Pegasystems Inc. (PEGA) Earnings Call Transcript & Summary

Good morning, everyone. Thanks again for joining us on day 2 of our Barclays TMT Virtual Conference. I'm very pleased to introduce and start the day with Pegasystems. So Ken Stillwell, the CFO from Pegasystems, is here with us today. Ken, really great to have you at our conference again, and obviously, this time as a covered company. So thanks for joining us today.

Thank you. Good morning. I guess good afternoon for some as well.

Exactly. Exactly. So Ken, maybe let's start with the background a bit, right? So Pegasystems has been around for -- and has been innovating for decades now. But maybe for people on the session who are maybe new to the story and are trying to ramp up, give us a quick background on where Pegasystems started and where you guys are now. And then we can do a few questions on the product portfolio before moving on to questions -- financial questions.

Sure. So Pegasystems was the leader in a space that was called business process management for a number of years. Business process management was -- to simplify what that means, it was typically very complex processes that went end-to-end. There wasn't typically a commercial off-the-shelf application to solve that problem. It may be something that may -- in some cases, there was a commercial off-the-shelf, but that, that particular company had a very complex workflow and they needed to build something that was a little bit more specific to their company needs. That really relied on 2 capabilities, workflow and the concept of case management, which was the container of the event that happened. We were -- in 2010, we did an acquisition called Chordiant, and they had a marketing automation in the CRM space. At the time, CRM was not really referred to as sales, marketing and service. It was more just sales automation. It was kind of the old Siebel solutions that Salesforce was very dominant in at that time. So we started to sell a lot of, what I would call customer-facing solutions, but we didn't really connect it to the space of CRM. About 2013, 2014, the CRM space really further defined itself as sales, service and marketing. And even since then it has actually grown to expand into some other definitions like e-commerce, et cetera. So in 2013 to 2015, we started to brand ourselves a little bit more of who we were, which was a BPM solution provider, but also a CRM solution provider. I think that really stuck in like the 2015 to 2017 time frame, where people actually recognized that we were selling lots of customer-facing digital transformation type environment. And now if you fast forward to 2020, I think it's kind of commonly known that we are in the CRM space, primarily around client engagement, which is our clients engaging with consumers. So if you think about that -- the very large transactions, large volumes of consumers, very -- everything needs to be fast, real time, lots of different systems that need to be integrated in that workflow. That's where Pega thrives.

Perfect. That's a great start and a great background for people on the call. So maybe let's dig into the product portfolio for the first few minutes. So BPM, right? So we have also seen that BPM market evolve a bit. So it was BPM, and now we hear low-code a whole lot more. And then you -- your portfolio acquisition business, digital process automation certified offering. So help us understand how you're positioned in that market? Obviously, you were one of the pioneers in BPM. But given the market evolution, how you're positioned now and what differentiates in that market?

Sure. So I'll give you my -- give everyone my perspective on how to think about this concept of low or no-code in the context of the spaces that you referred to, BPM, digital process automation, even CRM. There is a concept of low-code that is something that Pega has been since the '80s, which is we wanted and we have a solution that you do not -- you should not or 95-plus percent of the use cases have to write code to be able to execute some activity. You should be able to do it in the browser, in the actual UI, so that you don't need software engineers continually evolving a solution, change management, testing, taking things offline. You'd like to be able to add a step. And you'd like to make it so that you or I could do it or anybody else that may be a business analyst type skill set. So that's the concept of low or no-code. The fact that a solution needs to evolve over time, but it is never really done because business change, markets change, technology changes. So you wanted the ability to evolve and you don't want to have to have a situation where a solution becomes stale and then you have to do -- it becomes "legacy" and then you have to go and redeploy a brand-new solution. So that's the concept of low/no-code. We are all in on that concept, have been for the better part of 30 years. There are other players that take that same approach, companies like Salesforce, companies like ServiceNow. Microsoft tries to deploy low-code, I would say, maybe less so than some of the other ones I mentioned. Appian is a company that we've competed with in some verticals that has low-code. Pega has low-code. There are other low-code providers that are -- I would call it more the technology of low-code. So there are some other companies that have built very, very simple tools to be able to build simple workflows, like something like I want to check the badge of an employee when they check-in. That application isn't going to expand into something more than that, but you can build it really fast and you can do it with nondevelopers. That's what I would call the low-code, the product. Although that is interesting and clients want to test it and use it as a sandbox, that's not where enterprise software is going. Enterprise software isn't going back to writing, starting all over and starting from scratch and writing custom applications. What they want is the flexibility of a best-in-class application, but the ability to iterate change, low-code as an approach. When you start thinking about low-code as the product, I'm, I would say, skeptical that any enterprise company or any company of size would actually build an application from scratch. It's very inefficient. It doesn't leverage best practices, et cetera. So that's how I differentiate low-code as a methodology versus low-code as a product.

Perfect. Perfect. And the second piece of your portfolio, right? So you mentioned about you entered into CRM, and now you have not just mindshare, but obviously, very healthy adoption in CRM. And there are some large enterprise vendors like Salesforce, like Microsoft, which seem to have consolidated the market share, at least historically, right? So how do you -- I'm assuming the integrated portfolio helps your positioning, but give us a high level on how do you differentiate in that CRM market before we move on to go-to-market changes?

So in any market -- and I'll answer this question in a general way because I think it will kind of paint the picture of how we can differentiate. In any market, if you're trying to get a solution that hits, say, the one standard deviation from the mean, so to speak, you have to make your solution very homogenous. You have to make your solution be able to hit lots and lots of users. You can't have a really powerful application that can solve certain use cases because if you do that, you'd make it not apply to large parts of the population. So I really think companies really have to pick. Do you want to be the company that's more of a general solution that can cover lots of clients? Or do you want a solution that differentiates for maybe 20% or 30% or 40% of the market, which, by the way, is still very big in CRM? When you think about that being differentiation, real-time, the ability to actually connect real-time. Real-time creates -- if you do real-time in an SMB solution, it's not necessary, right? Because many SMB companies only have one solution. If you're -- my wife is a small business owner. She has QuickBooks. I mean she doesn't have 10 different solutions. So real-time for her is not necessary. Real-time for Bank of America, for Barclays or JPMorgan Chase. I mean you need to know when somebody initiates an ACH. You need to know when somebody makes a payment. You need -- these are things that can't wait a day to transact and batch like they used to 25 years ago. So real-time is a differentiator. End-to-end, which means the ability to integrate quickly with all of the different application landscape. Smaller companies don't have that problem. Enterprise companies do, right? The ability to automate robotics, native in the product. The ability to automate small companies don't have the transaction volume, where the complexity of touching different call centers in different parts of the world, depending on if I go through the web at 2 in the morning, who is going to be there to help me? You want to automate as much as you possibly can. You want to build self-service. So some of these -- these are some of the pieces. When you go to the enterprise space, companies more than $1 billion or $2 billion in revenue, of which there are thousands of those, as you know, those companies need real-time automation, AI and decisioning. They need the integration -- the smooth integration with all the applications. They need to be able to see things, audit. They need to be able to audit things afterward. I mean these are security. These are things that are really, really paramount for enterprise companies. And when you try to hit the entire market, many times, you miss the enterprise needs. And I think that we have not tried to hit the entire market. We haven't tried to go to my wife's small business, for example. Someday, maybe we will. But right now, we're focused on the largest enterprises that we really fit well with. And we still have tons and tons of room to sell, even with our existing clients.

Perfect. Perfect. And staying on that go-to-market and customer segmentation, right? So you guys have been adding sales capacity for the last 12 to 18 months, and you brought in Hayden to lead that customer-facing organization, right? So give us an update on what were his priorities? Like how has he settled in? And when do you expect that the sales productivity to sort of like get to a level where you envision it will be?

So we've had -- it's probably been -- it's probably maybe been not noticed as much, but we've already had an uptick in our growth rate over the last few years based on the increased capacity that we put in the field, even pre Hayden joining us. And we feel really great about how we went from what was normally a low -- was historically a low-teens grower up into low 20s grower. So we feel like we've made that first step of the journey. We've moved into SaaS, right, that we've made that first step. We now have a SaaS business that's over $200 million, where it was only -- when I started, it was $25 million or $30 million. So we've made a fairly big jump in the last few years. Where Hayden comes in is the next leg. Right now, we're approximately $1 billion company. How do we get from $1 billion to $3 billion to $5 billion to $10 billion? And that requires not only what we've done to get here, but it requires additional things. It requires more cloud-native product offerings, right, so that we can actually leverage the newest technologies, Kubernetes, multitenancy, et cetera, to be able to scale more clients. It requires the go-to-market to mature. More partners being able to help get us leads and help us close deals, a product that can be deployed very quickly to a larger population of customers. Also the ability to start fast and deploy, the ability to continue to radiate, upsell, cross-sell, build the customer success culture. And so Hayden has lived in companies that have done that very well, right? The places that he's worked before are who we aspire to be as we expand and grow because they've been very successful. So I think he knows the formula to take from where we've taken it to the next level.

Perfect. Perfect. And then, I guess, you mentioned about this SaaS transition, subscription transition, right? So just give us a refresher on what was the motivation behind it? And where you are, I think you're halfway through the transition, obviously, right? So some metrics are beginning to normalize versus some that are still going to take some time, right? So help us chart that journey. And also from a CFO perspective, you have always been saying ACV and maybe RPO are the 2 KPIs people should focus on during the transition. So give us the dynamics there.

Sure. So I'm going to start with the last question you had, because I think it's a really important one. Although I am a CPA and I grew up in a traditional accounting and finance role early in my career, I think the problem that CFOs have is they focus too much on the accounting. And at the end of the day, what really matters is that you get increased annual commitment spend from your customers that you have high retention rates, and that those commitments last many years. At the end of the day, from a revenue standpoint, that's what really matters. How the accounting gets transacted is supposed to represent the nature of the business, but many times doesn't. The accounting rules are not meant for investors. The accounting rules are meant for equality across companies. It doesn't necessarily mean that they represent what's really happening. So I really like the operational metrics that help people understand what's really happening. And I believe ACV is the primary and most -- ACV or ARR. They are interchangeable in my mind. ACV or ARR are the most important. The second most important is how much additional commitments you have that you haven't actually taken to revenue. And if you look at those 2 and then revenue, kind of the picture makes sense. So now jumping back to why did we move to SaaS? We moved to SaaS because the market was really pushing us to move to SaaS. We didn't -- we weren't -- we didn't move to SaaS early. We were probably late -- not probably. We were late to the move to SaaS. I think we've done a good job catching up. And I think that our clients have really welcomed that move, but we were -- we saw the market. We saw the need. So we moved. The transition now, the last kind of the middle question in your 3 questions, was a transition -- so I'm -- fortunately or unfortunately, I've been through a lot of transitions. So this is not my first one. And when you think about a transition, a transition typically takes about 5 years. If you go back and look at Adobe as like the poster child for a transition, which I think they did a very good job transitioning, it took them about 6 to 7 years, right, before everything settled. But let's just use 5 years as a rule, because that's about the normal. What happens is you have 3 parts of the transition. Part 1 is you change your go-to market. You sell the recurring. You sell the SaaS. We are largely done with that. We sell 90%, 95% of our deals in nonperpetual. So I would check that as almost 100% done. The second one is that you actually start to see your revenue growth rate and your ACV growth rate converge. That typically happens in about the middle of the transition. Because you go down 2 years, you have an easier compare, right, because your revenue and then you start to see that growth. Well, I would say we are almost there on that one, too. We're probably 75%, 80% of the way there. The last one is the accounting transition. And by the way, the accounting and cash flow connect on this one because you went from billing everything upfront and getting the cash upfront to billing things over time. And that typically takes 5 years to stack in all of the recurring deals and get back to when you started. And that's the one that we're about 60% or so of the way through. So I think there's 3 pieces of it, right? We're done -- we're almost done with 2 of them, but the accounting when you have to wait until you just get those multiple years of layers of the bookings.

Perfect. Perfect. And I guess, let's move on to the recent performance. You guys have been able to defy the gravity somewhat from the pandemic. This performance -- ACV growth has sustained in the low 20s, right? So help us understand what's driving resilience there? And also, just on the most recent quarter, I think -- or actually, I'll wait to ask that question. Why don't you talk about the recent performance, give us the highlights and then I'll enter into the most recent quarter.

So we have the advantage, and this is not -- I wish I could say this was our strategy. It just happens to be connect. Most of our clients are selling to consumers. And there are larger organizations that are thinking past the pandemic. They're not just thinking about the next quarter and the next 2 quarters. If we were in travel and hospitality or the rest -- or if we had airlines, if we had things, we had restaurants, we had like retail -- lots of retail that was in-store retail, point-of-sale systems, that would be harder. I would admit. And I feel bad for companies that are in that situation that have to go through that. We have some of those, but we don't have many. And we -- and I've a lot of empathy for that because this was -- they didn't do anything wrong to deserve the situation that we have. But our clients, banks, insurance, health care, communications, in some cases, some of those are actually even doing better during the pandemic, but mostly they are thinking about the long term of the consumer. And there's been no question that this is a temporary situation. The consumer, in some cases, when this is over, the consumer might come back and there might be pent-up spending demand on the other side of this in terms of people waiting so long to be able to get back to normal life. So our clients have continued to invest -- the majority of our clients have continued to invest and, quite frankly, are using this as a preparation for digital transformation. They know now that people aren't going to walk into stores as much. They're going to do more commerce on mobile devices, on computers digitally. So that's the transition that they already knew about pre-COVID. This is just maybe in -- reinforce that they should prioritize it.

Understood. Understood. And I guess, also, one thing that has stood out in the recent quarters has been Pega Cloud, right? So Pega Cloud versus Client Cloud. I mean you've always talked about that you are pro-customer choice and you want to be -- you don't want to sort of like push one deployment model to your customer, let -- leave it to the customer, right? But Pega Cloud has seen particular strength. So can you help us understand the drivers there? What's resonating well with Pega Cloud?

So let me clarify one thing because it is easy to get confused on this. We are all in on Pega Cloud. We would rather have clients buy Pega Cloud. We aren't -- I don't -- I wouldn't say that we're indifferent. I would say we want Pega Cloud, but we recognize that clients aren't ready for SaaS in all cases. So what I think is, as you see Pega Cloud become a bigger part of our business, and quite frankly, even a bigger part of our new bookings, which is what happened in Q3, which is what you're referring to, it's really the demand environment that's actually causing that. It's the clients are moving more to SaaS than they increasingly are looking at Pega Cloud. It is -- is it a good or a bad thing? I'm not sure that it's necessarily good or bad. I think I want Pega Cloud because the more scale that we have, the more that we can get operating leverage, the more that we can get our margins up to best-in-class and that's really important from the financial model of Pega. But in terms of the client, we just want the client to get our solution and get the value from our solution. And so therefore, if a client buys Client Cloud, is that a bad thing? No, of course, not. They bought Pega Solutions. But we would like more clients to move to Pega Cloud because of the scale advantages that we get, and then we can attribute back to our clients.

Understood. Two follow-up questions to what you just said. So first, do you expect this to continue into 2021? So do you think this is just COVID-19-related? Or do you think the mix of Pega versus Client Cloud will stay pretty healthy going into 2021? And then second question is on margins, like you mentioned about it helps you on the margin front as well. Can you help us understand as to how are the gross margin dollars different -- maybe different between Pega and Client Cloud?

Sure. So I don't know -- I wish I knew because I would arm the company from an investment standpoint in a different way. I don't know if the momentum of Pega Cloud will continue. I'm mainly focused on the ACV growth and continuing to grow Pega, the spend that our clients invest with us. But my gut would be that SaaS is more relevant than less. And so for everybody that is going through this transition, I would think that you would have more people move into the SaaS environment, into the Pega Cloud environment. So that's one aspect of it. From the margin standpoint, if you think about Client Cloud, it's the traditional higher margin, kind of like the 90%, low 90s kind of margin. If you think about the SaaS offering, best-in-class would be maybe the low 80s, right, is kind of a best-in-class kind of SaaS margin. The -- because naturally, you're getting more revenue on the SaaS side than you are on the Client Cloud side. Our margin target for the next few years is to get into the mid-70s. That doesn't mean that's the ending point. It's just kind of a rest stop, so to speak, on the highway of getting our margin up. We went -- when I started 5 years ago, our margin in Pega Cloud was 35%. Then it went to 42%, then 47%, then low 50s. Now it's low 60s, actually closer to mid-60s. So I think we've made good progress, and we still have -- we're only $200 million or so of a business. So if you compare us to other enterprise companies, at even $1 billion, I don't think their margins at $1 billion were where our margins are at $200 million. So I think by the time we get to $500 million, $600 million, $700 million, you're going to see that margin creeping up closer to 75% or 80%. And then the key is then the cloud-native aspect, things like Kubernetes and leveraging multitenancy. That's where that comes in to really be able to get us that last leg of margin expansion.

Perfect. Perfect. And on the ACV growth, right? So you mentioned obviously, all the moving parts on Pega versus Client Cloud, they all come together to ACV growth. And you have sustained low-20s ACV growth, but have also talked about maybe a potential for acceleration there based on some vectors. So help us understand those vectors and give us a trajectory, like where you are in terms of where you want to be and how you're thinking about that going forward?

Sure. So the market we're in is $150 billion plus. Our addressable market is probably about half of that, right, because we don't sell into the SMB. So just we don't sell in some verticals. So let's just be realistic and say it's half. We have less than $1 billion -- if you take professional services out, we have less than $1 billion. As you can imagine, we have a lot of runway there, right? I mean we have maybe 1% market share in all those like. So for us, it's not a market thing. If you look at our product and look at where we benchmark, where the analyst benchmark our product against it, we are definitely competitive. In some cases, we're the best, but we're certainly up in the top right. So if you put the product together with the market size, it really comes down to, do you have adequate selling capacity in the field, do you have the ability to get density on those organizations, to get coverage on those organizations, to be able to have the volume and the momentum of the capacity of selling? And then the last piece is, do you have -- and that includes partners on that capacity. And the last piece is, do you have the selling cadence, the sales discipline, the sales operational, the business system, the offering management process connected, where you're really not just selling a custom solution based on having really good engineers. And you're selling -- you know the market. You have product market fit and you're again -- so we're touching on each of those. We want to make sure our product is best-in-class. We want to make sure we understand and size the market and target the market that we're increasing our selling capacity. And then we're working on the business system and making sure the offerings that we have are relevant for the market. So all of that combined is our strategy to get from $1 billion to, say, $3 billion, right? And that is -- other companies in our space have shown the ability to grow at that pace. So we wouldn't be an outlier in that respect. So that's what gives us confidence that the opportunity is there.

Absolutely. Absolutely. I know we're almost out of time, Ken. So I want to throw in one last question. So you don't guide intra-quarter, right? So -- and help us understand, obviously, right? I mean you guys have a very predictable -- much more predictable business model than you used to have, but again there is macro uncertainty. So at this point in time, how are you feeling about Q4? How is the quarter looking? And also, do you think that -- because Q4 is traditionally the time you will guide for the next fiscal year. Do you think you will have enough visibility to provide that guidance because we have seen many companies actually withdraw their fiscal year guidance? So help us understand around the guidance cadence.

So it's a really good question. And once again, I am -- I would say, I am not embarrassed to say I am very highly critical of public companies that guide quarterly when they do not have the level of predictability or visibility to guide quarterly. I think it's a little bit of -- and the whole beat in a race thing, I know it sounds good, but it really is a game. We're not in the short-term games of quarters. A 12-month period, we have reasonable visibility, right? So we can peg a number, and we can target to that number. It doesn't mean that it's 100% accurate or 100% predictable, but we -- but at least has some directional connection to the amount of capacity, the bookings, the overall productivity that we get. So we know that if things don't -- like currency doesn't move, Pega Cloud mix doesn't move and we directionally hit the level of activity, that's kind of in the range of -- that, to me, is the right way guidance should be framed up. Because I think overengineering and/or trying to give some false confidence on the guidance. Now the other direction of that, which is to just rescind guidance completely. For me -- and we did talk about that. I mean we talked about like other companies are doing it. We saw research on it. We decided that, that was a little bit -- we felt like that wasn't the right message to send to our investors or to the market that we actually had no idea what our business would look like for the next 12 months. So we don't believe in quarterly guidance, and we feel strongly about that because we feel that it is easy to be manipulated. It becomes more of a selling and marketing tool than it is running the business. And the second part is to not give any guidance for a year, to me, it feels like it's wrong for investors. It feels like you should actually have it. It's almost like I have no target. We'll just see how it goes. And I don't think we believe in that, and we don't believe in quarterly. So we land at the 3-year plan annual target and why not share that with investors. That's kind of our philosophy.

Now that's loud and clear, Ken. So I know we are out of time, Ken. So always enjoy the conversations with you. And hopefully, you have a productive day of meetings here at our conference. Thanks for joining us today.

Thanks, everyone. Have a good day.

Bye. Bye.