Pegasystems Inc. (PEGA) Earnings Call Transcript & Summary

Well good afternoon, everybody. Thanks for joining us for the final track of the day. We saved the best for last here, of course. I'm delighted to welcome Pegasystems to the conference. We're very fortunate to have CFO, Ken Stillwell, join us. Ken, thank you so much.

Thanks for inviting me.

Absolutely. Since this is your first time at the conference, Pegasystem's first time at the conference, why don't we just spend 5, 10 minutes, a little background on Pegasystems and the market opportunity that the company is addressing, please?

Sure. So Pega's been around for quite some time. We started off as more of kind of a custom application development company where we helped our clients with solutions that they typically couldn't buy kind of off the shelf, and they were more for customized use cases. That kind of grew into us becoming a leader in what was previously referred to as the business process management space, BPM, where we were a leader for a number of years. And the 2 biggest aspects of that, that helped us be a leader was our solutions-supporting workflow, using a case management approach. And so what that really was, was it was executing work through a series of process steps in an organization, and that was primarily in the operations or in the back office, so to speak, of a large enterprise. As time grew, we moved closer into the customer segment where we started to support our clients around the contact center, where -- the customer service software. In the early stages of the CRM segment, most of the CRM association was related to sales automation. So we really -- we never kind of connected ourselves to the CRM space in the earlier days of -- talking maybe 10 years ago or so. But as time grew and we did an acquisition that got us into the marketing automation space, we had very deep expertise in service automation. We bought a best-in-class company called Chordiant that did marketing automation with deep customer decisioning and AI capabilities. And we actually built a sales automation tool on our platform. We've been increasing our penetration and growth, leveraging our growth in CRM to grow the business. And that's been since probably 2012, 2013 that we really started to enter the CRM space. We became a little bit more well-known in the CRM space, probably a little less than 5 years ago, where we started to get recognized as a leader in the client engagement segment for CRM. So that's a little bit of kind of how we got to where we are now. The business is about evenly split between what is now called digital process automation. And that -- what that is, is that's the legacy BPM segment but also including things like robotic process automation, kind of fit into that digital process automation bucket. And then there's another segment that we're in, which is the CRM segment. And that's about 50-50, between the CRM and digital process automation. We focus on some of the larger organizations in specific verticals. So we do have a vertical-focused go-to market. And we are not only deep in the horizontal solutions of sales, service and marketing, but we also have vertical-specific use cases for -- as we go to market to be able to also augment that horizontal capability with the real vertical applicability. We've been moving through a transition to cloud over the last 3 -- 2.5 to 3 years, where we moved from a legacy perpetual business into a SaaS business and a cloud-relevant business. And in the last quarter, actually 95% of our bookings, what we call Pega Cloud or Client Cloud. So that was a pretty big shift for us. And right now, the market opportunity that we're focused on and have been focused on for the last few years is really more of a general theme called digital transformation, which is where our clients are moving away from their legacy ways that they managed both engagement with clients and also the way that they actually executed work in the operation of the business to move into a modernized digital engagement platform and really moving to the cloud, getting away -- trying to be more nimble with the way that we're supporting application-to-application work that needs to be done. And that naturally is much more relevant even now given some of the events of COVID and people moving now to remote work and also the expedited move out of physical data centers that will come with that.

Excellent. Interesting. So the roots are in DPM with the entry into CRM later. I guess the question is, do you have accelerators here for these verticals, obviously satisfying the needs, very specialized selling processes behind the industries that you go after. Financials, insurance, health care, communications, they're so different from each other and unique. And that's -- and I know that's part of the value proposition that you guys satisfy that. But how do you do that? It sounds like there's a platform that's extensible. Do you have solutions that you kind of built around here? From a product and a go-to-market standpoint, how do you address the varying needs of these verticals?

Yes. That's a great question. So maybe I'll start with just kind of highlighting a point that you started with, which is, whether you are in an operational environment or you're managing in an omnichannel digital environment with clients, there is work that is being executed across applications to accomplish a certain task. So that work has to go from a start to a finish. And what clients are trying to do is that end-to-end work automation. So they could execute whatever that thing is that they're trying to do based on each vertical. So now let's talk about some examples. In financial services, they might have a loan origination. They might actually have an onboarding of a new client. They may have a credit card marketing campaign. They may actually maybe have a wealth management cross-sell/upsell opportunity with a client that works with a commercial bank. That might be for financial services. For insurance, it might be an underwriting of an insurance policy. It might be processing a claim in insurance. Or in health care, in government, there's a lot of constituent management applications like at the U.S. Census, where we help them manage the census count and the aggregation and the deployment of all of the enumerators that then go out and canvass communities after the online census tallies are completed. So in each one of our verticals, there is a very similar workflow activity that needs to execute. And it is normally communicating with lots of different disparate applications. So Pega is used to centralize that process, that execution. But when you go into each vertical, well you need to understand the relevancy of that vertical. You need to understand the nomenclature, what matters, the regulatory environment. So it's very critical that not only do we have the domain expertise, but even the taxonomy of the way the product is structured is very relevant for that vertical. So the way that we go to market is we look for our sales teams and our industry marketing teams that support the sales teams with messaging and with kind of credible sponsorship for our clients. We need them to really be deeply versed in the issues that our clients have, which are vertically specific issues. And then we need to allow the leveraging of the Pega platform, the applications and the deep horizontal capabilities that we built on the product, to be able to execute that very vertically specific solution and leveraging robotics, AI, our case management capabilities and workflow, among others, to be able to deliver that very specific solution or integration or orchestration that we're doing for our clients.

Interesting. No, that makes a ton of sense. And you've also talked about different personas in your sales audience, Chief Customer Officer, customer service, operations. You talk about things like loan origination, underwriting, I mean these are getting into kind of very back office-type operations that you wouldn't associate with a CRM application. So I think that speaks to kind of the depth of the offering. I guess my question is, how do you bridge the gap with all these different sales audiences and departments? Is there an entry point into a certain organization that you target initially, and then you kind of go from there?

So it does depend on what problem we are helping our clients solve. We're discussing how we're going to help them solve it. But we do interact -- in the front office, we interact with the Chief Marketing Officer who may be thinking about how to manage in and outbound lead and how to work in the digital properties, and what messaging and what call to action, what do we need to do with those consumers to be able to improve the lifetime value and enrich the relationship. We also go into the Chief Digital Officer that may have a mandate or an initiative around digitizing the technology infrastructure. We work with CTOs of our clients where they are at the forefront of the technology strategy and how Pega can help to orchestrate using best-in-breed applications for specific point solutions but not having those be disconnected as part of that workflow. So an example would be they can they can purchase an outbound-lead solution, a sales opportunity management. They might do digital marketing, they might have a contact center software, but all -- they may all be different vendors, and they need these things to work together. And they just can't -- they can't just strap together APIs and use RPA to copy and paste information between systems because the regulatory environment may require that they keep good context of what's happening through that workflow. There's also operational groups that we support, like the leaders of contact centers, which could be a VP of customer service or a COO, where they're thinking about things like the customer experience and moving to self-service, so that when clients -- when their consumers have an issue, that they can actually help to solve that issue by using a -- kind of a digital, kind of interactive, virtual contact center person. It could be a chatbot. It could be a virtual interactive call center. It could be through a mobile device. It could be actually in the distributor's store. They're all the different ways that a consumer wants to solve a service issue. So you need to really be conscious of the flexibility that's needed. So we're touching lots of different parts of the organization. And in a lot of cases, in enterprise, the buying decision is consensus buying. The buying decision for an enterprise application does require different executives in the organization to be kind of bought in to the strategy of an investment in enterprise software.

Interesting. Great. And you've talked about ease of integration as the differentiator here for the platform. I guess, how are you solving for how much of the out-of-the-box software -- how much of the software is out-of-the-box ready versus customization? These are very specialized workflows, how much can you satisfy with packaged software, where does that leave off and then the SI and the customer kind of come in and making that platform more customizable, extensible and to more bespoke-type processes?

So in some cases, our product is almost entirely out of the box for specific solutions, where clients can get up and running in 30, 60, 90 days, it'll be in production with very little configuration work even. In other cases, the work product is more extensive in terms of what the client might want to do from our product. I would say we are not dissimilar to some of our competitors in terms of hoping that the product will have a 60%, 70%, 80% kind of out of the box and really trying to configure that last mile or 2 to be relevant to the specific use case that the client is solving. It's never -- in enterprise software, it's doubtful that much will be 100% out of the box. You certainly don't want to be starting from writing code. And so that's the kind of the other extreme, which is in our early days of our existence, we did focus more on the latter, which was more of a custom build on the platform. So we've made tremendous strides on trying to get us well past the 50%, 60% range of completeness. And then our SI partners, our system integrators, help to then finish that product exactly the way the client wants to look and feel.

Got it. And you've talked about the -- one of the advantages is cloud choice. You can run this on-prem, you can run it in the cloud. How do you provide that choice? And in these different verticals, how far along are some of these in kind of their propensity to kind of go to the cloud versus others?

So everybody wants cloud. I think let me start there. Our clients are looking at some cloud strategy. The question is, are they ready to go, to have their complete environment managed by another company? Not all companies are ready for that, depending on the application, the data, the security of the data and quite frankly, the rest of their infrastructure drives that decision. But we go to market primarily with our -- or as a first go-to market, is our Pega Cloud offering. But we understand that clients have very complex and evolving needs, and they may want to manage these applications in their own virtual private cloud. So I would say, how many clients are thinking about cloud in general? Everybody. How many want a third-party to manage their cloud like Pega Cloud? An increasing amount, but there still are specific needs the clients have where they need to manage it as part of a bigger, kind of virtual private cloud that they're managing on one of the larger cloud vendors. So we're -- our view is that we want to be accommodating to our clients and respectful of their decisions in that evolution into the cloud. And by forcing them to pick one or the other, we are making it harder for them to actually embrace digital transformation, which is not our goal.

Got it. Got it. And you mentioned earlier AI that you've kind of embedded into the platform. It sounds like an acquisition you've made that's pretty far along at this point. Can you talk about how you're applying AI? How does that manifest in the product? And how are you leveraging the data?

So the beautiful thing about Pega AI, our Customer Decision Hub, is the speed and the flexibility in which it operates. Meaning that we can take numerous data elements from either third-party applications or service bureaus like the FICO score or other places or data from website traffic, and we can put that all into a model that becomes not only a predictive model but also self-learning, where over time it will learn from the actual data that it is collecting and the outcomes that it is observing, so that, that model becomes richer over time. And then the speed aspect of it is that we are doing thousands of decisions per second, right, for our clients. So that we are -- the ability for us to be able to look at information, render a decision in a millisecond and be able to direct an application to change a screen, change a view or an image, put a different offer in front of a customer or a contact center person or a marketer, that is really where the power of AI works. Our belief has always been that AI is beautiful, but it has to be operationalized in real time. Because if it's operationalized in batch or with a lag, then the value of that decision is certainly not as great when you're dealing with consumers. You need to make that split-second decision while the consumer is on a page, in a store, on a mobile device. It can't wait even 30 seconds or a minute, and you lose the value of the decisioning.

Got it. No, that makes a ton of sense. And I think it's always helpful to kind of use a couple of customer examples as an illustration of we have some customer history here and ROI metrics. Could you pick a couple maybe in different industries, maybe the customers that you've had for a longer period of time. What do they start with? What have they added over time? What are they doing today? And then how are they measuring ROI for the projects?

So one of the biggest values of Pega is that the ROI for our clients is measured in terms of months, not years. A lot of the challenges with enterprise software is that the ROI, you need to make years of investment in a software product to get the return. And when we're solving -- when we're helping our clients optimize their efficiency or their cost structure, or the amount of human touches that need to -- that are occurring to deal with the consumer, those are massive dollars that our customers are spending to support their clients. And so the return on investment is, like I said, it's -- the payback period is well within 1 year of the investment that's being made. So that's one thing that makes us very proud is the speed at which and the size of the savings that we can actually drive. Some examples of how clients have scaled with us. One example is we have a financial services customer in Europe that has bought with us for the first time in 2006. And it was a relatively modest purchase. It was a purchase of about $100,000 to $200,000. And over the course of 23 interactions over a 10- to 15-year period, that customer, that client is now spending over $5 million a year with Pega, an investment in solutions that touch not only front office but also operational aspects of the business. So clients will start in different places. They will start with a marketing automation or a one-to-one client engagement. Sometimes they'll start with digital process automation, using Pega as an orchestration. They might -- we might support them in the contact center. And there are ways that we can enter a client in terms of that first deal. But the breadth in which we can offer them in terms of solutions and the cross and upsell both front -- front meaning the client-facing organizations -- and also the operational systems is massive. And we've often said that our penetration with clients is not -- in our largest of clients is not 20% of the market opportunity for Pega. And in most cases, our customer penetration is in the 1% to 5% range. So we have a tremendous opportunity to grow even with our existing clients. That's assuming no new logo growth, which, of course, new logos is an important aspect of our growth. So there's just -- we have just a tremendous amount of opportunity with both our existing clients and also new prospective clients in -- just in our core verticals.

Got it. And then on the 20% -- only 20% of your largest account, I guess, how do you drive that expansion? Do you have customer success teams that are kind of dedicated to that kind of selling motion and where is the effort? And how do you see this evolving as you go after that opportunity?

So that's a great question. And we have a concept that we use -- that we refer to, which is called density, which is the amount of concentration of client relationship individuals to support our existing clients, to see the exact outcome that you're talking about, which is more adoption with our clients, of Pega so that we can help them be successful over time. Historically, we have not had adequate density or coverage of our organizations. And so although we were doing great work with our clients, we maybe didn't have the amount of account management and customer success resources to continue that journey with those clients, to continue to have them expand and up and cross-sell and invest more with Pega so that we can help them reach their goals and objectives. So what we've really pushed hard in the last 2 years is to increase the amount of coverage and the support that we're providing to our clients, both with account management-type activities, which is selling and prospecting activities, but also with customer success so we can help with adoption and enablement and actually help to expedite clients getting incremental value over time from the solutions that they've invested with Pega. So really -- it's really a coverage and density challenge that we've been dramatically addressing in the last few years. And what that's driven is that's actually accelerated our ACV growth. So as we get deeper with our clients, as we actually find more opportunities to help them as they see that opportunity and invest in Pega, that deeper dense in engagement and coverage that we have of our organization is driving accelerated annual contract value over the last few years. So we're really getting the return for that investment. And also, our clients are getting much better coverage and enablement and support from Pega.

Got it. And you have a target of 20% ACV growth this year. You mentioned some acceleration within that. Where could be some sources of upside? How -- are there areas you're excited about that maybe you took a conservative stance here with this 20% target, that you could see some upside? Any discussion on that would be helpful, please.

Yes. So there's certain verticals that I would highlight, that I think that we are -- we just have incredible opportunity, like the public sector, our helping government agencies. I mean, that was not -- that has not been a traditional sector that we've been -- I would say, it's not been one of our core verticals from our early success. But we've really increased the amount of focus on it with our FedRAMP certification recently, with us getting IRAP in Asia Pacific, with us focusing on a lot of the larger -- both domestic, meaning in the U.S., and also larger organizations like in Europe and Asia Pacific. We've made a lot -- we have a lot of momentum. Our public sector is our fastest-growing vertical. So it's just absolutely fantastic, and we think that's a great opportunity. But also, we have this incredible opportunity within our existing clients. Remember, I said that even our largest client isn't 20% penetrated or concentrated. What that means is that there's so much we can do with our existing clients. Even in our largest verticals, there's still a lot of opportunity for us and for our clients to leverage what we have. So I think there's -- certainly, public sector is one we're specifically targeting. But also our financial services and insurance and health care and telecommunication clients, I think there's a lot we can do to increase and deepen the relationship that we have with them. That's -- and like I said, I'm not even referring to any new logos that we might be able to gather from those core verticals. So just there's opportunity, quite frankly, everywhere for us. And it's a big market we're in, and we're not one of the largest-sized organizations competing in that. And so that gives us opportunity to gain market share.

Absolutely. And you've talked about a Rule of 40 target. Can you -- everyone has kind of a slightly different version of that. Can you unpack that for us, please? And maybe just speak to kind of the margin target and the sources of margin expansion.

Yes. So -- and there's really 2 big levers for margin expansion. The first one is the investments we've made in our go-to-market resources, our sales, our customer success, to be able to accelerate that ACV growth. So that's kind of one area. And it's really -- first, we're going through a cloud transition. So as I'm sure most investors that have studied Pega realize that there is this trough of revenue that you have to go through when you move from perpetual to cloud. Taking that aside, we've also made a significant investment in our go-to market, and those take some time to gestate in the system, right? You're ramping people in. There's a level of tenure that's required to get to normalized productivity level. So that is one very big lever. In addition to that, we've really changed the -- kind of the way and the aggressiveness in which we sell and cover our organizations. We're really -- we're not looking to sell 3 or 4 or 5 big deals in a year like it may have been 10 or 20 years ago, we're really looking at having broad concentration and allowing customers to start smaller in scale over time, which is very consistent with our as-a-service mentality. And then in addition, separating away from sales and marketing leverage, there's another big aspect to leverage, which is our cloud margin. Now our cloud business is not yet $200 million in revenue, but our cloud margin is improving significantly over the last few years but still isn't at a best-in-class level yet. So just scale of that cloud, of that Pega Cloud business, we'll be getting our margins up into the -- kind of into the mid-70% range over time just as we get scale. And those 2 are very big levers for us to be able to change the margin profile. So we keep growing ACV above 20%. We become more effective and efficient in selling, and our cloud margin becomes better as we scale. And that's how we will get to our Rule of 40 targets.

Got it. Great. And we only have a few more minutes here. Maybe just one on COVID impact. We always have to ask this question. On your Q1 earnings call, you mentioned you hadn't seen much impact, but you did see some project delays and cancellations. Just any color generally on the category, how do you view it? Do you view this as a beneficiary of COVID and all the disruption in the short term? And then in the long term, when we emerge from this, do you think -- is the value proposition here resonating further with your solution and the adoption cycle as a result of all this disruption and working remotely and cloud applications?

Well, so we would have -- as I'm sure you would agree, we would have never wished COVID on any of us that have to deal with it. And so we're -- it's a trying time for all companies. Our company has done an amazing job and our employees have just been -- just incredible in terms of how they've stepped up and how they've kind of operated in this, in this new normal that we've been dealing with for the last 90 days. So I'm just really proud of the organization. And I'm really proud of our clients because our clients have done just an amazing job of continuing their strategic investments and initiatives and moving things ahead. I do think digital transformation will be accelerated as a result of this. And I think you're already seeing that. I mean, I've heard a large competitor of our -- a CEO of a large competitor of ours mention that he saw 2 years of digital transformation advancement in the last 2 months, and I don't think that's an exaggeration. I think that this probably does pull digital transformation initiatives in 2 to 5 years in terms of its relevancy. We thought digital transformation was here to stay and was going to be something that clients were going to adopt. But I do think some of the specific observations that companies have had through this will make them want to accelerate faster. For example, it's going to be very challenging to have data centers in physical locations if you may have a disruption of getting employees there. Second, you know that you're going to have a distributed workforce even more than you had before. So you're going to need to accommodate that. Virtual interaction applications are going to be more important. You're also going to have a more globalized workforce because once people are working remote, you're going to probably allow people and hire talent from all over the world. That's going to require a level of digital transformation. You're also going to have consumers not necessarily walking into stores. And even when they do go to the stores, much of the buying may be digital. For example, if I go to a Home Depot or a Lowe's, I may buy the product on my phone and pull up and pick it up where before, I may have walked into the store. So those buying patterns, which were already changing, are just going to be accelerated. When you put all that together, I think digital transformation will be the #1 theme for the next handful of years because people are quite frankly behind on it. And I do think this situation we find ourselves in, it just highlights the importance of it.

Absolutely. Well, Ken, that's all the time we have. Thank you so much for joining us. Great to get your perspective and pleasure to hear your take on the business.

No problem. I really appreciate the invite and thanks to everyone, and I hope everyone stays safe. And hopefully, we get back to seeing everyone soon, face-to-face.

Absolutely. And thanks to the audience for listening in, not just for this session but the course of the 3 days. It's been a great few days. And we look forward to another great conference next year. So thank you all for joining us. And thanks again, Ken.

No problem. Take care.