Pegasystems Inc. (PEGA) Earnings Call Transcript & Summary

Hello, to everyone, and welcome to the Wells Fargo TMT Summit. We're excited to have Pegasystems joining us, Ken Stillwell, their CFO. Ken, thank you so much for joining us today. We're super excited for this conversation.

Awesome. Thanks for having us, Rich.

My name is Rich Hilliker, and I'm on the software team here at Wells Fargo. If you have a question during the conversation, feel free to e-mail me at [email protected]. So Ken, I'm excited to be back on stage with you, and I always look forward to it. This is a multiyear thing. I'm pumped that guys are such loyal supporters of us and our TMT Summit. So thank you so much for being here. And also congratulations on hitting the $10 billion market cap threshold. It's great to see your continued success.

Thank you very much. Although we are definitely excited about the momentum that we've had at Pega, these milestones are simply kind of exits on the highway to where we're trying to get to. So we plan on staying on the highway and continuing to the next one.

Absolutely. Yes, yes, that totally makes sense. So as you pop up on even more radars now, I think there's a great understanding of Pega amongst some investors, some software specific investors. But could we maybe start by introducing yourself and Pegasystems a little bit more broadly for those who are still getting up to speed of the story as you continue to gain more and more presence on radars here.

Sure. So Pegasystems has been around for -- have been a software company for a while. We started off in the business process management space years ago, and we did -- we were the leader in that space. That space has since kind of merged with a few other spaces: robotic process automation, digital process automation. It's really become kind of kind of this digital process or digital workflow or executing activities across digital channels. And that is a very close adjacent space to customer relationship management or CRM space. The primary place that we sell in CRM is around client engagement, around customer engagement. So our clients are typically the largest brands in the world, and they interact with millions and, quite frankly, billions, in some cases, of consumers around the world, and they need to do that in a real-time fashion, where they can put offers, they can put information, they can render website. They can make split-second or actually microsecond decisions around what they do, what's the next offer, what's the next action. And it's very critical to have all of their infrastructure that relates to that particular consumer to be connected in real-time and to be able to execute the work end-to-end. So that's kind of the connection between CRM or client engagement and this end-to-end work automation because you're really executing an activity or a group of activities through a series of steps across a series of systems. And that's where Pega comes in. We come in sometimes as the actual solution that you use for something like claims processing or loan origination or know-your-customer. But additionally, we also helped to stitch and weave together the workflow across those, in some cases, disparate applications that sometimes exist on the client's premise and in the cloud. So that's what Pega does.

Got it. That's a really helpful overview. And to your point, Pega has been traditionally known for its strength in BPM and CRM. But to your point here, we have seen that evolve. And I think more recently, you guys have been talking about a center-out engage and automate platform. So could you dive into a little bit more about what that means? And basically kind of curious if you can talk more about the functionality and the value that your solutions bring when deployed as a fully -- when deployed together as a full platform?

Sure. So there's a few ways that you can think about solving a technological challenge. You can start from the customer and come in. So that thinking about, let's put a website or a browser or URL, and then we're going to figure out how to make the rest of our environment work given that kind of customer-facing experience. Another way to do it is from the inside out. We already have a set of existing systems, and let's just make the client experience captive managed given the complexity of our internal environment. We view that neither one of those are appropriate because, one, coming from the outside in doesn't take into account the existing infrastructure that you have that quite frankly, in many cases, you rely on and maybe some of your compliance aspects. It's the heritage of where you maintain and control data for the business. And the other one, starting from the inside out, really just there's no empathy for the end user, has no empathy for the consumer. So the concept of the center-out approach is to really think about marrying up the fact that you have an existing infrastructure instead of collective solutions and partners and whether they be in or outside of your environment and you want to be modern with how you interact and you want flexibility with how you interact with your consumers, whether it be on a mobile device or whether it be on a laptop or whether it be in a store, or quite frankly, through a distributor. You want that experience to be kind of situational for that particular channel, but you want the experience for the consumer to really feel the same way. And so trying to reconcile the 2 of those. And that's really where we believe kind of the center-out approach is the ability to exist -- to live with what you have but be able to modernize all of your digital experience with consumers. And so that's kind of the concept of center-out.

Got it. That's so helpful. I always love your in-depth answers, Ken. These are -- they're always great. So let's take a step back here before we start talking more about products. We're now into 10 months or 12 months into what's been a really interesting year and 10 months into the COVID-19 pandemic. And we believe CIOs have been forced to reevaluate their strategies. We've coined this phrase basically that "No cloud is officially a no go." And it's kind of resulted in a lot of digitization, companies really leading into automation and intelligent workflow, as you know really well. So I was wondering if you can talk a little bit about some of the trends that you see from customers, some of the demands, the conversations and what this has meant for Pegasystems throughout the last 10 months and the evolution of that now as we kind of close the year here of 2020?

So before COVID, I think that there was already momentum around digital transformation. I mean if you go back to, really as Amazon became a retailer and really completely changed the concept of, what was called, Black Friday into Cyber Monday, right. I mean the whole kind of world has changed. I mean they had a big part of that, right, in terms of disrupting the way retail operates. If you think about that, just as an example, people are thinking about, do I want to go into a branch, a bank branch? Do I want to transact in a mall? Or do I want to go to a website? The -- even back even when I was in college, which was many years ago, there were catalogs. You used to get the LL Bean catalog and you could call in and have something direct-shipped to your dorm room, if you wanted to buy a backpack or a sweat shirt or some -- that existed -- that was in the '80s, right? That kind of technology existed. Now people are going to devices, and they want that same kind of experience. Forget about COVID. That was happening. What COVID did was it really accelerated the discussion around that. It really forced people to think, this isn't just a temporary thing. Some of this will stay, right; some parts of this will be the way we operate in the future. And I think that that's where COVID has really changed our behaviors, right? It's changed our behaviors because we now recognize that you don't have to get in a car and commute 1.5 hours into the office every single day to be productive. You don't need to get in a car and drive to a the mall to buy an article of clothing. By the way, they may not even have your size when you get there. You don't need to go to a store to change your cell phone plan. There are things that we know that we don't have to -- you don't have to go to a bank to transact. I mean there are even apps where you can send money direct consumer-to-consumer in real time, right? And that would be unheard of 10 years ago. So COVID has just reinforced that if you weren't paying attention to this, you better now because people are now much more in tune to this remote transaction world that we live in.

Absolutely. Well, why don't we dig into process automation and management for a quick question here. Can you help us think about how to delineate your BPM roots from now what's becoming intelligent process automation? There's really a lot of buzz around this space today. And we're excited that we're hearing you pop up more and more in terms of workflow automation as well. So can you help us understand your place in the landscape here and maybe what your vision looks like moving forward?

So we've always prided ourselves on being able to help clients do real work, get work done, right? And so we thought of processes for sake of processes as being overhead for an organization. You have a process, you have a workflow because you're trying to execute something. And if a software company provides a workflow to you but yet can't actually help you get the work done, well then they're not really helping solve the problem. So we've really prided ourselves on actually getting the work done, getting the actual activity executed. And so with that, things like robotics and automating within an application workflow, super important. You want to take human interaction out, you want to skip steps, you want to automate, you want to use decisioning or AI to be able to understand what's the next best thing we should do. It's not -- maybe in many cases, it's not 100% accurate, but it's accurate enough to be statistically accurate at scale. Remember, we're talking about lots of transactions. So you may need to say, listen, we need to route this. We need to display this offer to a customer and not rely on this false precision of, well, let's get all the data, let's send it to a lab, let's run it through a bunch of models. You are 6 months, 12 months behind even analyzing what you should do, where our clients are making decisions in milliseconds. And they have to because they're dealing with volume. So now thinking about the fundamental tenets of what we have, workflow, case management, process engine, decisioning, robotics, the ability to connect that end-to-end, that's where we're really excited about. Helping our clients solve their real problems of getting work done at scale fast and allowing the consumer to be able to be managed and sold and serviced in real-time as opposed to this kind of batch world that, unfortunately, companies have been living in for far too long.

Great. That's a really exciting opportunity. Let's also talk about CRM, which is equally as exciting. And within CRM, you're primarily involved in the B2C client engagement space. But we're hearing more and more from customers and enterprises that it's important to have a 360-degree view of the customer to really better serve them and help them get work done, like you've been talking about. So how is Pegasystems helping to enable that? That 360-degree view to drive these better experiences and to help customers get work done and better engaged?

So it starts with having the ability to connect -- to go back to that center-out discussion, right, which is the ability to connect to your internal systems that are systems of record that can control data, that hold data and manage work activities between those systems. And then also the interaction channels in which you're interacting with consumers. If you want to really help consumers match -- or match a vendor to a consumer need, you've got to have all the data that's relevant, you've got to have a model that helps to predict and analyze what is the consumer need, what are they looking for. And you need the ability for the consumer to be able to have that offer, have that interaction or have that experience in a seamless, real time fast way such that they feel like they actually will make the decision or they did get the outcome that they were looking for. So I think the Customer 360 is less around just populating a bunch of data on a dashboard that may be scale or that may not be serviceable or help in drive -- but using that information to be able to execute the work, to be able to -- and that's where Customer 360 -- the value is not just knowing the data. The value is what you can do with the data. And more importantly, how you can automate what you do with that information based on the context of the consumers' needs at that second in time.

Those are great points. And it's exciting to see how increasingly CRM and intelligent process automation are really overlapping, kind of really playing right down the fairway for you guys. So exciting stuff there. As we think about on that topic, can you help us understand the cross-sell opportunity? What sort of spending increase results from multiproduct relative to incremental cost to sell it? And then how penetrated is that opportunity?

So although we've sold quite a bit to a number of our clients over the years, we feel like the opportunity that we have in front of us with even our most penetrated clients is still massive. We've often talked about the clients that we have and the really deeply concentrated spend that our clients have given us. We're still only 10% or 20% penetrated on the market opportunity that's in front of us. And that's just with a small number. Most of our clients that we have, we're penetrated 1% or 2% of what the actual spend is. So for us to say, well, we're done with those clients, let's go get the next 1,000 or the next 5,000 really, I think, is a flawed strategy because there's so much need that even our existing clients have for the solutions that Pega offers that we should certainly be prioritizing those opportunities because those are the clients that have the biggest problems, the most volume, the most consumers, the biggest need for digital transformation, the most critical need to be able to execute work end-to-end at scale and leverage exactly what we do. And so I think that we're certainly not exclusively looking at those clients, but there are certainly a -- there's a tremendous opportunity with them.

That's really exciting. It sounds like quite a long runway ahead here and a great opportunity for cross and upsell. So excited to see how that progresses. On executing on that opportunity, you've been adding sales capacity for maybe the last 12 to 18 months or so. How should we expect to be seeing productivity improve? How should we be gauging their productivity from here?

So the one mistake that we made a few years back, and then certainly I would put myself in the accountable parties for that mistake, was that we allowed ourselves to have episodic investment in sales capacity, which is you have a good year, you get excited and hire some more. Then you have a year that's okay, you slow down hiring. And what happens is that you don't have that continual ramping and enablement and recruiting machine that you can actually really attract the best and brightest with a level of consistency and sustainability. The risk with that is that when you have starts and stops in hiring, you have starts and stops in enablement, and starts and stops in performance, quite frankly. So that was something that we learned, and we've really tried hard over the last few years to not allow ourselves to fall back into that trap given the market opportunity that's in front of us and our ability, our belief and our optimism around being able to continue to be a high-growth company. So now to the point of hiring, when you hire an individual in enterprise software -- which I've been in enterprise software for a lot of years, when you hire someone, there is a ramp. There's a ramp because there's an enablement ramp, but there's also a selling ramp, right? You have to start to talk to the organizations and generate the opportunities and drive those through the pipeline. So you typically have a phased ramping approach where someone comes in and they start off being, I would say, less productive in terms of booking or accretion to ACV growth. But then over time, as you get, say, 2 years out after they're hired, they are more normalized in terms of their tenure and their productivity. So the trick for us is to keep consistent hiring, consistent enablement, so we build sustainable ramping. And then, of course, to accelerate the ramp to productivity curve, right? We don't want to accept that it has to take a certain amount of time just because it took that long in the past. So we really need to be thinking about that. We also need to layer in the partner strategy and how can partners help us to develop opportunities alongside our selling teams to be able to help to accelerate pipeline build, pipeline maturity and progression and subsequent closing. So that's kind of how we think about enterprise hiring and how those ramp. So we would expect that when you make investments in, say, 2020 for sales hires, you would start to see some of the benefit of that in '21, but you would largely really see that probably more like in '22 and beyond. And so that's kind of the importance of this consistent investment because if you turn something off, you don't necessarily feel the impact right away. You feel it over time, and it creates maybe a less consistent growth model.

Got it. Great. We're excited to watch how that capacity starts to really add more and more here, being that we're kind of approaching that 2-year threshold. So we'll be keeping our eyes on that. And on the topic of key hires, I think both you and Alan mentioned your excitement about the addition of Hayden Stafford to Pega's management team as President of Global Client Engagement. I think this was back in June 2020. So now that he's been here for a little while, just kind of curious, what are Hayden's priorities? What is he focused on?

So Hayden is responsible for all of our go-to-market activities, which means he manages the direct sellers, the solution engineers or the solution consultants that help the sales team, the entire sales part, including the implementation teams and also our marketing activities. So he has complete accountability for generating the business, the growth of the business, and that's really what we hired him for. What is interesting about Hayden is there's a number of aspects. One, he knows our space very well, which is, I would say it's not uncommon that someone would know the CRM space, but certainly coming from a large company that was very successful in our space is helpful. The next thing is that he was very instrumental in driving a sales management cadence and operating discipline within the sales organization that is much more consistent, focused on pipeline build, pipeline maturity and productivity, and less focused maybe on episodic wins like large deals or whales really driving the day. Now we will still have large deals because we're an enterprise software company, but we would really like for the whales to kind of be on top of larger base business, of booking consistent deals. And that's helpful as you move to a SaaS company because that's the way consumers like to buy. Another aspect of Hayden is that he is very collaborative. If you -- executives typically have a few different styles with them, right? Sometimes they're very aggressive style, very competitive. Sometimes collaboration is not as great there. Sometimes they are more -- a bit more kind of a higher level, meaning they sometimes can get disconnected from the details. So they may be very strategic, very well-rounded as an executive, but may not necessarily be as in tune with the way the manufacturing facility is kind of running. Other executives have really strong focus on kind of clients, client-first, right, really focusing on how do we make sure client experience is paramount in the organization. What I think Hayden has is a mix of all the positive things that I've seen in software. He understands our space. He's very in -- understanding the details of how a company operates. He's very focused on client success. He's extremely collaborative with other parts of the organization, but also holds them accountable for what we all need to do to deliver to the field so that the field can be successful, right, that our sellers can be successful. Because one of the worst mistakes you can make in software is just assume that the sales team just needs to sell and not understand how you build the product, how you structure your internal processes. Your cloud, your partners, all these things are contributing factors to sales productivity. And I think that he's just shown me -- and I guess it's been about 6 months now. So I think he started in June, June 1 though. So yes, 6 months yesterday. He has shown me a tremendous appreciation for really bringing the organization along and really being one Pega, which is really important because that's part of our culture.

Great. So in the couple minutes we have left here, we'll try and do a couple -- a few quick-hit questions here. As Pega is approaching $1 billion in annual revenue, that's an exciting milestone, just kind of curious your thoughts on how that will change the company? How does that change how you think about resource allocation? How does that think about the advantage -- how do you think about the advantages of scale and then getting to the next big milestones?

So as we go over $1 billion, and just as importantly we sell SaaS and Pega Cloud at a much higher pace, we really need to be -- we need to be thinking cloud-native on everything. We need to understand that our development, our processes, the way we sell, our partners, everything is cloud native. I mean you said it early on is there's no option on cloud, right, for our clients. So that's one thing that will be different than how we ran the business 20 years ago. Also, as you get to $1 billion and beyond, you would expect operating leverage from certain parts of the business, right, and you have to -- and that will help. And as we come out of the cloud transition, you'll see that come through in our results as well. But that's a really important aspect of continuing to drive operating efficiency because scale should provide you certain operating leverage. Really getting the gross margin of our Pega Cloud business to be best-in-class as we scale because that's one of our fastest drivers. And I think more -- I should say, more importantly, another aspect is really being the kind of organization that all of our candidates want to work at, really being inclusive, building a diverse representative workplace of what our clients and our consumers and our communities look like and being focused on making sure that we are attractive for all of the top talent that's out there because as a fast grower we want to get the top talent. And that -- and the top talent only come to a company that really is inclusive and diverse and really doing cool things from a technology standpoint.

Got it. That's really helpful. So the topic that you mentioned was the subscription transition. And that's something we got -- I think we could talk about for quite a while here. You guys have progressed really nicely through that. I'm wondering for those investors digging in there, could you talk a little bit about the relationship between ACV, ACV growth and remaining performance obligation and backlog? Why are you pushing investors to look at these 2 metrics as the most important to focus on as you continue through this 5-year cloud transition?

Sure. So when you book a deal -- in the perpetual world, when you booked a deal, it would go right to revenue. In the SaaS world, when you book a deal, it goes to backlog. And the way that you think about revenue is you look at backlog, and that's a predictor of the future revenue. And typically when you look at something like ARR or ACV growth, there's normally a connected but a lag connection between the growth in ACV or ARR and the revenue growth. So because our business has client cloud, which is -- has a revenue that tends to be more reported in period and Pega Cloud, which is SaaS, which tends to be recorded over time, it's important to balance the 2 of those by looking at revenue, the mix of our bookings and backlog, because if your mix would shift in one direction or another, for example, like it did in Q3, a much higher amount of Pega Cloud, that means that you would have less current period revenue but you would expect for backlog to grow faster. And that's exactly what you saw happen in Q3. So it helps when you look at the 3 of those to get a complete picture of what's really happening in the business in a period of time.

Got it. And that's really helpful. And I think that helps to kind of lay a ground-level view for everyone digging into the story. One point further on that, how should we be thinking about the underlying pace of net new versus expansion, given some of the moving pieces of mix?

Sure. So in a typical year, we would have somewhere around 2/3 of our bookings, our new bookings, our growth bookings would be from existing logos and about 1/3 from new logos. That's been kind of a -- it's been somewhere in that range over the last handful of years. In 2020, that number skewed a little bit more toward existing clients, not unusual in a time like COVID or quite frankly even in -- you'll see even in recessionary times, vendors tend to buy from -- excuse me, customers tend to buy from existing vendors and new logos. So that's kind of one aspect to think about how...

Everyone, I think we might have just lost the audio stream there for a second. But we've had a great conversation with Ken so far. Let's see if we can get him unmuted here for the last second or 2 of our discussion. Just a second. We appreciate you holding on here.

Rick, can you hear me?

Yes. Yes, there we go, Ken.

Yes. Okay. I'm not sure what happened there. But I will -- what I was talking about is new versus existing. New logos are really important to be able to expand the opportunity set of where you can sell. But for us, up-sell and cross-sell net retention rate expansion is really important as well. So for us, we've got to have new logos to be able to seed the new ground, but we also rely on a lot of expansion sales with our existing logos. So for us, the mix of 2/3, 1/3 or 75%, 25% is kind of a maybe a sweet spot for the mix of having enough new logos but also knowing that we can continue to land and expand model -- can do land and expand, which is the selling motion that we use.

Well, Ken, this was a great discussion. 30 minutes certainly went fast. I think we could probably talk for another 30 about your -- all the great things you guys are doing at Pegasystems. So thanks so much for your time, for your participation and always supporting us. Thanks to all the investors and those who joined it on the livestream here. We really appreciate you joining us for the Fourth Annual Wells Fargo Tech Summit. Thanks again to Ken.

Thanks, Rich. See you, everyone.

Take care.