over the last year.

Raghavan Sarathy – Dougherty & Company

All right. And then in terms of Chordiant, you said Gartner has actually ranked you in the leadership of the CRM. And I looked at the report, too. Chordiant obviously – when I looked at the report, Chordiant isn't really in the leader category. So, my question is going forward, do you plan to continue sell your product instead of Chordiant product in the CRM situation? How do you transition those customers? Give us some color.

Alan Trefler

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

I am actually pleased to say that the PegaWORLD next week, we are going to be demonstrating five different sets of interactions between the Pega and Chordiant technology live including one that I think will be of great interest to the Chordiant CRM customers. On a go-forward basis strategically, obviously as Gartner has pointed out, the Pega product is meaningfully stronger and is a leader and I see us frankly being able to offer that more advanced product to the Chordiant sales force, which I know they are pretty excited about.

Raghavan Sarathy – Dougherty & Company

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

Craig Dynes

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

Raghavan Sarathy – Dougherty & Company

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

Craig Dynes

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

Raghavan Sarathy – Dougherty & Company

Okay, great. Thank you.

Operator

Ladies and gentlemen, due to time constraints, please limit your questions to two. Our next question comes from Greg Spiker from Moss Creek.

Greg Spiker – Moss Creek

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

Alan Trefler

Yes, we are actually going to be showing it at the user conference. It’s gotten pretty positive responses. We traditionally used it to primarily for QA in development, because our customers traditionally given who they are have wanted to run their production systems internally. And it’s been very, very positive, it’s also been taking out by several of our partners who are running in some cases dozens of platforms of service instances to help them do developments for their customers internally as well.

The thing that’s interesting is that as we go into the second half of this year, we are going to be offering a managed service full-blown, you can run production environment and we are right now just putting those contracts into place, and we are going to be discussing it with our clients at PegaWORLD, and I think we are going to start to see some uptick and we can start to talk about revenue for that probably as we, you know, meaningful revenue from that as we go into next year.

Greg Spiker – Moss Creek

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

Alan Trefler

I kind of believe we should be calling on everyone of the Fortune 100. I don’t think that’s a very radical thought. And today, I would say, I don’t have a hard number in front of me, but I would say we sort of like just crossed the 50% or so threshold. So, buying into the value prop that BPM is applicable across industries and if we attack this as an industry-by-industry basis, so we can do it somewhat more reliably by showing up with things and make sense to people in an industry. I want to continue to grow this until we have got frankly coverage deeper into the Fortune 300 and Fortune 400 as opposed to just the Fortune 100.

Now, you can cover the smaller companies with a very different ratio of salespeople. I mean we actually have in some cases two or three salespeople tied to literally one organization because the organization is just massive. But obviously the ratios are not going to be the same, but we have got to continue to ground, and as I say, I view us as being primarily constrained by our ability to on-board and make sure we are supporting them in the verticals.

Greg Spiker – Moss Creek

Okay, thank you very much.

Operator

Our next question comes from Richard Davis from Needham.

Richard Davis – Needham & Company

Thanks. The pushback that I hear from corporations against these aggregators, maybe they are headquartered in New York State somewhere, but in any case, is that they come in and they go, hey, look, we have got a Chinese menu of stuff. Sorry it doesn't really work together, but we have got these great global services guys that will glue gun the thing together. So, the question I have for you is can you go in to your clients and go, listen, they may have a couple of the modules than we have, but the fact of the matter is you are not going to spend a bunch of money on services. So, it's really, the question is can you come in with a lower total cost of ownership? And if so, can you give us orders of magnitude how much better that is because to me it seems like a competitive advantage if you are able to do that?

Alan Trefler

I think we can come in with a lower cost of ownership, but the thing that we can do that these Frankenstack [ph] vendors, we have tough times referring them to as, can’t remotely do is we actually improved the return on investment and the value by improving the return. So, whether it’s making it much, much faster for an insurer to do a quote and buying process, or whether it’s making it feel that they can do the same work with far fewer people, because one of the things we do is automate the work so much better than these cobbled together solutions even if they use services. We routinely see clients who get 50% and 60% reductions in staff in meaningful operations, because the stuff can be automated without technology and it cannot be automated in remotely the same way. All that can be done is sort of feed to people.

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

Richard Davis – Needham & Company

Got it. Perfect, thanks a lot.

Operator

Our next question comes from Brian Murphy from Sidoti & Company.

Brian Murphy – Sidoti & Company

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

Alan Trefler

I don’t think that the way most software companies' price is very rationale, which is frankly why these aggregators keep scooping up these companies that are unable to grow sustainably, because most software companies I think are, they panic in pricing negotiation. We are very, I would say and very commercially disciplined in terms of the way that we do these things. And we will sometimes have customers, particularly new customers try to hold this up at the end of the quarter. But once people see that doesn’t work, then they stop being tempted to do it, and it’s actually just a much, much better relationship to have. So, I think that often with a new client and obviously we are adding a number of new clients, we will see that occur.

But we tell them we don’t mind for the quarters, we give them copies sometimes of these sort of call transcripts, but we have a reason to believe it, and to be honest, I think it works well and I think other companies should do it so.

Brian Murphy – Sidoti & Company

Okay, great. Alan, also you touched on the additional adoption potential in the installed base. And I know you guys get a very high percentage of sales through existing customers. Can you give us a sense for what the ramp looks like after you get to a certain sort of critical mass? With some of these large customers, what is the typical sort of annual increase that you see from this land and expand strategy?

Alan Trefler

It’s significant; it is not uncommon to see adoption go up 50% to 60% year-after-year in some of these customers. It still though I will tell you requires some sales effort. I think it’s lands and expand not land and sort of automatically happen. So, we do continue to need to invest sales effort in those. It’s just a lot easier when a customer is internally referenceable, particularly in organizations where they doing meaningful things with the technology. So, I would say on average, it would be sort of 50% to 100% growth rates in these customers, once we have gotten in after the first year.

Craig Dynes

And in PegaWORLD, you have a chance to talk to some customers that will tell you that they start with one application, two application. And now, they have 6, 7, 8, 10, 12 applications building up at the same time.

Brian Murphy – Sidoti & Company

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

Craig Dynes

It’s a little early to term exactly what the margin is going to be, but I can’t tell you, Chordiant does about $9 million a quarter in maintenance, and we are doing about $15 million. So, you are looking at a company that’s pretty close to $100 million in maintenance. That’s pretty impressive.

Alan Trefler

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

Operator

Our next question comes from Edward Hemmelgarn from Shaker Investments.

Edward Hemmelgarn – Shaker Investments

Actually my question was answered. Thanks.

Operator

Our next question comes from Laura Lederman from William Blair.

Laura Lederman – William Blair

Hi. Thank you. A few follow-up questions. Can you talk a little bit, and I realize you just got Chordiant, how the pipeline looks? Did it totally or largely disappear because of position or is it starting to grow? Any sense you can give us of that? And finally – sorry the phone kept going in and out because I am in a taxi and there were some areas where the phone wasn't working. Can you give same sort of bookings growth you gave us last quarter? It was like 30% last quarter. Can we get it for this one as well? Thank you.

Alan Trefler

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

So, we feel pretty good about that, and I think frankly the customers in some cases are more likely to buy because Pega is a larger firm. So, I think that will be positive as well. Relative to bookings growth, I don’t have a quarter-to-quarter number there.

Craig Dynes

Q1 is pretty tough quarter to measure, it’s the weakest quarter. You clean out all your pipeline in Q4. In Europe and Asia-Pac, it was up. In the US, if you put that one big booking back when it was fine, it was up. If you sort of leave it into our conservative nature, because of the contingency, it was down slightly in all verticals with the exception of healthcare, bookings were up.

Laura Lederman – William Blair

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

Craig Dynes

So, this was a deal back in Q4 ’08 and Q1 ’09. Deal closed in Q4 ’08, typical end-of-quarter kind of budget flush deal, but it had a kind of contingency and we are so conservative until the contingency gets cleared off. We held it off and we moved it into Q1.

Alan Trefler

And it was a big deal. As I recall over $4 million, maybe close to $5 million. So, it makes that sort of an unfair compare, because frankly all the work was done in Q4 and the commission was accrued in Q4, just didn’t hit our own internal record until Q1. And once again, that’s not this quarter, that’s ’08, ’09, a year ago. So, it’s nothing to do with our go-forward position at all.

Laura Lederman – William Blair

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

Alan Trefler

There were more clients, there were more deals than we expected, and a bunch of new customers, much more from new clients than we have had a year ago, but the average number was like a little lower, and some of that because we are frankly very, very happy with the land and expand strategy. So, that’s not at all troubling and as I said sample sizes are somewhat small.

Craig Dynes

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

Alan Trefler

But that always happens.

Craig Dynes

That always happens.

Laura Lederman – William Blair

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

Craig Dynes

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

Alan Trefler

It’s great to service, Laura, to this market. They have spent as much time as we just have talking about any single deal in any single, but I just kind of feel like I slipped back into just the whole provision that’s just not consistent with people who are going to see at PegaWORLD next week when they actually talk to the clients.

Laura Lederman – William Blair

Okay, thank you so much.

Alan Trefler

Thank you.

Operator

I am not showing any other questions.

Alan Trefler

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

Craig Dynes

See you all at PegaWORLD.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Pegasystems Inc. Q1 2010 Earnings Call Transcript
This Transcript
All Transcripts