Pegasystems Inc. (PEGA) Earnings Call Transcript & Summary

Hello, everyone. Welcome back to Day 2 of the Software Conference. My name is Luv Sodha. I'm part of the Jefferies Software and Equity Research team, focusing on apps. We're lucky to have Pegasystems join us. We have Ken Stillwell from Pega. Before we dive into the conversation, just as an FYI for all the investors listening in, if you do have questions, please feel free to enter it into the chat now that you have within the portal, and we would be more than happy to take them. So with that, we have Ken, who is the COO and CFO at Pegasystems. Ken's been responsible for the finance, IR, legal, IT at Pega. He has more than 25 years of finance leadership experience, and he's a graduate of the University of Pittsburgh. So welcome, Ken. Great to have you.

Why don't we start by talking about Pega story? What is the true north and what drives the company?

Sure. Thanks, Luv. Pega, I think, is squarely focused and has been focused for a number of years on trying to help the biggest brands and most well-known companies out there to streamline activities in their organization. Some of those activities could be operational activities, end-to-end work that needs to be done, the transactions, managing activity, updating customer records, et cetera, that really rely on a connected workflow across multiple applications, leveraging robotics, leveraging AI to be able steer the workflow or inject the human into the process only when necessary. And if you think about that same set of activities, that also happens on the customer engagement side. Whether you're selling to them, marketing to them or supporting them through your digital contact center, there are still workflow-type activities that need to be done. So that's really like at the highest level. We're helping to automate these end-to-end workflows and activities and actions that need to be done. The key way that we differentiate is that we have a best-in-class workflow capability. We leverage a concept called case management, which is the ability to contextualize the activity and keep a certain amount of data that's only relevant to that activity, but also the ability to associate with other similar activities. You can learn and build robust actions. We have robotics native to the platform. We have decisioning or what's commonly referred to as AI native in the platform. And we have this concept of dimensionality, which is when you build something, you can releverage and repurpose it for other activities, other regions, et cetera, by just configuring what is different. So it really allows a tremendous amount of reuse. And it's all done in a low-code/no-code way, meaning you don't have to write Java code, you don't have to do certain fixed activities that then you have to go and break and retest. So I think that, that is kind of the space that we're in and how we differentiate.

Awesome. No, that's a great overview. Maybe sticking to that point around low-code/no-code, there has been this -- I would say, this traction that a lot of these low-code/no-code platforms have had for the past few years, especially given the rise of the citizen developer. Could you talk a little bit about how the Pega Platform kind of appeals to these citizen developers and what functionality within the platform enables this low-code in-app development, if you will?

So yes, I'll touch on that. I'll also clarify our perspective on the citizen developer population community. So what happens is you have certain types of solutions that wants broad users, meaning citizen developers, people that are not actually software engineers, could leverage if you made the tool easy enough for them to leverage it and you allowed certain capabilities within the tool to kind of protect you from a guardrail support, meaning not allow you to go outside the parameters, get yourself in trouble. The simplest example that I'd like to use is Microsoft Excel because everybody on this call has used Microsoft Excel. Probably everybody in business has used Microsoft Excel and probably even outside of business. What does -- Microsoft Excel is such a simple tool, but yet powerful. What it does is it allows a very basic user to start doing things. And then, it allows you to learn, well, maybe I want to sum a column, maybe I want -- and you can do that through coding at some -- or you can use it through a toolbar or a dashboard to make it easier. Click a sum, it pulls up a little screen. It tells you what data you need to enter. But also what it does is it tells you, oh, there's a circular reference in this file or there's some error in your formula. It allows some guardrails, as you might call it, to not screw that up. If you think about what the citizen developer wants, what they want is they want the ability to build a simple application. They might have a 1- or 2-step, may not have a lot of integrations, maybe relatively straightforward, and you might call it simple, but they don't want to have to go to their engineering group and say, "Can you build me a registration app for an event that I'm hosting, or my facilities team would like to manage people's vaccination attestation that comes into the office." These are things that are not complicated applications to build. Analogous to something like an online survey tool that's very simple. You create questions, you send an e-mail list, you get the answers in a confidential way. That's all a low-code-type application, right, for surveys. If you think about what Pega does and others that we compete with in our space, we're focused on that, making it easy for citizen developers, for you and I and other people that aren't writing code to be able to go in and build applications. If you don't have that, you create an opportunity for your competitors to come in and say, well, there's lots of people in the organization that would like to try things out, do things in a simple way. Now they can't use Pega or whatever other platform you're using. So that's an obvious kind of value and defense mechanism for low-code. Now let me clarify one misconception that I believe in the market. Citizen development is not the way enterprise applications are going to be done, right? It's not that JPMorgan Chase or Jefferies or Bank of America is somehow just going to pop-up and say, let's just let all our nonengineers start building stuff and then we'll ask them what they like, and then we'll scale that up and make, that's not the way applications are built. So I think we need to maybe be careful. We don't kind of spin into the citizen developer as the way of the future. It is a very important aspect of how innovation is done. But when you think about enterprise freight applications, those will go through a little bit more rigorous security, validation, UI, et cetera. So I think it's -- I think that there's -- sometimes we get a little bit out of control, thinking system developer is like everybody is just going to be out building their own use cases and applications, and that's the way software will be developed. I don't believe that's true. I could be wrong, but I don't think that's where this is going. But you do need that capability for those business users that want to do more simple things on their own.

Awesome. No, that's very helpful. All right. Moving a little bit to your recent quarter, it looked like you had impressive ACV growth of 22%. You -- it is just clearly about the 20% mark. You had RPO growth -- exceed RPO growth of 23% as well. Could you maybe unpack this a little bit? And what are the levers that are driving this outperformance? What are the areas of strength, if you will, within the portfolio?

So -- yes, so we -- Q2 was the strongest non-Q4. Q4 is always the stronger quarter for us because of just the way enterprise software deals tend to commission accelerators and buying patterns, et cetera. In a non-Q4, Q2 was the best quarter we ever had. It was noticeably higher than Q1 of this year and noticeably higher that Q2 of last year. So if you just compare it on the seasonality or sequential basis, you can't help but see it was an incredibly strong ACV growth quarter. And with a good mix of Pega Cloud and client cloud, meaning our fully managed SaaS offering and where our clients -- our subscription offering where our clients manage that on their virtual private cloud. We actually like that balance because it really represents how our -- how we view our enterprise clients who are thinking about deploying solutions. They're not thinking about only public cloud, and they're certainly not thinking about everything in their virtual private cloud. Even the same clients have different needs for their use cases. So it's a really good balance between the 2, incredibly high growth. Now where did that come from? A couple of things that were noteworthy. One, we had a deal, not -- it added a few million dollars of ACV. It wasn't like the only driver of growth. But we had one deal that was -- just demonstrates how much opportunity there is with our existing clients and our ability to up and cross-sell it. And that deal had about a $30 million revenue impact in the quarter because of -- because it was client cloud. And under ASC 606, there's some kind of weird kind of front-loading of accounting revenue under that scenario. But it really highlights that we're doing very big deals all the time with our largest customers. And I think that's an important one because sometimes clients say, well, why aren't you sold out in your largest clients? And not even close, right? So that's one observation in the quarter. Another observation is that we continue to differentiate on this end-to-end unified real-time platform. Nobody else that we have seen can actually execute the strategy of integration with lots of other applications containing a workflow with scalability, leveraging automation, leveraging AI and is -- and real-time in terms of the transaction workflow, being an orchestration engine. And more and more clients, as part of digital transformation, are looking at solving that orchestration issue. We need to get things done. We need them to connect other best-in-breed solutions. We need it to be real time, and we need to reduce the amount of human touch. One small example from a client that we -- that I talked to actually as recently as last week is that people used to do digital transformation to -- maybe 3, 4 years ago to try to reduce costs. It was like, well, I've got all these people, I've got all these costs. If I could take out some of those costs, it's a different motivation now post-COVID. What it is now is, I can't find the people. I actually can't find the work the actual humans to go into a building to do this set of work. So I need to automate my system so that I can get more scale with a lower amount of human interaction. So it's an interesting flip. It went from really a efficiency play to almost an urgency of growing because you can't actually grow without the ability to support your clients, and our systems help our clients be more efficient in that communication, distribution, marketing, retention, everything that we do -- everything they do around the consumer.

Awesome. You mentioned the large deal, right, that you had that give you -- that gave you some idiosyncratic benefit this quarter. I guess, could you talk a little bit about the -- what that large client is buying on top of the initial deal that they had with you? And what are the other motions that you could replicate with other clients in the future?

Sure. So that particular client used a significant amount of our traditional case management workflow-type software to execute certain activities. They also had started to use some of our decisioning capabilities, or what we call our one-to-one customer engagement, where we allow kind of next best offer, next best action decisions to be made in digital channels. And so this particular engagement took that scope on both, but a little bit kind of prioritized around the decisioning to a much deeper level. They're using us for making decisions digital, like what video do I show them? What offer do I put in front of them? What action do I automate? Do I make recommendations for what they actually want to do? Do I engage with a human? Do I refer them to some other action that they need to take, maybe on their own, with a third-party, et cetera? So it's really around this kind of this digital engagement with an inbound kind of consumers, either going to a website, going to a call center, support center, et cetera. So it's really kind of highlighting our -- really our marketing automation is kind of more where that solution leans and how powerful our one-to-one Customer Engagement solution is at scale.

Awesome. No, that's impressive. And could you maybe talk about -- a little bit about how we should think about the back half of the year? Obviously, you had this great quarter. How does it set it up for the back half of the year? And how should we think about the compares? And then any insight into how pipelines are holding up?

Sure. So when I first -- when we first started the year, the way I thought the year would play out was the first half of the year would be a little bit more kind of, I would say, less acceleration in the first half of the year and a little bit more tipped towards the back end of the year. And that had a -- it was -- it had a combination of our new partner program, the onboarding of some of our sales leaders, just a lot of things that had to do with change management and the timing and the shape of the pipe and where I saw the activity. What happened was Q1 kind of started off, I would say, a little bit less impressive, Q2 more than maybe made up and caught up. It actually even pulled some activity from the third and fourth quarter because we were so -- we were good at executing in terms of getting those commitments earlier than maybe even I thought. So I think the first half of the year was pretty solid. And the second half of the year, I think, is still going to start to continue this continued acceleration. But I think Q2 really is a good foundation to kind of give me confidence that, that will continue through the back half of the year.

Got it. Maybe switching gears a bit and talking about everyone's favorite topic, cloud migrations. We've been through many of these, right, through Adobe, Atlassians in one now. Could you maybe talk a little bit about your cloud transition? It sounds like you're fairly far along in your journey. Could you talk a little bit about what's left and what innings you are, and how we should think about the financial impacts going forward?

Sure. I think of the cloud or a subscription transition in 3 phases. First phase is actually changing the go-to-market and making your go-to-market really sell subscription. I would call that the ninth inning, right? Like maybe even the end of the game, right? Like we're done with that. We're basically selling subscription. It's in our DNA. It's been that way for a number of years. The second phase of it is around the revenue normalization. If you have a trough, you have to normalize. I would say, maybe we're in the sixth or seventh inning of that. We've gotten to the point where things have -- so we passed the midpoint, we're starting to stabilize. We're starting to see revenue normalization already in '21. You will -- '22 will be another year with revenue normalization. So I think -- I'm anticipating we'll be done with the revenue normalization at the end of '22 as we start '23. So I would say, we're pretty far along, sixth, seventh inning, maybe, using the baseball analogy. Then the last one is the cash flow normalization. I would say, we're probably more in the early to mid-innings of that, right? Because if you think about the revenue -- when the revenue corrects, the cash flow tends to trail that by, say, a 6 months to a year, you're normalizing. So I think we'll get to the point where the cash flow is starting to normalize probably towards the end of '22 and the beginning of '23. It would probably be fully normalized in, call it, '23. So if you kind of think back, I'd say we're maybe in like the third, fourth, fifth inning of the cash flow normalization. If you average all that, I would say, we're still in the kind of later innings on total, maybe the -- so we're probably 60% to 70% of the way through all 3 of those phases.

Awesome. That's helpful. And maybe to level-set with investors, if you could give us -- how do you think about the business post that transition in terms of not only revenue growth, but profitability or cash flow? Over the long term, how do you think of it once you're done with this?

Yes. So think about there's kind of a number of transitions we went through in the last few years, and they all will settle at different kind of -- not -- they won't all settle at the same time, they'll settle over a few years. The first one is we moved away from perpetual and went to subscription. The second one associated with that was a very big push for our SaaS solution, people moving to Pega Cloud. The third one was a change in how we really sold and went to market where we're leveraging partners more, we're leveraging ISVs, et cetera, and the sales cadence and management team around that, which just kind of just happened maybe last year when Hayden came in, and we've kind of started to build out a little bit of a different style of sales manager to really build repeatability. And then another transition you might -- or evolution is when Project fnx gets released, right, which has a more multi-tenancy -- has multi-tenancy, it connects to really scalability to ISVs, where Pega can be white labeled as a platform in the ISV environment and multi-cloud, meaning you can use AWS, Azure, GCP. So there's a lot of things going on and all that. Some of which we're well along in, some of which actually we're not even started yet, really, which is the rollout of clients on Project fnx. So what happens at the end of all that, right? We should be an entirely subscription business with likely more Pega Cloud than not, scaling at somewhere, hopefully, north of where we are now in terms of the growth rate, with the same level of retention, with hopefully improved sales productivity, which ultimately leads to better operating margin. We're out of the revenue transition. We're out of the cash flow transition. So that's really where Rule of 40 starts to kick in, where we see ourselves as hopefully a mid-20s grower with 15% plus free cash flow, where our sales productivity is more improved and our gross margins are kind of more standard with the market because now Pega Cloud has more scale. So I've said a lot there, but that's kind of how I think about the phases and where we hope to be.

Awesome. That's clear, that's clear. Maybe -- you mentioned Hayden, right, and you mentioned the go-to-market motion. Could you talk a little bit about how that go-to-market has shifted or has changed a little bit since Hayden got onboard?

There's a noticeable maybe thing that Hayden has done, which is he is bringing a great perspective of how he has seen other companies manage growth at a higher level than ours, but also significant consistency and scalability and reliability in the sales performance. And what we've done, we went from a 12%, 13% grower back before we moved to subscription up to a 20% grower. So we've made some progress. But it's still our sales process and productivity is still not consistent. It's not -- I wouldn't call it efficient, I'd say it's inefficient right now. We need to improve that. But I think Hayden's real job is -- what we're asking him to do is to take this machine that we've got, where we've accelerated growth, where it's subscription, it's recurring and now evolving into something that might grow faster, but also build scalability like other best-in-breed software companies have done at scale. So that's kind of the -- I don't want to say trick because it's really not magic. But that's kind of the operational transformation that Hayden is driving, accelerated growth, but also accelerated productivity.

No, that's great. And is he driving new playbooks as well, or is he using some of the same playbooks that you've historically had and he's just refining some of those?

So we've done a lot of work on the playbooks over the last 3 or 4 years. I would say -- I would characterize it as more refining the plays that we run and making sure that we have the right profile of the salesperson, the right level of enablement, and that we're targeting the right organizations with the right message, right? Those -- if you have really good salespeople that don't get enabled, that's a failure. If you have really good salespeople that are enabled, but they're on the wrong organizations that they want to buy your product, that's a failure. So it's a connection between those 3 pieces.

Got it. And maybe the question around the evolution of the platform and Project fnx. Could you talk a little bit about how you view the platform evolving over time? And what is the long-term vision with the Pega Platform?

So the -- I think the biggest change that we want to see with Project fnx and that I'll connect Project fnx with the platform as being the same. The thing we want to see and what we're pushing for is broader applicability of the platform to organizations. Right now, with a single tenant, more unified platform approach, as you can imagine, the best place to sell it is an enterprise, right, and the top end of enterprise. You're not going to sell it to a company with $50 million in revenue or $100 million in revenue because the platform is not really designed in that way. It's designed for millions and billions of transactions, not for thousands of transactions. What is an opportunity that we want to take advantage of is that mid-market companies want our capabilities as well. And that's proven by the fact that we get inbound requests for mid-market companies to buy our solution where we're not even selling it to them. So clearly, even with this -- and our brand is the best brand in the world. So even with a mediocre brand, we still have people hearing about us and saying, I've heard what you guys can do. I want -- so I think the applicability of multi-tenancy and how that will actually allow us to scale into a broader market where we can actually provide our capabilities -- our differentiated capabilities to more and more companies, that, to me, is the most interesting thing out there with the platform evolution.

Awesome. We'll leave it at that. Thank you, Ken, so much for your time, and I appreciate you being on -- at the Jefferies Software Conference.

Thanks, Luv. Bye.