Pegasystems Inc. (PEGA) Earnings Call Transcript & Summary

Great. Okay. Good afternoon, everyone, and thanks for joining us at JPMorgan's 40th Annual TMC Conference. My name is Tim Carpenter. I'm a managing director in our technology and investment banking group here at JPMorgan. I'm very excited today to have with us Ken Stillwell, CFO of Pegasystems, which is an enterprise software company and powering digital transformation at the world's leading enterprises. Ken has over 20 years of financial leadership experience in hybrid tech organizations. He's a certified public accountant. And he's based in the company's Cambridge, Massachusetts headquarters. Ken, welcome, and thank you for joining us today.

Thanks, Tim. I appreciate it. Glad to be here.

Absolutely. So to start today, I guess, for those in the meeting who may be new to Pega, can you give a quick overview of the company? I think just understanding a little bit around the product set, the markets you serve, and also just kind of that automation market, how that and your company specifically has evolved over time?

Sure. So for those of you that may not know the history of Pega. Pega has been around for a number of years. We started out as a little bit more of a custom engineering organization where we helped our clients with very transformational applications, processes, things that were -- where we're trying to help them execute certain things across a workflow. What that led to was us productizing our workflow and our case management capabilities to really help define what was called the business process management space. From there, it led us into a primary use case that we still see, which is supporting the digital transformation of contact centers, of customer service and customer experience management across multiple channels. And that was our first entrance, where we started to engage in what you might call front office or CRM-type opportunities. We did a transformational acquisition about 10 years ago that gave us -- kind of augmented our rules and decisioning in AI with a best-in-class one-to-one customer engagement marketing automation solution. So with our experience around service automation; and then our product set and experience around marketing automation; and we've built out capabilities to support the sales automation space, we really had a full suite in the CRM between sales, service and marketing automation. And what is interesting is that the workflow and the process execution orchestration, as you might say, in the front office, across the different ways that you interact with your clients, is very analogous to the way that you might manage a workflow across operational systems in the traditional business process management space. You're really dealing with disparate applications where you're trying to seamlessly execute end-to-end automation and leveraging things like robotics and our decisioning and AI capability to make that execution brilliant across the organization. And hopefully, to minimize the effort required by not only your employees, our clients' employees, but also the consumers themselves that are actually trying to execute certain things. It also really is relevant in an omnichannel environment, where the customer journey should not be thought of in a channel; it should be thought of across channels such that you can bring that experience together. One of the biggest challenges that we've seen with our clients is that they want to buy best-in-breed software. And that best-in-breed software doesn't always talk to each other in terms of executing work. And that's really where Pega can help to become the orchestration or the management across all of the different applications as well being one of, or multiple parts of, the application landscape. Our primary verticals that Tim alluded to earlier is, we've done very well in financial services, insurance, the comms industry, health care, manufacturing and what we would consider to be the public sector, which if you think about governments are really managing constituents very similar to customer service use cases. And so when you think about Pega, you want to think about that end-to-end automation, real time, the ability to put robotics and AI into that execution to be able to drive efficiency across getting work done.

Yes. Absolutely. Okay. And I guess real quickly, you spoke about kind of the industries you serve, the companies you focus on. Where on the spectrum of kind of small to massive do you focus?

We have traditionally stayed towards what you might say would be the top of the pyramid, the global 500 to 1,000 organizations. Now about 5 to 10 years ago, we made a concerted effort in -- to go into what is more the global 2,000 to 3,000 to 5,000. Because what we realized is that those organizations have just as much of a need for digital transformation as the very largest. A top 20 financial institution has the same types of digital transformation needs that JPMorgan has. And so -- and they have significant scale. And so we realized that our solutions weren't really just -- it was maybe not capturing the market opportunity that we could. Now we're not going to go into very small, regional -- and using financial institution as an example -- regional or small banks because maybe it's -- we may not be -- our solutions may not be as relevant in the very, very smallest organizations. So think of us as if you've got 1,000 employees, if you've got $1 billion of revenue, which lot -- there's a lot of companies in that mix, Pega's very relevant, and probably those companies have heard of us already.

Yes, yes. Absolutely. Okay. And you talked a little bit about CRM and customer experience. So as we think about within those and then even outside of them, can you talk a little bit about some of the use cases, so some of these workflows that you speak of, that most kind of capture some of the things that you're automating? And what does next-gen -- from a use case perspective, what does next-gen automation kind of mean for enterprises today?

So some very common use cases that many people will have heard of that are very maybe -- that all of us live every day is when you're interacting with a provider, whether that be a piece of equipment like a cell phone, or whether that be a credit card or a bank loan, et cetera, you interact through different channels. And you may start that interaction, maybe on the web, and you might transition that interaction to getting on the phone with someone that may lead you to want to go to a distributor or to an actual branch location to be able to help further that discussion. That kind of interaction with your potential vendor, that client interaction, that customer interaction, to you as a user, is 1 interaction. But you may touch 3, 4, 10 different systems inside that provider. And when that provider's not able to manage that interaction, that customer journey in a seamless way, it leads to significant customer satisfaction issues. You have people where they will fall off that journey. They won't buy necessarily in the pattern that they would otherwise buy. They may have a bad experience. Quite frankly, they may actually cancel a product that they've already subscribed to. So that's an example where we would -- Pega would help, either through an actual service automation solution that we might offer, or actually helping to weave together other solutions to be able to unify that experience across those channels. Another example would be managing kind of a digital engagement channel. So think about a credit card servicing provider, a financial institution that's trying to do -- to try to customize and make relevant the interaction of consumers when they go to the website. You want to understand who that person is, what's the most relevant thing to offer, what's the way to maximize that experience and the conversion of that client to be engaged with you when they come to your digital properties. How do you improve and increase the lifetime value of that consumer. And so there's a lot of decisions that you need to make that are relevant to that consumer that are different person by person. So those are 2 examples of, one, where you're connecting channels and making it efficient for a consumer, and another where you're actually trying to offer the right thing. You're trying to help -- we're trying to help our clients put the right decision in front of their consumers so that they really make the buying and the evaluation process very efficient and also optimize the outcome for both our clients and the consumer.

Got it. Got it. Okay. That's really helpful. So maybe switching gears, let's talk about kind of COVID. I'd love to understand how you'd characterize the overall impact 2 months into lockdown and whatnot?

So there's a few things that are surprising to me and a few that maybe aren't. Our workforce at Pega, we went to remote work in, I don't know, March 7, March 9. Something -- we were pretty -- we were, I think, pretty early in terms of having people go remote. And what's been amazing is that we went from having 4,000-odd people in an office, to, I think yesterday, we had 50, right? And the amount of productivity that we've seen from our workforce is, quite frankly, amazing. Like it's very -- I thought that it would be much harder to be able to deal with a remote workforce than we've actually seen it to be. Now we did have technology issues, and some people have not the best workspaces at home, and you need to get some equipment to people like monitors and headsets, et cetera. Take away that kind of operational work that we needed to get done, which our team executed just flawlessly on in terms of supporting our workforce. But I just think the engagement levels, virtually, is just -- is really kind of encouraging. Now naturally, nobody wants to operate like this forever. We want to be able to get back to seeing each other and working each other. We are social, right? So but I think we're doing really well. What's also amazing is our clients are really engaging incredibly well. I mean, they're operating kind of in the same pace that we are in terms of really getting used to this temporary kind of environment and normal. Now granted, some countries have more restrictions than others, and so we do have to work through and try to be empathetic to our clients. But I think you've seen a lot of really hard work from our clients and even our partners, to really keep things moving. Now that said, there are going to be some things that are disrupted, right? Trying to do implementations remotely is not always effective. I would say most of the time, it is. Maybe 85%, 90% of the time, you can be pretty productive. But there are some that are just challenging, maybe because of the security requirements around the application, et cetera. Selling is, in some ways, more efficient, right? Because you're able to get a -- you're able to do a virtual interaction with a client. And in some cases, it's easier to get to the executives now because you know where they are, right? They are actually -- and they actually have made themselves available versus trying to get, say, a 1-hour physical meeting, getting people on a plane, traveling. So in some ways, it's actually more efficient. But it is somewhat unnatural for all of us, right, to try to keep the selling and the implementation process being virtual. So you do have that -- even though things, I think, are going much better than I thought. I do think it's not -- it shouldn't surprise us that it is hard, right? It is hard because people have -- they have children at home, they have distractions. I mean, you might hear a dog or a child bark in the middle of our discussion today right now. It is hard to keep the pace that we would have when we were in the office, but I'm really proud of how we've responded as an industry, quite frankly.

Yes. Yes, absolutely. It makes you wonder. So like pulling on that thread a little bit about digital selling. So help me think through a little bit, what's the impact on sales productivity? And I guess, specifically, what's the level of engagement that you're seeing out of customers and prospects in the upselling, in the new business? Like how should we think about that change in the world?

So once again, I don't think this is going to be surprising what I'm going to say. But I think when you're trying to engage with new prospects and new logos where you have no relationship, no previous relationship with them, I do believe that's harder than selling and engaging with someone that is already a customer of yours. So I think businesses that are more reliant on new logo acquisition as a very material part of their growth are likely to have a tougher go in this environment than ones where your -- more of your activity is with your existing client base. We are kind of in the middle of that. We have 2/3 of our new business with our existing clients and about 1/3 with new logos. So I think we'll do probably better than most because we do have very deep relationships and we focus on density within our client base to make sure that we have coverage and that we are really kind of helping our clients in as many ways as we can. But naturally, the inability in this environment of virtual, to make as much progress with new logos is something that everybody in enterprise software, I think, will deal with. I think the interesting thing also is the initiatives that you're working on. It is my perspective that initiatives where you're making significant improvements or transformation of the business to help you get a competitive advantage, either pre-COVID, during COVID or after COVID, are going to take priority over, say, just switching out an operational system that may be able to wait a year or 2 to actually execute that. So I think that there are some business models that rely on, say, replacement cycles and trying to get market share from incumbent systems. They may be a little bit more pressed than companies that are really selling something that is a new transformational value proposition to our clients. So we're hoping, with us being in verticals that are very financially sound and stable, and most of which are not impacted in the direct line of sight in the short-term from COVID, and us having a lot of our bookings coming from our existing installed base and relying in very high retention rates and doing digital transformation projects, that the combination of all of that will hopefully help insulate us such that we can do maybe better than some other companies that might go through this. And I believe there's a massive opportunity on the other side for a company like Pega. Because it's really helped -- companies are rethinking what they do. They -- are people going to be in offices all the time? Do you want data centers inside your facility? Do you want to move things to the public clouds faster? These are all initiatives that people are going to be thinking about, many of which kind of help to move the market closer to Pega?

Yes. No, it's a great point that everybody's been focused on the first couple of months here. But as you think about the longer-term impacts of the world we're in right now, the new normal. Certainly, it feels like some of the digital transformation and automation that you're focused on specifically get pulled forward in terms of prioritization. Not -- there are already pretty strong priorities, but it certainly pulls in a little bit. So let's talk a little bit about Q1 results. How do you feel about -- so you talked about ACV growth being kind of the primary -- one of the most important metrics to focus on in the midst of a cloud transition. How do you feel about 21% ACV growth in Q1? And how does that line up to kind of what you were expecting in the business?

So I'll flash back a little bit to March 7 or March 9, or whatever date we decided to encourage people to work remotely. I remember, and I shared this with our leadership team at Pega, I remember looking at our bookings to date in the quarter and thinking to myself, well, this might be it. I mean, we might not get another deal in March, right? I wasn't sure if people were going to work, or I wasn't sure what was going to happen. I mean, we've never had anything like this. This is unprecedented. And so I kind of was not really sure what to expect. And to my pleasant surprise, the business just trucked on. I mean, the -- our sales teams continue to engage. And did we lose some deals because of the natural melt that happens in a quarter and also some of the noise of COVID? Of course, we did. But we finished, I think, really in a respectable way. And our ACV growth stayed above 20%, constant currency, 21 -- actually over 21%. So I felt really confident that, that was a good finish for March, given all of the noise that you saw in the system. And I'm pleased to say that April and May have kind of continued to show activity and engagement. And so it's -- I wouldn't suggest that we are out of the woods, but I would say that business is definitely moving forward. And our clients are talking about their initiatives, and they're focused on it and they're driving it. Now I will tell you, people will reprioritize projects in this environment. And they will look to the projects that are most critical as you go through this type of -- things that can maybe help mitigate the dependency on people in the office, maybe help people that are remote, right, a distributed workforce. But I think net of all of that, it should be a positive factor for someone like Pega because we're helping our clients with exactly those initiatives.

Yes. Yes. So I guess similar type of growth was witnessed in the backlog, 19%. And so I think there's generally more focus on backlog because of RPO and so forth these days in disclosure. But help me understand a little bit around kind of why backlog is an important metric for you guys with your cloud transition? And maybe a little bit just in terms of where you are in that cloud transition.

Sure. Sure. So we started cloud transition in the fourth quarter of 2017. So we are a little over 2 years into our cloud transition. And we went from having a cloud business that was $25 million or $30 million of ACV, up to what is approaching $200 million in Pega Cloud ACV just in the last 2 years. So there's been a fairly big movement in the direction of Pega Cloud. And as a SaaS company, right, which we are increasingly becoming a SaaS company, where more and more of our bookings and more and more of our revenue and ACV and backlog will be SaaS, naturally, backlog and ACV are leading indicators to revenue, right? Revenue becomes a lagging indicator. So one of the things I think is important is ACV is an important measure, but backlog is also an important measure to show the amount of commitments, the duration of commitments, and also to help validate that the ACV or ARR measure is really a good measure for the business. Backlog is the place where you can kind of validate some of the revenue in the ACV expectations and make sure that the clients are still committing to reasonable durations of contracts, et cetera. And so we give a very robust RPO backlog disclosure. We give it by revenue type. And we actually even segment it by the year that the backlog will come in. And so I think that, that's something we've always been recognized even before ASC 606, because we disclosed backlog before it was required to disclose backlog. So we've always been proud about trying to demonstrate our transparency and highlight the commitments that have not yet come into revenue. And so you have to look at backlog and ACV. And naturally, revenue will be a kind of a lagging indicator of the activity that you've already had.

Great. Great. So maybe quickly, just to touch on capital structure. So you did a convertible debt offering in February. Help me think through kind of why you did that and what you plan to do with the proceeds?

So we started thinking about convert, quite frankly, over the last couple of years -- we talked to JPMorgan about it as well. And as you know, you participated in helping us as a sponsor for the -- for our convert offering amongst some other of our clients. And what we realized was that with the volatility being high and interest rates being so low and, quite frankly, the market really being kind of at a reasonably attractive level for software, that there really wasn't maybe a better time to consider a convert. We were also finishing up -- we got about halfway through our cloud transition. And for those of you that have not seen this model, when you go from a perpetual to a cloud transition, there's something called financing the transition, right? You go from getting all your billings upfront in perpetual, to getting your billings over time, and there is a cash flow headwind that you have as you go through that transition. We had funded about halfway through the transition from our -- from what we already had on the balance sheet and the earnings of the business. And we got to the point where we looked at options about finishing that transition but also creating kind of a capital structure that provided leverage that allowed us flexibility for share buybacks and also some tuck-in or strategic acquisitions, assuming that valuations were reasonable. So when we thought about this, we went to market looking to get really a few hundred million dollars of a convert, and there was so much interest in such attractive terms that we ended up upsizing it to $600 million. As you know, we could have went much higher than that if we wanted to, but we just didn't feel like there was enough of a rationale to go higher at the time. We didn't know anything about COVID when we did that, right? So now, in a COVID world, we're really thankful we did that because it just provides a level of insulation and allows you to execute on your business and not be distracted by some of the things that, unfortunately, some of our peers, our competitors, our partners are going to deal with. With just the financial pressure in the short-term of operating the way that we've been operating as a world economy. So I think we really didn't have a specific large acquisition when we did the cap raise. It was more of a mix of a bunch of things that we actually saw in the horizon. And thankfully, our timing worked out really well. And so we're really thankful that we did it now, given what we know of the last few months.

That's great. That's great. So maybe -- you announced a big win in April with the IRS. Can you talk a little bit about that and kind of that contract in particular? And are there other kind of opportunities that you would put on that same level out there in the future?

Yes, so -- Yes. So we're supporting the Internal Revenue Service in the U.S. for enterprise case management. And if you think about that couldn't be kind of a better definition of what Pega can do for the public sector, tend to talk about really managing work, helping them to execute work across all of their channels, which is what we're going to do with that agency. So much like our win at Census, where we were actually helping them execute work across a distributed channel of data gathering, et cetera. IRS is a similar type engagement. We went -- and typically, these things end up being an RFP where you compete against a number of providers. They down-select to a couple, and then, thankfully, we were selected as their partner going forward. I think if you look at the opportunity, and this isn't -- this is not a U.S.-specific. This is globally. There are agencies and governments looking at modernizing their work and their constituent interactions everywhere. There's a lot of homegrown software that is way past the useful life, so to speak, and the effectiveness. And they want to move to public clouds. And it's no surprise that governments want to be less dependent on hiring people as they go forward, and they want to use automation, and they want to use technology, and they want to leverage public clouds and products like Pega to be able to help streamline their work. And so I think the example at Census, the example at IRS, and I think there will be many more to come in the public sector for Pega.

Got it. Okay. That's great. So thinking about that kind of outlook in 2020 more -- kind of more immediately, the total sales pipeline today, how would you characterize that versus maybe this time last year?

In terms of pipe?

Yes.

So our pipe -- so we made a very -- a very big push into increasing our go-to-market resources about 1.5 years ago. We saw the opportunity. We are well-positioned. We have the best product in the market. And now, Pega is really recognized in the CRM space as a leader. And we really wanted to kind of increase our density and our push to be able to cover the largest organizations so that we could make sure they were aware of what we could do to help them with their digital transformation. And with that, we've now had our first kind of opportunity to demonstrate value from that, which is our pipe. And as Alan mentioned on our earnings call, our pipe has been growing nicely for the last year or year-plus, really where we've just -- and not only is it growing well, but some of the sales cadence activities that we implemented at Pega and, really, the pipeline scrubbing and precision of looking and challenging the pipe and really making sure that it's reflective of the future business, the fact that we've been doing that and the pipe has grown in a healthy way, is just encouraging sign that our investment that we made in go-to-market resources is starting to pay those early dividends in terms of helping to lead to our acceleration in ACV growth. We've been growing ACV by a little over 20%. But quite frankly, that's not fast enough. We should be growing much faster than that. And that's the reason why we made investments in our go-to-market.

Yes. So when you think about those investments going forward in a COVID world, are you still hiring? How do you think about sales capacity going forward?

We are still hiring. Albeit, we will hire in a very -- in a more strategic way. Probably a little bit more selective around the verticals, the regions, what types of resources we put where. I think we have to be, right, because there are -- there's going to be spend. There's going to be projects. But it's not just going to be everywhere. Some companies are very disrupted. Some industries are very disrupted by COVID. And some are used in COVID, quite frankly, as the catalyst to really get that next level of digital transformation. So I think that although we may not hire at the same pace that we started 2020, we are still hiring because we believe in the long-term value that we can provide to our clients. And we don't believe that any 3- or 6- or even 12-month period will distract us from that goal to increase our penetration with some of the best and most respected brands in the world.

Yes. Okay. That's great. So how do you think about ACV growth for 2020? And maybe as an add-on to that, one, I did notice that your guidance for the year of 1.1 and $0.20 on the EPS, that you didn't withdraw that. And we've seen a lot of companies, particularly ones that are not pure SaaS, change guidance or remove it. So help us think through a little bit kind of what the thinking was.

Sure. So we've guided -- we've had a history of guiding at the beginning of the year and not commenting on guidance, unless we did an acquisition of size that would make sense to adjust guidance. What I would say on the whole guidance philosophy, and this is something that I believe very deeply in. First off, if you're a business that has very strong visibility into your business, i.e., a recurring or a SaaS business, some amount of your revenue will be related to bookings that you do in the year, but not as much as the companies -- as, for instance, when Pega was a largely perpetual-led business. Given that we have much better visibility to our business, that was one of the factors that I think companies should consider about whether you make any adjusted commentary around your guidance. The second point that I would make is that I believe that we have a little bit of a challenge in the way that we think about guidance as an industry. And I do -- and I firmly believe that if you have visibility to your business, but you understand that there are inherent risks in your business, then I think you should present your guidance or your business model with that level of qualification. I think to drop guidance for a business that has the level of predictability in the business, I think, maybe unintentionally signals either a significant lack of visibility in what's going to happen in the business or, potentially, an unwillingness to maybe provide a qualitative view of what you think might happen. And we didn't really want to go down either one of those paths in terms of withdrawing our guidance or making any changes. So like I said, we typically do not address guidance unless there is some material event like an acquisition that would happen within the year. And quite frankly, we're moving ahead. There's going to be opportunity across the board as we move forward, and we're going to try to take our fair share of it.

Yes. When you talk about that opportunity, I mean, I guess, how would you characterize thinking about it in terms of downside pressure versus upside opportunity maybe in 2020? And then looking out beyond 2020, how would you characterize that longer-term outlook for digital transformation?

Yes. So it'd be disingenuous for me to suggest that anybody out there in software, any other industry, maybe with the exception of some companies that -- like telecommunication companies, et cetera, that may be -- that may get short-term uplift in their usage, to think that 2020 is not a harder year than when we started the year. So I definitely think there's more downside pressure than upside opportunity. That said, I think with Pega having, being in the verticals that we're in, having a large amount of recurring, having a very high retention rate, being -- supporting digital transformation, and really having a decent amount of our new bookings, our new incremental business from existing clients, we're set up to probably be better positioned than, unfortunately, some other companies maybe. When you get to '21, '22, '23, look, we will get through this. And we will emerge on the other side. And I say we as all of us, right, as an economy. We will see the end of this time. It may not be in August, like everybody wants it to be, but it will come. And when we're on the other side of this, digital transformation is going to be critical. Public cloud and moving into SaaS is going to be critical. And quite frankly, engaging with the most important organizations that are out there that actually drive a lot of the digital transformation spend is going to be important. And I think we're very well-positioned in all of those areas.

Well, that's great. Well, that ringing sound you hear is my timer. So we're out of time. Ken, appreciate your time, appreciate your candor and your insights. Really, really helpful. And thanks again for being with us at TMC.

Thanks, Tim. I appreciate the invite.

Yes. Take care.

Bye.