Pegasystems Inc. (PEGA) Earnings Call Transcript & Summary

All right. Good morning, everybody. I'm Steve Enders on the enterprise software team here at KeyBanc. So we have Ken Stillwell from Pegasystems. Ken, thanks for coming. Really appreciate you guys being here.

Thanks, Steve.

I guess to start off, can you give a high-level overview of Pega, for those who may be new to the name in the room?

Sure. For those of you that have not heard of Pega until the more recent years, you're probably going to connect us more to the CRM space, which is kind of the fastest-growing part of our business. For those of you that maybe have known Pega for a while, you may have thought about us more in the business process management space, which is now kind of combined with a bunch of other things like robotics and others to be called digital process automation. So our business right now is about half and half, half CRM and half digital process automation. The common question that people ask is, "Well, those are 2 different spaces. What is the relevant kind of symmetry between the 2? Or how do you split the business between them?" Business is largely split equally between the 2. And if you think about in both, there is a workflow or an activity that needs to be executed, whether that's an issue, an event, a transaction in the back office or whether it's a client engagement across different disparate systems, different channels. And where people really see the value from Pega is the ability to orchestrate and drive that end-to-end automation across a series of steps in a workflow or even kind of concurrent steps that may be happening with the consumer to build a kind of a real-time view of what's going on. And so the actual process, whether it be front office, CRM or back office, digital process automation, is largely the same, trying to execute work across a series of disparate systems. And you want to try to automate as much of that as you can so that you don't have human interaction constantly getting kind of bottlenecking and stopping the process.

Okay. Got you. And also to this, you've been going through a little bit of a cloud subscription transition, so your revenue reaccelerating this year to roughly 20%. Can you help us think about the drivers to this growth guide? How much of it is renewal opportunity versus driving net new ARR to Pega?

So for the last few years -- so for those of you that aren't aware, we were largely -- going back, I've started about 4 years ago. When I started, we were about 2/3 of the business was perpetual. And so we went through a pretty significant shift to move from perpetual to where now that our perpetual business is less than 10% of our business. So in those, call it, 4 years, as many of you have probably seen with other companies, we went through this revenue trough of the transition to recurring, where we had a few years where the revenue was largely flat. And 2020 is the first year kind of halfway through the transition where the revenue starts to normalize. That said, where is our acceleration in growth coming? Because our -- even through that transition, we've actually had kind of an interesting acceleration in our growth, which is not typical for a company achieving $1 billion in revenue to then to start to accelerate growth at that point. I think it's a combination of a number of things, some more tactical like we needed to have more selling capacity against organizations. And we just -- we really needed to make investments in the go to market to help support that growth, some a little bit, once again, more tactical. We needed to go a little bit more down market. We were primarily focused on just the largest organizations, like the top maybe 500 or 600 companies in just a handful of verticals. What we found out was that if you drop down to, say, the Global 3000 or even Global 5000, the use cases and the propensity to spend in, say, a midsized financial services institution is still very large and certainly in need of a solution like Pega. And then more strategic, what we went through this journey over the last, call it, 5 to 7 years of selling applications and not a platform that you build an application on. We can still do the latter, but where a lot more of our growth is coming from is customers coming to Pega saying, "Look, I want to buy something that is a little bit more finished. I don't want to build it myself. I want to finish maybe the last mile, but I need something to be more 60%, 70%, 80% out of the box, and I can configure the rest versus building something from scratch." And so with that, it's made us kind of looking at the best of both worlds. You can get a very powerful real-time platform that you can configure and build for change, which, by the way, is our tagline. And you can also get started faster with something that's a little bit more complete when you buy it, whether that's a horizontal, like sales, service or marketing automation or if it's a vertical like Know Your Customer in banking, or disputes in credit card or maybe customer decision, customer offers for digital channels, as example.

Okay. It's interesting. So I mean, I know you're going through this cloud transition. How are your customers actually thinking about where they're deploying to when they get to the actual purchase end of it? How do they think about going on-prem versus running Pega Cloud?

So we typically -- our clients are typically -- I would say, given that some small percentage of our business is perpetual, you still do have the conversation about clients wanting to buy perpetual license and put it in their own data center. I'd say that's definitely not the norm anymore. But typically, clients are looking to do 1 or 2 things. They want us to manage their application or they would like to buy our technology and they want to manage it inside of their virtual private cloud. So we call that Client Cloud versus Pega Cloud. Pega Cloud is where we manage it. Client Cloud is where they manage it. What we've seen really kind of at a very accelerated pace in the last, say, 2 to 3 years is clients moving more to everything has to be done in some type of a cloud. And I say cloud, meaning, there's just so much dependency on other applications. There's so many -- so much security challenges, et cetera. So they either need -- they either use us for things where they really don't have the bandwidth or the capacity to manage or they try to use -- they use us inside their own virtual private cloud, like whether they use AWS or GCP or Azure, Pivotal or whatever they rolled for their own cloud, where they may have certain either security or internal policies where they need to manage it themselves. So that's why we really endorsed the concept of Cloud Choice, which is what does the client need? A good example is financial services, which is probably the easiest one to kind of understand. If you go through and understand the evolution in financial services, about 5 years ago, there were not many applications that the regulators would allow to be a managed provider data. If you look now, it's probably north of 50%, but there's still a lot that they want. And if you talk -- if you listen to -- if you listen to Jamie Dimon or the like, they'll talk about how they're trying to convince the regulators they can move more to the cloud, but the reality is there's the pace at which they can do that. So my view personally is you'll never see everything in managed third-party clouds, because there will be this balance. But I think you've seen the momentum of trying to get as much as you can there.

Okay. Interesting. So we've been hearing some questions from investors about your recent convert offering. Just kind of wondering how you're thinking about potential use cases for the cash? And I guess, what does that mean for dilution for Alan who owns roughly 50% of the company now?

Yes. So for those of you that aren't aware, we have -- our founder is actually still our CEO. He owns right around 50% of the shares and has for years. He has not been a seller. He's only been diluted through employee grants and other dilution. So he's well non-diversified in his Pega holdings. The convert that we did, quite frankly, was just -- the market was so attractive for converts. I mean with volatility high, with interest rates low, the attractiveness of our float now and a lot of investors that we use this as a way for them to actually get into Pega because they couldn't actually get in through normal liquidity measures to get a position. So we just felt like it was such a great opportunity to get exposure, to get investors an opportunity to invest. The actual terms were so favorable. Now to the use of proceeds side, I think there's a couple things to think about. One, naturally, we maybe look a little smarter than we did when we did this because we did it the week before -- we did this 2 weeks ago. So things have changed a little bit in terms of the market liquidity right now and the interest in things like converts. But we didn't have any idea that was going to go on. But I think what it did was it gave us this flexibility to be able to look at strategic acquisitions, to be able to buy back shares, to be able to expand and help to accelerate our growth rate and ACV, Annual Contract Value, which is our primary growth measure. So I think it just provides us a level of flexibility. Now in the event that we actually find the right investments 5 years from now, there could be a dilution impact, but we also intend to be a much different business with much higher free cash flow margin such that we don't anticipate that will be an issue for us.

Okay, got you. As we think about those investments you have been making, you invested heavily in the sales force and go-to-market activity. I guess, how are you thinking about how effective these investments have been ramping? Have they been executing as expected? And how do we think about future investments on the sales front?

So the decision we made -- maybe start with why we decided to try to increase our growth rate and why we thought that was possible. If you look at where we rank from a product or solution standpoint, I don't think that there would be much dispute about the fact that we -- our solutions are certainly good enough, if not best-in-class, to be able to win in the markets we're in. The second thing is we're in markets that are growing and are large. Well, CRM market, I mean, if you just look at any of our competitors and see how they size it and given our size, I think the market is plenty big for us to be able to continue to grow. The next thing was, can we hire the right people? Can we hire salespeople? Can we get them ramps? Can we make them effective? And that was a question for me personally, as a CFO, like I -- because we have not done that. So we started on this journey about a little bit more than 18 months ago. And what we've seen is we can actually attract people that we couldn't attract as hires 5 years ago. We can -- we actually are able to ramp people with applications and selling applications. They're coming from companies that are used to selling applications. So we can ramp people. They know the markets we're in. They know the acts of the companies because we typically hire based on a vertical slant because we're going to market largely with -- like you have to have vertical domain expertise in the enterprise space, as all of you probably know. So it felt like we have the solution, the market is big enough, and we actually can find the right people. Over the last 18 months, then my paranoia became, can we ramp them? Are they actually building pipe? Are they going to close the pipe? Is the quality of the pipe -- and is it -- are we going to be able to retain them? Are they going to turn over? So what we found through that journey is that pipes growing faster than the hiring, and ACV has accelerated over the last -- it certainly accelerated at the end of Q4 in 2019. But even when you look at compared to 2018, 2018, our ACV growth had a tailwind from the perpetual movement to recurring. So even though it looks like the growth rate was about the same, the actual growth rate of the business accelerated in 2019 because it's kind of more of an apples-to-apples. So I felt like, given the investments we've made, the growth rate is accelerating. Our solutions are that much more relevant. Our brand is getting more known. That helps us not only on new customer acquisition, but also retention. And now we have the ability to sell on a recurring basis with cloud optionality. So I feel like we have, like -- really the momentum is building for Pega.

Okay. That's great to hear. I know at your last Analyst Day you talked a lot about going head-to-head against some of the big CRM players out there and how -- you needing to hire headcount to more effectively compete. How have you seen that dynamic kind of maybe play out since these reps are ramping and reaching productivity?

So one of the leading measures that I look at in -- and I'm a little bit of kind of a sales-biased CFO is because of my background from private equity. But the way I look at it was, can we get people in and can they make the right types of connections with the right executives that are going to buy a solution like Pega? And what has been amazing is as we put capacity on some of our larger organizations, the amount of engagement that we're getting with executives, the amount of relationship building, the meetings that we can get Alan or myself or other executives in front of just because of the sheer amount of capacity momentum that we have with some of the largest organizations is noticeably different. Then you look to pipe build. And like I mentioned before, pipe build has been extremely strong. And then you say, "Well, are you converting the pipe?" And now you're seeing that each of the last few quarters, you've seen this acceleration in growth in both dollars and the percentage growth rate. So what I would say is we want to see maybe more of the same, continue to grow, continue to enable, get people ramped even faster than what we've seen. And we're still woefully under covering against our competitors. If you look at like our largest competitor in CRM, which many of you may have heard of, they actually have -- they might have 50 or 100 salespeople covering a large organization, and we might have 3. I mean just to think about the sheer massive -- so we still have a long way to go until I would say we're adequately covered. As long as they can produce, then it feels maybe not like a flywheel, but certainly smart incremental investment.

Right. It seems like there's huge opportunity to keep penetrating those kind of accounts where...

I think so. We're not even -- if you objectively look at the spend with any of our largest clients, I don't think we're 10% or 20% penetrated with any of them in terms of the opportunity that we could go after in each one of those organizations.

Okay. So you feel like there's still a strong opportunity to grow 20-plus percent over the next...

I do. I do. We're also dealing with a little bit of a law of small numbers in the space we're in. I mean, we're $1 billion in revenue in a space that's $100 billion. For us to grow 20% isn't even noticeable in terms of the cannibalization we'd have to do from the market. Plus the markets we're in are growing somewhere in the 11% to 14% range. So they're actually growing enough that we don't really need to cannibalize much to grow at 20%.

Right. Okay. I'm just saying maybe we can -- I'm going to pause here to see if there's any questions from the crowd. [ Sean ]?

I guess, I mean, you have the proof points that you've seen over the last 18 months. I mean [indiscernible] maybe step on the gas a little bit harder [indiscernible]

So I think that there are people in my leadership team that would probably feel that way. Certainly, Alan, our CEO, would -- believes that we can grow much faster, and we can. My pause is, and this is coming from just experience, not the market we're in, to grow a sales team 20% to 25% a year is very sustainable for long periods of time. To grow a sales team at 30% to 40% a year is very difficult. You have a lot of turnover. It's tough to enable at that pace. And to grow 40% 1 year and 10% the next is completely inefficient because your recruiters don't get any momentum. I feel like the sweet spot that I've seen is 20% to 25%. And I feel a little bit nervous of the diminishing returns I'll get trying to accelerate that much higher right now. What I'd like to see is productivity go up so we can increase sales people at 20% and grow at 30%. And because we're still not the most productive selling machine. So I think maybe that's more the angle I would take to try to accelerate the growth.

Okay. Great. Maybe just switching focus a little bit to emerging tech conference. So I mean, you guys have embedded like AI in the core of your platform for a long time. So just wondering how you think about the market today for process automation? And there's a lot of people up here talking about RPA. Just wondering what your view is on that market today.

So I'm going to connect RPA and AI together because I do think they link at a more advanced robotics. So for us, we view robotics in 3 buckets. First bucket is robotic process automation. This is just the way we view it. Not to say that this is necessarily the right answer for everybody. RPA for us is really the evolution of what used to be called screen scraping, right, which is OCR technology, grab something on a screen, repetitively help people log in to them. It's really unattended robot efficiency play. And I think that's really where a lot of the new entrants are take -- or capitalizing on that. When 2 applications have an API or an integration together, RPA doesn't necessarily solve the same problem because the systems actually can talk to each other. So you don't necessarily -- you can do that logging in through the application interface. So we view RPA as certainly kind of a necessary first step. And I use the word band-aid, not in a disrespectful way, because band-aids actually helps solve problems, too, but I do think it's more basic. Then there's the robotics that we have in our platform, which is inside of a workflow. What can you do to automate things so that it takes out human interaction, it takes out necessary -- unnecessary bottlenecks that advance the steps, it clears approvals, et cetera? Then the last point that really hardly anybody is doing, which is this robotics with AI, which is, now I've got a robot and I'm executing something, but what am I learning from the process that I'm going on? Do I realize that when I send something to Ken Stillwell, that I open up the screen and I hit click approved within 3 seconds, I'm seeing and I probably not really necessary for an approval because what could you process in that? So you kind of start to think about what are the things that the system can do automatically to change the workflow, to change the rules, to use the data to drive different information, to set notifications up, et cetera. That's where I think -- that's where this robotics thing can, I think, really get to where it's really around machine learning and robotics. Now the one caveat is, it's very difficult to do that if you're not operating inside of the application landscape because you have to understand the context of the application. It's tough to know what an application is doing by just looking what's on the screen -- looking at what's on the screen. And so understanding like all the way the fields on the screen connect, but also fields that aren't even on the screen. So I think that's why I think robotics needs to get closer to the application than it currently is. And that's where our big differentiator is at Pega, is our robotics live inside the Pega Platform than the actual end-to-end automation. Therefore, we can do things that you couldn't otherwise do with our RPA solution.

Okay. That's interesting. I mean, I know in the last call, you talked a little bit about Project FNX, and this has been a big investment there. I'm sure you guys are going to talk a lot more about this at PegaWorld coming up in, I guess, May or June?

Yes.

I'm just wondering, how are you thinking about Project FNX? How does that augment the Pega Platform today?

So what Project FNX allows us to do is continue on this journey of being more cloud native than we traditionally were. As we've moved to cloud, right now, the Pega solution is largely, not exclusively, but largely a single tenant solution. What Project FNX allows us to do is essentially compartmentalize some of the pieces of Pega technology into a microservices kind of environment, where then we can operate in a cloud control plane in a way that we couldn't otherwise do with maybe an application that was more tightly connected. So I think the real key is that we want the Pega application to be able to operate within this dynamic changing world of Elasticsearch and Kubernetes and do all the different kind of cloud control plane and AWS, Azure, Google, Pivotal, like all the infrastructure providers to be able to be as flexible as we can. And when we want to push a piece of new code or new capability, we don't want it to be limited to an upgrade cycle. The ability -- that's traditionally the way that on-premise software companies used to have upgrade, and that's really where microservices as a technique has really emerged. So that's where our Project FNX is driven towards, which is we've made a ton of progress. We announced it last year at PegaWorld, which is the beginning of June in Boston. And then -- so we've had about a year that we've been working on this. And we -- it's not a complicated thing. It's not like we have to rearchitect anything. It's just the fact that our products are tightly connected and we want to make them a little bit more with tighter APIs, but operating a little bit more isolated, so that we can evolve each of the different functionalities like workflow, case, AI, robotics, the pieces of the product.

Okay. And so ultimately, making the platform more nimble and you can update...

More nimble, which then allows us to go to multitenancy. And then at some point, it could allow you to go more down market, right, where you could actually go hit a bigger addressable market because you don't have the implementation, the size of the deployment issue that really keeps us kind of in the Global 5000.

Okay, interesting. I know there's also been a lot of discussion in the market about low and no code recently. And I know that Pega has done some -- made some more focus there and kind of built out that side of it. How do you think about, I guess, more customer interest in low and no code? And how has that changed over the past few years?

So the interesting thing is Pega has been a no-code company for 20 years, which is interesting, well before low code even existed as a term. But I do think it's important maybe to give our view of -- there's 2 different types of low code. There's low code as a technology and there's low code as a philosophy. If you look at low code as a technology, and I'm really generalizing here, it's essentially a sandbox where someone can build an application, small users, probably more simple to try things out. We have Pega Express. We actually do have an application that is low code, where you can do that. However, not many large enterprises build very mission-critical systems from the ground up, starting with low code. But we think it's really important because clients -- it's certainly a testing area and it's certainly an area that we need to be relevant at. Then there's low code or no code as a philosophy, which is when you build an enterprise application, can it evolve? Is it easy to change? Or do you have to go write C++ and Java and all this, .NET, all this custom code that makes it really, really hard to evolve it? We are all in on that. And that's what Pega -- our tagline, Build for Change, and the Pega ability to configure in the UI, so that when you change a UI, when you create an icon or a screen or a drop-down, Pega actually creates the Java code for you, right? You don't have to -- so that way, it's easy to upgrade to sustain the product. So I think we're all in on low code, no code. And I would say, low code is certainly something that a lot more clients want to use as a starting or trial point for innovation.

Okay, interesting. I think we have about time for one last question. I just want to check in the audience first. Okay. So I'm going to talk -- or ask a little bit, like as you think about Pega and where you see the platform in 5 years, how do you see the opportunity in the market evolving? And how do you see the Pega Platform changed in that time?

So I think there is -- there's been an evolution that I've seen at other companies before I was at Pega that is still continuing, which is more people want to buy best-in-breed applications. They're not looking to go to one provider. That's just -- we're going the other direction from that, right? Nobody wants the -- in fact, I would even say anybody spending 5% or 10% of their technology budget with one provider is probably too concentrated. So I think everybody wants to look at what's best-in-breed, what's my problem, maybe even have multiple solutions that are actually trying to help solve that specific problem. So that is where we're going. We're also going to a, what I would call, a cloud-flexible world, right, where it could be managed here. It could be on-premise. It could be region-specific because, remember, the amount of regulation that's happening in countries, in industries is just massive, right? So you don't know what is going to happen in Germany or France or even the U.S. 2 years from now. So you need to protect yourself. You need to insulate yourself from any of those external things that might cause a threat to your infrastructure. That's not going to change. The last thing is, it's the amount of data that you're going to need and the amount of connection points isn't going to change. And the speed in which you have to get things done is only -- the expectation is only going to be faster, right? So you're going to want things done in milliseconds, not hours and days and weeks. If you put all that together where Pega, I think, is well positioned is to be the orchestration layer between all of these best-in-breed applications that actually do not understand the full context of the whole journey with the customer, for example. And how do you weave together what could be 20 or 30 or 40 steps in an execution with a customer, with all disparate systems, with your company, with partners, with things or distributors, places where you don't really have the data? How do you orchestrate that in a way that you can actually keep some level of context? And we think of that as more the fabric of how workflow and process actually execute. And I think that you will likely see Pega not selling a Microsoft commoditized product like Microsoft Excel or Word. That's not really ever who we'll be. And you'll also not see us as a custom development environment. I think what you'll see is us being kind of almost kind of a middle layer or a foundation that allows this orchestration between the applications, so that you don't have to compromise by getting mediocre end point applications. You can pick what's right for you, but still allow this unification across the value chain.

Great. That's really interesting. Well, Ken, really appreciate it. Very glad you guys made the trip out. And thanks again for being here.

Thank you. Appreciate it.