Pegasystems Inc. (PEGA) Earnings Call Transcript & Summary

So maybe just to start, if you can give us a brief overview of Pega for those of us maybe less familiar with the story.

Sure. So Pega has been -- we've been around for quite some time. We started off in the BPM space, business process management space. And I would say that about half of our business right now is still coming from something that is at least closely connected to business process management, which is now referred to as digital transformation. It includes process, workflow, case management, robotics. It's kind of the end-to-end work automation. So about half of our business is still in that space. And about half of our business is in the CRM space. And when you think about CRM, you wouldn't traditionally think of Pega as CRM in terms of the sales automation aspect of CRM, which is not really where our heritage came from. It was really around customer service automation and marketing automation is where we have deeper penetration. So we have about half our business in CRM, leaning more towards the customer service side, because that's where you would connect with the back office a lot more. And about half of our business supporting the operational kind of getting work done as it's commonly called digital transformation.

Cool. Thank you. So just going in terms of the ACV growth. So it accelerated from 16% growth in 1Q '19 to 23% for the most recent quarter. Just in terms of how should investors think about that? And how do you think about the growth, if that's a sustainable there?

So in the previous couple of years, so 2017 and 2018, our ACV growth, optically, looks fairly consistent to the growth rate in 2019. The reason why that was is that we had shifted from a perpetual business to a recurring business during that time period. So you had somewhat of a tailwind in the ACV growth as you were moving from selling perpetual to selling recurring. 2019 is a very pure growth year, meaning that the percentage of recurring was about the same between '18 and '19. The percentage of Pega Cloud was about the same in terms of new business. So I think that the growth rate in 2019 accelerating is largely a function of 2 things. One, I think the attractiveness for Pega in the markets that we're in has been increasing over the past 5 to 10 years. But even in the last 24 months, we're recognized more as being one of the important players in the CRM markets. That's helped us. The second thing is that we've made investments in our go-to-market capacity over the last approximately 18 months. Because I think that we -- the supply that we have of sales capacity was, I'd say, woefully inadequate for the demand of the market size that we could attack. And so we felt like a thoughtful increase in the investment would yield bigger pipeline growth, which would then turn into ACV growth, which naturally then turns into revenue growth. And I think we're seeing the start of that now with strong pipe and with our ACV accelerating into Q4 of 2019.

Cool. That's great. And in terms of the -- you have a lot of metrics when you report. And so just in terms of backlog, how should investors think about that? Is it important metrics for Pega?

So the way that -- I mean -- and maybe I'm saying something that all of you take -- kind of understand and maybe even take for granted. But the simplest way to think about our business is the first leading indicator is whether -- the first leading indicator that the market can see is whether our ACV growth is -- what our ACV pace is. The first one we see is pipeline growth. But the first one that you see is ACV. So once you see the ACV growth, one of the validations that nothing has substantively changed around the duration of those deals is to look at the backlog or the remaining performance obligation because it gives you a sense of the layering in of commitments by each of the different revenue types. We actually show, I think, what is probably a more fulsome disclosure in our RPO because we show it not only by the revenue line items, but we also show it by each subsequent 12-month period. So it kind of gives you an idea that you can compare year-over-year. The next thing that would happen is, of course, it will turn into revenue. So for us, the revenue growth is really a very lagging indicator to the business in a recurring model. And the most important measure is the ACV growth, but the backlog is kind of that validation point. And so for example, if you wanted to gauge what the growth in, say, Pega Cloud would be next year of revenue, you could very easily do that by taking a look at the different tranches of years of backlog, and assuming that the renewal cycle is relatively linear, you could kind of get a prediction there on that would be a leading indicator to the revenue growth. So that's the way I use backlog. A lot of times, ACV growth is a little bit more difficult to translate into revenue because it doesn't always translate in a very logical manner, but the backlog helps to be that calibration between revenue and ACV.

That's great. That's really helpful. And in terms of you have Pega Cloud and then you also have Client Cloud, so in terms of your customer, how do they usually think about the difference in cloud choice, which one they should choose?

So there are a couple of factors that clients used to decide whether they want us to manage, i.e., Pega Cloud; or they want to manage, i.e., Client Cloud. And the -- sometimes, it's a regulatory issue. Some like banking, for example, there are certain applications they just cannot use a public cloud for because of the regulatory environment. Sometimes, it's a cultural thing. The companies don't want to use a public cloud for certain data, certain process or certain applications. And sometimes, it's maybe more of an architecture discussion. They have certain applications inside a cloud that they're managing, and they would rather let Pega sit inside of that environment that they manage versus allowing us to manage it for them. It is not typically an economics discussion. It's not a feature function product capability because it's the same product, whether it's in Pega Cloud, same capability set or it's Client Cloud. It's typically around their own environments and what's the best thing for them, which is why we really stick to cloud choice as a part of our strategy because we're not in the business of telling our clients how they need to deploy their solution. And we think that a lot of companies that force this transition risk forcing clients to either pick another solution or to suboptimize their own environments that they're comfortable with. And we're not selling low-end commoditized software. We typically sell transformational enterprise-wide software. So the decision on the client's deployment mechanism and management is really important to them.

True. That's great. And you touched on this a little bit just in terms of the pace of sales and marketing investment. So in terms of that, you decide to invest in the business. So maybe what are the expected outcome? Should we expect to see that in 2020 or '21?

So I think you've started to see some of the first signs of the return on that investment even in Q4 of '19. We started this in earnest the middle of 2018. We decided that the market was too big. We were woefully inadequate on our selling capacity, and we needed to make this investment. And as a CFO, I was watching this investment and maybe a little paranoid about this investment and whether it would yield the returns that I hoped it would and when. And so, for the last 6 quarters, for many of you in the room and others, I've been answering that question, like how confident are you? Why have you made the investment? When are we going to see the return? The first thing that I look to was the quality of the people that we were able to hire. The next thing I look to was the speed at which they became enabled and built pipeline, right? That's a measure that not all of you see -- or none of you see, excuse me, but I see, and that was kind of my first early gauges. The next piece of that was how quickly did they turn into deals? And are we retaining these individuals, right? Are we able to keep them and make them successful at Pega? And so what we started to see now is the pipe build has been strong now for a few quarters, which is now what that first batch of hires have actually been seasoned about 12 months into the company. You started to see the booking growth peak up at the end of the year. Our ACV growth is slightly higher than it was at the beginning of '19. You're now seeing, in 2020, the revenue start to transition over. So you're actually seeing the model execute into the optics of that -- so that I think a lot of investors are going to be more comfortable now that everything I've been saying for the last 2 years is actually coming true in the reported results. So I think if that all continues, I'm very comfortable that the investments we're making are going to ramp and yield the outcomes we want. I think the thing -- the 3 questions that I've asked as to whether -- I ask myself that I would ask all of you to consider is: one, are we in a big enough market to support Pega growing our sales capacity by 20% to 30%? I would suggest, yes. The second thing is, do we have the right product set? Are we competitive enough in the space that we're in? Is Pega able to actually grab more market share? I would say, look at the analyst reports, talk to customers, look at the momentum we've made even in the CRM space in the last 3 to 4 years in terms of the brand. The third one is, can we hire people that can be successful here? And that one, I would say, I am seeing really good signs that we are an attractive employer. If you're interested, you can go to LinkedIn and do some filters and look at where we're hiring, all of our new hires and see where they're coming from. I think they're coming from pretty interesting companies that have similar selling motions as Pega. So we can hire the right people, the product is strong enough to win, and the market is big enough. We're a pretty small player in this market. So I feel like that aspect of it is an obvious yes to those 3. It's all about execution then. Are we going to execute to actually get the yield. And I feel like that we're seeing the early signs of that paying off.

That's awesome. So I have a couple more, but just wanted to open up for questions, if we have any questions from the audience.

Related to OpenSpan acquisition, can you talk a little bit as to your thoughts on potential in the RPA market and how you [ view the competitive landscape and your position in that space ]?

Sure. Just to repeat the question. The question was around our OpenSpan acquisition that we did in 2016 and how we think about the robotics or RPA space and specifically around the Pega Solution. So -- and for some of you, I'm probably repeating something that I say often. I view that there are 3 aspects of robotics. There's RPA, robotic process automation, which essentially, the way I would frame that is that's kind of analogous to the old screen scraping, right? It's kind of control pay -- it's control C, control V, right, copy, paste. Takes a part of the screen, does OCR and uses it to automate populating log-ins to other systems, populations and Excel files, et cetera. So it's something that a customer service rep or someone like that would use almost in tandem with their own work to make them more efficient. That's RPA. There's the other extreme of robotics, which is the system making decisions without human interaction, right? They're using AI. They're just driving decisions. Everything is automated. So literally, you're interacting with the system, and there's a call center person that might instead of one-to-one with a consumer, they're one to thousands of people do it. So it's kind of like we are nowhere near that as a model of the way robotics is being rolled out. But there is potential to get there at some point. The middle is where we like the OpenSpan, which is we don't want -- we really -- for Pega the screen scraping aspect of it becomes a little bit of a band-aid where APIs don't exist between 2 systems. Because if there's an API, you don't need RPA because the systems know the field they can populate. You're trying to bridge things that don't naturally connect. But the problem with that is it doesn't understand what's happening off the screen. It only understands what's happening on the screen. So what we -- the reason why we liked OpenSpan was OpenSpan has taken a different approach, where they actually are in the code base, they understand the applications and what's running. And even though you might not be able to see like a drop-down on a screen, they know what those fields are, and they know the impact of copying and pasting or interpreting something. They know if you change the UI and you don't show something, they -- it still knows that that's part of the application. And that's what we call Pega Robotics. And what that allows you to do is, in a workflow, it allows you to automate things screen never sees, that a user would never see. It allows you to skip steps or auto approve based on patterns, right, that you can learn. And that, to us, is where the real value in robotics is. RPA is very helpful and useful, and we have an RPA solution. And I would say what is really core to us and why OpenSpan was so critical is they did it in a different way. They didn't just sit as more of a layer on top of the screen. They were embedded in the app. And I would make a -- but I don't think it's a bold prediction, but I would make a prediction that if you thought about the way robotics will really manifest itself, it has to be inside of an application. It has -- anywhere, if it's ERP, whatever. Because if you don't understand what the application is doing, you can only be maybe as smart as what's on the screen. And that becomes limiting in terms of scale rollout and the real value of the robotics. So that's our position around robotics.