Pegasystems Inc. (PEGA) Earnings Call Transcript & Summary

Good afternoon, everyone. Let's go ahead and get started. My name is Rishi Jaluria. I cover software here at D.A. Davidson. I'm delighted to have with me from Pegasystems, CFO, Ken Stillwell. Any investors who would like to ask questions to Ken, please submit them through the chat function. I'm going to continue to monitor that or feel free to e-mail me directly at rjaluria@dadco.com. Ken, always a pleasure to have you. Thank you for being here.

Thanks, Rishi. Good to see you.

Let's start with just kind of broad overview of Pega for the generalists in the room. And fortunately, you're starting to become a lot more well-known with investors over the past couple of years. But let's just start with that.

Sure. So Pega operates in 2 segments of the market. They are kind of eerily similar in terms of the challenge and the value proposition. We're in the CRM space. And we're what's -- in what's called digital process automation, which used to be -- some part of that used to be called business process management. But they -- although they seem like very different kind of segments of the market, they're actually quite similar in terms of the problem you're trying to solve. It's where you're trying to manage large volumes of transactions either in a consumer channel, i.e., CRM or in an operational channel, i.e., BPM or DPA, and you're trying to execute large volumes of work across a series of workflow steps that likely will touch and interact with multiple systems and applications within your -- within the customer's environment. And what's important is to get that work done end-to-end using robotic process automation where possible, using AI where appropriate, to be able to minimize the amount of human touches that need to happen either by our clients' employees or by the consumer. We like to say that we're not a workflow system, but we're a work-do system. We actually try to execute the work as opposed to just running processes. And I think that's kind of where we differentiate ourselves. Our clients use us to really try to streamline work activities across their organization. And a lot of times, the front and the back office do intersect and overlap because anything that you do with the consumer is likely going to rely on certain information that you may have in the operational systems.

Great, great start. I actually do want to ask about COVID, but I'm going to first go to something that you kind of touched on, which is there's been this evolution of the kind of back-office business from BPM into this broader DPA or digital process automation platform. Can you walk us through that evolution and how Pega's products have evolved alongside that?

Sure. So years ago, there was this concept of back office, where you executed typically ERP adjacency areas or types of -- ticket type activities like transacting an ACH within a bank or managing a claims adjudication and an insurer. Things that you would -- that would happen kind of using operational systems and really kind of not touching the consumer, not really even any -- there was a perception that wasn't really any value to connect the types of operational activities to things like how you would do an outbound lead management program or how you would manage your sales campaign. We quickly kind of matured ourselves into the customer service automation space. Although when we did, we didn't necessarily connected to CRM because at that time, Salesforce had acquired the ticker symbol CRM, and they were really a sales automation player, and a fairly disruptive one. And so the market was more viewed as customer record management as opposed to relationship management like it is now. And so even though we were in the service automation space, there wasn't a natural relevancy in how that would connect to pipeline management or sales automation. And then as time went on, we saw more and more of our customers getting us involved in their service automation initiatives, which then drove into marketing automation, how do I want to think about communicating with my client. When they come inbound, either through a digital channel or to the call center, what do I want to do with them? Do I want to market to them? And if so, what do I want to say to try to upsell, cross-sell, retain that client? And then you naturally think, well, wow, if you're going to market to them or you're going to manage that inbound kind of interaction, what about when you're selling to them. So the concept of CRM really evolved over time. And as such, it really brought us and our relevancy of our solution into CRM. And some of it was us. We bought a company called Chordiant, as many of you know, in 2010, that got us into the marketing automation space. But I think the market kind of evolved to come closer to us, and it became obvious that we were -- that we could have some success in CRM. And that was we really went in, in a large way about, I guess, it's probably been about 5 or 6 years ago where we really -- so we went from not even being someone that anyone heard of in CRM to now being someone that, yes, I think, is reasonably well-known in the CRM space.

Got it. Helpful. All right. Let's talk about kind of the current environment with COVID, right? How are we thinking about the headwinds that we're seeing, the tailwinds that we're seeing? And maybe alongside that, right, there's this term digital transformation that gets thrown around a lot. But what really is digital transformation the way you see it?

So I'll touch on COVID, and then I'll get to the digital transformation. So COVID is an unfortunate situation for a lot of companies. A lot of companies are really struggling. Employees are struggling. I mean it's taken its toll on us as a global workforce. In terms of Pega, we have some -- we've won at a faster pace, and we've had some demand move at a slower pace. I think on the total net of it all, I don't think we've been really impacted positively or negatively in the first half of the year. In fact, I would even argue to say that where we've landed through 6 months is probably where I would have thought we would have landed had COVID never happened. Now the longer term, what COVID does do is it highlights the next part of your question, which is digital transformation. It highlights the importance of having a digital footprint of making sure that when you interact with your clients, that those interactions are -- can be handled in real-time in a store, on a phone, in a digital property, at a reseller. Sometimes it's pushed, sometimes it's pulled in terms of that interaction. And I think the clients of ours were thinking about digital transformation for a number of years. What COVID did was really accelerated the prioritization of it. I first heard the word digital transformation, I can actually remember it was in the summer of 2017. At an investor conference where people started to bring up the fact that digital transformation, hey, everybody is talking about digital transformation, that should really help you. But at that time, I don't think people really understood what it was. Now people know. Well, if I have to shut down my call center in Manila and nobody can come in the office and nobody has laptops, and I don't have software that can be accessed remotely, what are my options, right? I mean how do I even have people work? So I think that it really forced the whole visibility of digital transformation in a very short period of time. Some of that was happening already with Amazon retail, really changing the whole model on how people shop and how people interacted. But now I think it's down to -- it's not about shopping. It's about everyone. It's about where we work. I think soon, it will be about how people go to college and where -- and how students go to high school, and how I just think it's the entire interaction is going to be so dependent on digital. And who would have ever guessed that, that would have happened so fast. But I think that, that is probably one of the positive aspects of all of this disruption, which is we're realizing how much more -- how much bigger reach we can have as a global workforce and how we can actually try to kind of make lemonade out of lemons, so to speak.

All right. Let's turn to the cloud transition. So we're past the midway point now. From your perspective, a, how has it played out relative to your expectations? And b, you looked around the software landscape a lot, I know we've talked about this. But if we were to benchmark your cloud transition against some of the other famous cloud transitions and software, what do you think that you've done right? What do you think you could have done better?

So given that I've seen a few cloud transitions myself at places where I've worked, I feel like I have a reasonably broad view of the -- there are companies that try to transition to cloud by forcing their clients. I mean literally saying to a client, "You no longer can use the product unless you move to our cloud." And although that does work financially in some sectors, it doesn't -- it isn't client-centric. It's not actually focused on the client. It's focused on the own economics of your business model as a company. Because you're being quite -- you lack a lot of empathy when you go to a client and say, "Thank you for all the investments that you've made. Now you have no choice, but please buy my new product, pay more for it and I'll manage it for you." I don't think that's -- that might be reasonable to do in commoditized products, where you're going to take the price down and you're actually giving them an option. But in enterprise software, I don't think that's the right way to behave with clients. They have complicated environments. There's another kind of transition that is more like a mechanical transition, but not really anything different. Meaning, I'm going to stop selling you perpetual licenses, I'm just going to sell you term licenses. And there, really nothing has changed. It's just the contractual elements have changed. And although that can make sense for clients, what real value have you created? You haven't added any type of a managed offering or an upgrade in service 24/7, the ability to stay current. You haven't offered anything other than maybe a different contractual relationship. And then there's a transition where you're really thinking about, I have a client that is using a certain type of capability in a way, perpetual license on servers. And that isn't going to work for them in the long term. They need to actually have maybe someone else manage that or they need that to exist in their own virtual private cloud. And as part of that, they need the ability to keep all the rich capabilities continually current. Meaning when releases come out every week, every 2 weeks, every month, they're getting that new capability. When bugs are addressed. When security vulnerabilities are addressed. When they need to access the system at 3 in the morning on a Sunday, they actually know that there's a reliable partner behind that. And I think that giving them the option to have that partner be Pega, with Pega Cloud, or if they elect being their own client cloud because many large companies actually have their own virtual private cloud teams that are actually quite capable, and they want that flexibility. So that's our transition. Our transition isn't a forced "You have no choice, you must move." And it's not just a contractual kind of cash flow-type valuation play. It's really around a new set of capabilities that clients need to help us manage them in some cases, but giving them the ability to buy what they need and expand as they need it. The biggest problem with perpetual license that I think most companies would agree is you don't know your need, you don't know your demand, which then requires you to overbuy and requires the vendor to deeply discount. It creates this very weird awkward contractual discussion, which is, I want you to buy as much as you can, and the client says, great, I'm going to buy more than I need, but I need you to give me a really big discount or maybe even give me the product or some maintenance. It's just -- it's not a partnership, it's more of a negotiation. It's a play-on usage. And I've always struggled with how that was right for clients. And so we are trying to balance that client need and client centricity and focus with also what makes sense for our shareholders and our stakeholders as well.

All right. So now at your Virtual Analyst Day that you held a few weeks ago, you reiterated your targets, right? 2022, $1.3 billion in ACV, $1.6 billion in total revenue. But you also said you'd be disappointed if you didn't do better. And I think the other interesting thing was you stuck to these Rule of 40 target but with a greater balance towards growth than you initially expected. Can you maybe talk about what's giving you confidence in the targets? What's changed that you're pivoting more towards the growth side of the equation while still being responsible about balancing growth and profitability?

So there's 2 factors that change from when I first started thinking about our long-term targets. When I first started to think about our long-term targets, I didn't think Pega Cloud or maybe I didn't anticipate. I hoped, but I didn't anticipate Pega Cloud would grow as fast as it has. That's become such a big part of our business. So that's one thing. And that changes a lot. That changes the ACV growth. That actually even delay some of the profitability improvements because naturally, there's a delay with SaaS accounting revenue. It actually gives us the ability to increase backlog at a faster pace because more of it is going to backlog. So there's lots of that -- I mean generally, that is a good outcome, right? The Pega Cloud is more popular. The second thing was that I didn't model that we would penetrate and grow as fast as we have with -- in the markets that we're in. I modeled a growth rate that was more at the higher end of what we had seen up until that time. But if you look now, our growth rate in the last 18 to 24 months is the fastest the company has ever grown in terms of the size, are not only in dollars but actually, the rate of growth. And so with the rate of growth increasing and more and more of that becoming Pega Cloud, that means you're going to get higher top line, but some less revenue conversion and certainly, you have to invest in the business, which causes the pressure on the bottom line. And so that's -- there's really not anything that's changed in the model other than that dimension.