Pegasystems Inc. (PEGA) Earnings Call Transcript & Summary

Hello, everyone. I am Pinjalim. I work with Mark Murphy and the enterprise research team here at JPMorgan. I am delighted to welcome Ken Stillwell, CFO and now COO, of Pegasystems. Ken, welcome to the conference.

Thanks, Pinjalim. Appreciate it.

Yes. [Operator Instructions] I believe you'd be able to ask a question, and I will keep an eye on those questions as it comes along.

But to start with, Ken, maybe we can start with your changing role. And congratulations on that. You are now both a CFO and a COO. So help us understand, what does the addition of the COO role mean to your work going forward? Is this kind of a major change in your roles or responsibilities or it is more of a recognition of the work that maybe you have already been doing?

I think it's probably a combination of both. It's not that unusual for a CFO to kind of have both titles nowadays. I think the CFOs, especially in companies, in SaaS companies, there's a lot around the business model, a lot around the economics of the growth model and really measuring it, which I think kind of connects us more into the operations of the business. The old perpetual model was a much more kind of booking deal closing kind of related model. And now there's your hiring, your cost and your cost trend and your ACV trend, there's a lot of things that are kind of leading indicators. But you don't see the results typically until a year out because a lot of your backlog is coming into revenue and quite fixed. So specifically around my role, about 1.5 years ago -- actually, probably a little longer than that now -- I took ownership for our Pega Cloud business, our operations, our engineering, our client support, the business model, really trying to manage the economics of that. At the time I took over, we were kind of in the low 50% kind of range gross margin. And we've kind of had a year where we actually even went flat to kind of a little bit down in terms of the margin because we did our FedRAMP certification, if you remember, back in the beginning of '19. So I got involved in really trying to focus on that as a business, not just as a cost center. And that led to us really trying to drive the incentives in the organization and the alignment with engineering, and really Pega Cloud being the future of our go-to market. So when that happened, Alan and I kind of talked about -- look, the future of Pega is Pega Cloud. And if the future of Pega Cloud -- should be the future of Pega is Pega Cloud, the way we build it, the way we model it, the margin profile that we are kind of skating toward needs to be managed by a business owner. It can't just be left to kind of arrive there on its own. So I took a much deeper ownership through 2020. And then at the beginning of the year, Alan had kind of talked to me about taking on the additional responsibility. And I think what's new with that is not the Pega Cloud kind of business ownership but I'm really playing, I would say, a role as an integrator in the organization, which is to make sure that our product and our strategy road maps match our go-to-market layout, our interaction with partners, how we're thinking about the outcomes that we want and the economics of kind of that model because, I think, left to a functional organization, which is the way Pega has been organized, you can have a lot of places for disconnect or expectations that aren't aligned. And so that's where I think I'm playing a role is to make sure that everybody has held accountable to the investments that we're making and the outcomes, the collective outcome, that we want to drive. And that allows Alan to really focus on what he's really good at and what he should be spending his time on, which is customers, product strategy and vision, the culture of the business and really building a durable business that will kind of sustain higher growth levels that we aspire to. So my job is a little bit of what I was doing for the last 1.5 years and what I think the company needs me to do. And then lastly, the last 4 to 5 years, I think I've built the CFO function in a way that it isn't as dependent on me every day coming in and doing some of the brute force lifting that I had to do 4 or 5 years ago. So I think that the team that I have is able to sustain less day-to-day, kind of minute-to-minute involvement of me that allow me to help pitch it in other places.

Yes. No, maybe I should have asked you this first. For a few people maybe who doesn't know Pega, I mean Pega has been in the landscape for quite some time. Maybe it's been 40 years around maybe, if not less. And it's incredible that it's still kind of growing that 20% ACV growth. Help us maybe, very briefly, the -- where was it, where are you today and where are you kind of growing as a business, as a solution?

So yes. So Pega has been around for almost 40 years. Alan has been our CEO since the inception, our Founder. The company's growth rate, if you take away the last 3 years, the company's growth rate varied from anywhere between 11% and about 18% or 19%, kind of averaging around 13% to 14% a year for probably the previous kind of 10 to 12 years. We didn't have a year where we declined, and I don't believe any growth year was above 20%. So that was kind of pretty respectable, certainly nothing to be embarrassed about or ashamed of. When we move to a recurring business, our growth rate accelerated up around to a little bit over 20% as we first made -- we had a little bit of tailwind from moving away from perpetual. But the last year or 2 has really been kind of apples-to-apples growth rate of about 20%. So we've taken the company from what was a 13% to 14% grower into being a SaaS first where SaaS is more than half of our new deals, it's 1/3 of our ACV, and our growth rate has accelerated to about 20%. So I think we've done a good job making that first step of really getting the company -- and so interestingly enough, the last 3 years is the fastest the company has ever grown, and we're actually at a reasonable amount of scale. I think that should just be scratching the surface, so to speak, because the markets that we're in, the solutions that we have, the growth that we can achieve, we're still relatively small compared to the market that we're in. So we should be able to accelerate our growth without much disruption or attention from some of the larger providers because the dollar amounts of our growth is relatively insignificant to the market size. So I do think there's an opportunity to accelerate. Certainly, we need to do some things differently than we've done in the past, which we're working on.

Yes. Now you obviously squarely kind of sit in the customer experience space, which has recently gotten a lot of boost after the pandemic in terms of budgets kind of flowing into that space. As we come out of the other end of COVID, I mean based on your customer conversations that you're seeing, do you feel like -- my statement about people putting more weight on the CX category as such versus your low-code/no-code development platform, would you say there is a weight, higher indexing by customers towards that category that you might benefit from?

So I saw something just the other day that suggested that all of the increased it spend year-over-year for the next 4 years was going to be digital transformation, right, meaning that all of the increased spend, the growth. Now granted, that doesn't mean that that's the only spend. It just means that dollar for dollar, the total growth is all driven by digital transformation. Now what is digital transformation? It's a laundry list of things. But I think the fundamental difference that I see -- and COVID accelerated this, but quite frankly, it was happening independent of COVID, is with the adoption of mobile devices and mobility in general and what we're doing right now on kind of digital meetings, it's really given consumers an option. And the option is, do I have to go to the mall or go to the grocery store to get my goods? No, you don't anymore, right? You can order lunch, dinner, your groceries, a sweater, a car, and it all gets delivered to your house, right, if you choose to. Now I think that you still -- some people, including me, will want to still get out and see things in bricks and mortar. But the reality is you have to account for the population that won't. The other thing that's interesting is digital banking, digital commerce, the ease of even investment transactions that can be done by high schoolers on their devices, very different world we live in. And I think that, that really means that anybody that has a brand needs to account for that. And so they have to figure out how to engage with their customers even when they don't know that their customers are engaging with them. And that, to me, is a very big change in the way that we all interact with kind of our customer base, our prospect base, versus the traditional billboards and magazines and mail. And when they come in the store, that's really the ancient way of dealing. It has to be digital. So that, to me, is a portion of the digital transformation. And what COVID did was almost lit a fire under companies to say, "Hey, I better get this in line because, at some point, I'll lose out because I won't be able to touch my customers." So some part of the momentum is around that. And the other part -- I think another part that is relevant for us, is this concept of orchestrating work, right, of orchestrating activities. You've got disparate systems. You've got a workflow that needs to be done. Sometimes it's with a consumer, sometimes it's not. But it needs to be streamlined. It needs to be fast. It needs to be automated. It needs to use AI. And it doesn't need to force everything into one application, right? So you still need the ability to use different applications for your sales automation, for your marketing, for customer service, for outbound lead campaigns. So given that ERP, right, no vendor is going to be able to solve all of those problems as a best-in-breed. So given that we all buy different things, we need to kind of stitch them together. I call that orchestration. So I think the orchestration and the digital engagement, those are 2 things that are just top of mind with, I think, every client we see.

So that orchestration piece that you're talking about, it seems to me that's what is kind of morphing into this thing you call the Process Fabric, right, which is kind of tying the low-code side of the business with the CRM side of the business and external applications and kind of bringing it all together, it seems like. But I think what had helped probably -- if you are able to kind of make it more tangible in terms of maybe your customer use case, like how is somebody using it or would use it in the future or currently using right it now.

So an example that is a really simple example that is completely unrelated to our business, and then I'll touch on that orchestration, if you think about the way Outlook, or a tool like that, manages multiple email addresses, right, it gives you a UI where you can organize your email addresses. You might have a Yahoo! and a Gmail and Microsoft and your company and you might even have your life and your children's e-mails. You're able to organize it, be able to have one UI, you can toggle between them, you don't have to worry about logging into one system, logging into another system going to Outlook, when you're on your mobile device, you can collectively merge your calendars or not merge your calendars, so if you think about that really simple use case. Now I'll take a step back and you say, so I'm using Pega for application X. I'm using Salesforce for application Y. I'm using Pega for application Z. And I'm using Adobe for application A. I have to log in to potentially 3 or 4 different locations. Those systems may actually do related work. I don't have a view of where my work basket is. I can't see when things get hung up. I can't delegate things. I can't turn on robotics or turn on decisioning to be able to maybe even suggest rule changes that I should do to be able to maybe get the throughput faster. I needed a place where I can see that. That's the starting point. Then I need a place where I can actually execute certain things that will then go and execute in the end systems. So now imagine not only seeing the visibility, but I don't have to go and log into that system to address that specific item. I can actually execute it with inside that dashboard. And as it becomes more robust to the integration, I can literally create a dashboard that shows every system, every application that I may have a role, what is in my work basket, and I can actually initiate certain activities from that dashboard. So you're really creating a layer over top of the potential many, many systems that you may engage in. That's the dream for what a user wants, right? The user just wants to go to one place. Now how do company solve that right now? They build internal company portals with the right custom code to create view boxes with links and complicated links and deal with single sign-on issues and security issues, right? And then how do I go into a system and then how do I reverse back out of that system back to my dashboard, it's very clumsy how companies are trying to solve that because there isn't an answer. So I think we really thought of Process Fabric as kind of the way to kind of pull that thread of all the places in the company. Guess what else it can do? It can auto-discover. It can look for things like where is Ken Stillwell a user in a system. And maybe there needs to be something that where does a process stop and maybe get orphaned, that might be a great thing to understand as a business owner, to understand where people are getting slowed down, where the system is breaking down. So it just really is helpful not only as a user but almost as somewhat of a diagnostic of the landscape of what's happening with all of your work across the organization.

That makes a lot of sense. And I'm not quite sure who's doing something like that at this point in time. But how are you monetizing? First of all, is that generally available? Or is it close to be -- or is it in a beta? Like where is the maturity of the product at this point in time? And how are you monetizing it? Or how are you thinking of monetizing it?

So we're still in the early phases of this. We do have some clients using it. It is generally available. But it is still, I would say, not sold kind of as a primary lead-in solution yet. But I would say that there's 2 ways to monetize it. The first way is to go into a client that already has Pega and really package this as a way to create that ramp or that dashboard over top of not only their Pega applications but other relevant places where work is executed which is, of course, not exclusively in Pega. Work executes across lots of applications. The next way to monetize it is to actually use it as a lead-in solution, to really go into a client and sell that as the way to manage what is probably a very complicated set of individual workflows and process automation systems. We've had clients that we've talked to that have 5, 6, 7 different work management systems or process management systems. They would like to just collapse down into 2 or 3 or 4. Even 2 or 3 or 4 is a tremendous amount of activity that's happening for similar users. So 2 ways to monetize it is sell where we already have as really that dashboard, go in and sell that dashboard as the way to really help our clients organize things and where the radiation opportunity, or the upsell, cross-sell opportunity, is what you can get from that visibility around where some of your processes could be broken.

Is that vision kind of what Gartner and IDC is basically talking about? They call it hyper automation, right? And I forgot the term that IDC uses. I think Gartner uses hyper automation. It sounds very similar to the vision that you're laying out about Process Fabric.

It's a combination of hyper automation and process mining, right, where you're actually trying to look at processes, understand where relationships are, allow yourself to get the automation to the end point from the user without having to have multiple log-ins. We have an RPA solution. And some of the RPA vendors sometimes solve some of the single sign-on or log-ins by copying and pasting user names and passwords and trying to -- but the reality is, and many of us know this, is a lot of the systems now when you're logging in, they have certain security protocols where they'll actually ask you to identify images. And that's where RPA breaks down, right? It's not smart enough to be able to simulate a human interaction. Well, you really want to tie those APIs back to that dashboard, so you don't have to do popping-up browsers and trying to kind of, like, fake a human interaction to be able -- that won't work as you scale and certainly with the sophistication of a lot of the applications. So that's where our RPA -- our clients use our RPA solution for some of those use cases where that's not an issue, copy and paste from e-mails or Excel files, things like that, they'll use that. But once you get into this application environment, it becomes much more complicated, especially with the onset of a lot more stringent security.

Yes. That's probably a good segue to talk about RPA because I have actually gotten a few questions from investors, not right now but in the last week and so, about RPA. And obviously, after UIPath being public, that's kind of a hot topic. And you, Pegasystems, actually have the vision to -- OpenSpan, I think you bought it 2016 or something, right? And that was a time when people were hardly talking about RPA. But we haven't heard much from Pega about RPA per se. It seems like it's kind of embedded within this Process Fabric vision. So help me understand. One, how integral is RPA? It seems to me like RPA is required for this automation of task in processes that may not be right to be integrated with API. If you have a process, there might be a portion of those processes, which are tasks that is ideal for an RPA. And you have the RPA piece, you obviously have the API piece. And so you can talk a broader game and seam it all together as Process Fabric, that kind of vision. But is that correct? Is that kind of very integral to the Process Fabric vision? And then one question I have gotten, since you're a CFO, I'll ask you that, how big is OpenSpan at this point in time, right? I don't know if you have attributed revenue like that or not. But people have, I think, tried to kind of look at a sum of the parts valuation. What can I say OpenSpan is? And maybe I'll give x multiple to it and look at the rest of the business as y. So help us unpack that level.

Sure. So there's 2 pieces of robotics. And I don't like using the RPA too generically. So I'm going to call RPA as being what a UIPath would do, an Automation Anywhere, or what OpenSpan, some parts of OpenSpan did, which is the traditional screen scraping, like OCR and e-mail on a screen and an Excel file, copy, paste somewhere else, doing it at a speed that helps a human be faster because you would otherwise -- so you're looking at data processing centers to be a great place where you're trying to manage lots of data coming in on faxes, electronic documents and trying to -- that's a great use case for RPA, right? Just trying to collect what is like manual documents where you can have an API into some repository. When you have an API between applications, you don't need RPA, you need what I would call robotics, which is the robotics is really embedded in the application. Now you're trying to automate things that would happen in an application with a human. So very similar to where RPA was data center, I'm copying and pasting data, I'm transcribing data. Then now I'm in Pega, or Pega the application, and I'm actually executing steps in a workflow. I'm doing certain information, but the robotics will allow me to turn it on to be able to help automate things: skipping steps, automatically filling in certain fields, like things that are going to be native inside the application that you may don't even have on the screen. So you need to actually be able to understand the application and understand the APIs to be able to pull data, to be able to auto-populate things, to be able to close out tickets automatically, to send actions to other third-party systems based on the closing of the ticket. Things that a human would normally have to stop working and actually spend time to do. I read an article a few years ago that a customer service call -- when a customer service representative hangs up, they spend sometimes 6 to 8 minutes documenting the call, right? That's lost time. They might only spend 3 minutes on the call and 6 minutes documenting the call. That's where robotics in that kind of application can help. So that's kind of our view. If you think about OpenSpan, we did that -- you're right, we bought OpenSpan in the beginning of 2016. And robotic use cases are somewhere around 10% of the business that Pega does right now. It kind of depends on the use case, of course, but it's very, I would say, very integral to the way our clients use the product, and it's very common. And I kind of roughly would say right around 10% of our business is some level of a robotic use case. We don't focus too much on RPA, though, because there's a misunderstanding, I think, that RPA and digital transformation are naturally -- there's a maturity curve of you start with RPA and you land in digital transformation. I view it a little bit like a bicycle and a car, right? They both are transportation vehicles, but just because you're in the bicycle business, it doesn't mean you'll automatically be building cars. So there isn't necessarily -- there are 2 different problems: one is for maybe short drives where you're trying to get exercise and it's not worth starting your car and stopping it, and another one is for a specific use case. So that's kind of the way I think about RPA versus BPM or digital transformation. And I do think that's very misunderstood in the market that sometimes they get put together as kind of being the same problem that you're solving, and the problem is actually different.

So just to double-click on that, the robotics part that you're talking about, the Qurious acquisition that you did, right? And I saw a demo in the user conference where somebody calls -- I think an agent picks up and the other person is talking. And I think the Qurious application is kind of auto-populating the agent desktop and kind of surfacing stuff which he needs to, to answer that call, right? Is that kind of a good example of basically robotics that you're talking about?

That's a combination of AI and robotics using kind of a rules engine. So the way that AI works is typically, it looks for patterns. It goes to its pre-described set of rules and outcomes. And based on those patterns, it can kind of pick an outcome. Then it learns from that. It starts to see kind of the logic -- you're kind of automating AI, right? You're making the AI kind of become smarter and making it really streamlined, not to be kind of this magical thing but really just routine, like, what-if scenarios. And the robotic piece of that is the grabbing of all the information. So Qurious does the translation, the robotics grabs the information, puts it against a rule base that populates it in certain fields and then the AI engine makes the prediction of what you should do. What should you do with that information? Is this person upset? Are they happy? Are they confused? And by the way, what's the top 3 reasons why they're calling? Are they calling to close an account, open an account, add a child to an account, ask for where they can actually get their product service, whatever that is. And we've just solved both problems. We've solved an input problem of why people get frustrated and spend 3 to 4 minutes explaining the problem, and then we've sold a back-end problem, you have all the information there that now can auto-populate all the systems when the call is done. So now you've taken people's wait times down. You've taken a number of people in the call center. You've actually moved to where you should probably be able to do self-service with a robotic customer service person, right? So I think we've really taken the concept of what is commonly the chat, you go in a chat window, you ask a question and they go against a search database, we're trying to now do that in a live environment, right, where someone can almost think they're talking to someone and they're getting a real-time transaction.

Yes, that demo was pretty powerful, and I had no idea that Pega was doing that kind of thing. We don't have too much time, but I wanted to go touch upon the go-to-market changes that have kind of put in place this year. Maybe talk about how extensive they are. I think Hayden Stafford seems like have made some changes. And I guess, with respect to that, do you expect any kind of -- typically, when there is a change, there is some kind of a turbulence -- or not turbulence, it's the wrong word probably, but some kind of a disruption is the word, right? We did see ACV growth tick down a bit from 20% on a constant currency basis. So help us understand the trajectory of ACV, that curve. Maybe it starts a little bit lower this year and maybe picks up towards the end of the year. Help us understand that, along with the go-to-market changes.

Sure. So Hayden came in, in June of 2020. So it's been about a year. And with any leadership change like that, you're going to have some distraction, right? You're going to have like -- they're going to come in. They're going to get acclimated. They're going to implement some positive change. The organization has to figure that out a little bit. They'll probably make some personnel changes. There's lots of -- it's no surprise, it happens all the time. So we saw a little bit of that, kind of like digesting of those changes, in Q4 and a little bit of it in Q1. So when we finished the year, I knew that we were on a good trajectory, but I also knew that some of that would kind of trickle into the beginning parts of 2021. And so when I gave guidance, I talked about bookings being a little bit skewed more towards the back of the year, the shape of the pipe, the natural kind of evolution of the change, right, of bringing in some new leaders. The partner program that we hadn't announced yet in a full way. I didn't want to bring that up when we did guidance in February, but I knew it was coming in May at Pega World. So these things are all kind of positive forces of change. But they do kind of cause some of the elongation of some of the sales cycles and even push some of the deals towards the middle to the back of the year. So I'm very confident we're doing the right things, and we're on the right path. But I did kind of see that coming and even signaled it. So I don't think that, that was surprising. I think Q1 and, quite frankly, 2021 looks very similar to the way that I thought it would look when we started the year off.

Right. Okay. But your long-term goal about accelerating ACV, right? It seems like we'll probably hear more about it in the Investor Day next week. With all the changes that's happening, I mean, product-wise, it seems like it's really good differentiated changes that is happening. Go-to market seems like -- I keep on forgetting his name -- Hayden has brought a lot of changes, hopefully, that's very good, and then the partner program. I mean would you say that ACV growth acceleration, I mean could we see it in more near term? I mean I'm not saying 2021 but more near-term versus like 5 years out or something, right?

I think we have a better shot, Pinjalim, in 2022 than we had before Hayden joined the company. So I think that we have figured out how to get the company to a 20% grower. And kudos to us for doing that. But we probably didn't have all the pieces to be able to get it to a 25% grower. And I think bringing in people like Hayden and our leaders for North America and EMEA, and we brought in a gentleman to run customer success and professional services, coming from companies like ServiceNow and Microsoft and Salesforce, they've seen the higher growth pace. And I think that that's something we didn't really have inside of Pega before bringing some of these individuals in. So I think that gives us a much better shot of getting to that higher growth. Now naturally, nothing is a foregone conclusion. We need to execute. But I do think that we have the right types of people that have seen those growth and actually know in an enterprise software. Don't just know it in any industry. These are people that we have that are very relevant to the space that we're in.

Yes. Yes. Understood. And lastly, well, I'll ask you this question, let me check at this. Let me ask you this, do you feel like there's any investor misperception? As you talk to investors, do you feel like there is any misperception that is worth pointing out?

So there's 2. One is the misconception of RPA being obviously kind of transitive to digital transformation, right? I think people ask us all the time, well, you have an RPA solution, is an RPA a BPM? It's really not, very different things. That's one. The other is low code. We've led low code since 1983, right, which is kind of funny. We called it no code. We call it model-driven. Essentially, all the players that are in the low-code space are all the companies that are doing something similar to Pega, we would argue not as good but similar. Then there's another group of low-code vendors, what I would call, more simple low-code vendors, meaning like -- the word that is typically used is the citizen developer, right? Like the individual that's not technical that can build a case: a vaccine status tracking application in your office or something that's like 1 or 2 steps, not very complicated, not a lot of integrations, almost like a survey on the web. So there are lots of low-code use cases. The problem with low code is you need to be able to scale it to enterprise. You need to have the same application that you're building because, guess what, that might actually become a medium in terms of complexity and then a high in terms of sophistication. And if you start off with something that really was built for simple, you have to almost start over again. If you only have something that deals with the very, very, very complex, you can't really solve lots of the simple ones. So the adoption will only be on very complex. And what we're proud of at Pega is that we can kind of go across that continuum, right? We can actually have Pega Express deploy low code in like that citizen developer. And we can also build enterprise-grade applications using the low-code concept so that you can build for change, you can evolve, you can add business units, add steps in the process without having to write kind of Java code. And that to me is I think the thing that is probably lost. There's really different parts of low code, and there's very few people that do it across all of them and, I would argue, no one that does it as well as we do.

All right. With that note, thank you so much, Ken, really appreciate it. And thank you for joining.

Thanks, Pinjalim. See you.