Pegasystems Inc. (PEGA) Earnings Call Transcript

Okay. Great. Thanks, everybody, for joining us today for our Virtual ETS Conference. I'm Steve Enders. I'm one of the software research analysts here at KeyBanc. Today, we have with us Ken Stillwell from Pegasystems. Ken, thank you for being here.

Thanks, Steve. Great to be here. Thanks for the invite.

Yes, sure thing. Just as a reminder, if you have any questions or want to ask anything, populate the chat box underneath the screen there and we'll make sure that we get to them through this chat and make sure that we get those answered. So Ken, thanks again for being here today, really appreciate it. I guess maybe just to start off, can you give us an overview of the company? For those who might be new to the name and are still kind of ramping up on Pega, I guess, kind of how has the story evolved over the past few years and where does Pega focus in the market?

Yes, sure. Thanks, Steve. So Pegasystems has been around for quite some time. We started as a company in the 1980s. We started as more of a custom code company, kind of matured into the business process management space. And we're a leader, we're probably the leader in that space for a number of years. Over the last 10 or so years, we've transitioned where we still do leverage the power of the Pega Platform, which is driving end-to-end automation, workflow, process within and across the different application landscape. But in addition to that, the CRM or the customer engagement space is really a space that is fundamentally about process, about getting work done. And so we matured kind of into there through a small acquisition or an acquisition that we did called Chordiant and also our deep experience in the customer service arena. So now we are considered, I would say, a fairly significant player in the CRM space as well as a leader in what is now digital process automation, which is kind of the business transformation in organizations across the globe. Now where we focus, however, is we typically focus towards organizations that have some reasonable amount of size. The reason why is that where the Pega solutions really help is when you have, when you're trying to automate and drive intelligence around transactions volume. We're not a solution where you would have one customer and one call a year. We're typically ones where you have millions of customers and hundreds of millions of prospects of which are interacting through stores, through channels, through mobile, through distributors and really trying to buy, upsell, communicate with you, service the products. So that's kind of where we target the size of the organization. And there are verticals that are more relevant, typically verticals that have more consumers, so the financial services and insurance and health care and comms, places where you're selling to consumers, given that consumer spending is anywhere from 60% to 80% of a country's GDP. Consumers are behind most of the spend that we have and the clients that we support are actually behind supporting all of that then.

Okay. Got you. I know you've been going through a cloud and subscription transition for the past few years now. I guess, can you take us a little bit through that journey and kind of where you are today and kind of how you see that progressing?

Sure. So I commonly talk about it in 3 stages. We started this transition in 2017. We were, at that time, a largely perpetual, on-premise kind of software company. Up until probably, we didn't really sell SaaS solutions until sometime in the 2014 time frame. So we're very small in terms of our SaaS footprint. We actually flipped the business to subscription model largely driven by the market. The space that we were in, the competitors, the customers, I mean, they were looking for subscription solutions and increasingly solutions that we manage through our SaaS solution. So we've made that transition over the last 4 years or so. And we are largely complete with the first transition, which is moving the go-to-market to where we sell a subscription as the primary and almost exclusive go to market. We had 95% of our bookings in 2020 that were subscription, just a very small percentage that were the historical on-premise, perpetual licenses. When you jump to the next phase, the next phase is really where the growth normalizes. What happens is when you go through as an accounting issue, but when you go through a movement from where the revenue is upfront and you move to revenue taken ratably, you kind of go through this trough, so to speak. We didn't actually have a reduction in revenue, but we did have a few years of flat revenue where I shifted everybody to talk about ACV, annual contract value or ARR there, you can use those interchangeably, to think about the increased spend in the recurring business. That number, when we started this, was a few hundred million dollars. Now it's approaching $1 billion. So you can see the momentum of the growth in the subscription. Now the revenue is starting to normalize and you're starting to see that accelerated growth towards the back end of a cloud transition. It normalizes at the end of your transition. The third phase is the phase that we have. We're just starting to inflect into, but really we haven't completely transitioned into, which is where you get abnormal profit and free cash flow margins, right? What happens is, you went away from billing all of these licenses upfront, billing them over time, and it takes time to stack in the annual spend such that you can get back to a place where your billings are normalized. Naturally, if your billings aren't normalized, your cash flow can't normalize because your vendors and your employees don't suggest that they can wait 4 years to be paid, right? So you do have, the costs are kind of more linear. So that's kind of the last part of the transition.

Okay. Got you. That's helpful for level setting there. I know you guys just reported earnings last week. I guess, how do you feel about kind of the results versus what you're expecting? I think kind of for us, it kind of seemed like a middle of the road kind of quarter instead of a blowup. But how would you kind of characterize your performance in 4Q and I guess, overall in 2020?

Our growth rate at 20%, I think, is very respectable. It is certainly not the rate that we feel like is a ceiling by any stretch of the imagination. We think we've got tons of room for upside in growth, but we think 20% is respectable. It is not I think where we are investing in the business. We're investing in the business to see growth that is a little bit higher than what we saw in 2020. So I would characterize 2020 as a certainly a respectable year given COVID, given everything else that was going on, the fact we continued another 20% growth year is, I'm pretty proud of that. But I think that there's more upside going forward for Pega.

Okay. Got you. And just as a reminder for those on the line, if you have any questions, please feel free to enter them in there and we'll make sure to touch on that. I guess maybe just taking a step back and thinking a little bit more high level. How are your customers thinking about their digital transformation investments? I know it's kind of a big topic area for the past year or so. I guess kind of what have you seen since kind of the onset of the pandemic from customers and them needing to modernize?

So digital transformation is, I think, at the forefront of what all of our clients are thinking about. If you summarize digital transformation as clients are attempting to modernize their architecture by not replacing every single application, you just make it that simple and say, they want to transform, they want to leverage new digital solutions and opportunity areas, but unfortunately, they cannot just change everything at once. And so there is a connective tissue. There's an order of how they actually modernize some and leverage other applications that they may need to keep within their -- and they might be very happy with in terms of the go-forward strategy. So digital transformation is everywhere. It's been driven by consumers coming to digital channels more. Pre-COVID, people were moving to digital channels already. It wasn't like this is some new phenomena that just happened in the last year. The big box retail stores have certainly been impacted by the Amazon direct-to-consumer model through digital channels. I think you're going to continue to see that. You're going to see more people buying and transacting through mobile devices. That already happens in some parts of the world. The mobile device is their main commerce channel. They live their whole lives on their mobile device. Western Europe is even a little bit ahead of North America on that. In North America, we've just started to really rely on our mobile devices in the last 5 years or so. It is where we're going. So clients need to think about digital interaction, whether it be on a computer, through a distribution partner, through their own stores, through mobile devices. And they need that to be self-service and automated as much as possible because clients may come to your store at 3 in the morning from a different country and you just don't have the capacity to constantly be able to have a human behind every single interaction. So that requires decisions that need to be made in those channels around what you do and then also self-service and being able to connect, be that connective tissue across all of your, the steps in the journey with your clients.

Okay. I mean, I guess, I know we've been kind of dealing with the pandemic now for almost a year now, it kind of feels like a year ago at our ETS conference just as like everything was shutting down. So I guess, just in the past year, what are kind of the big changes that you've seen from your customers about where they're focused and has there been kind of any change in the types of projects that they're really working on now versus a year ago or pre-pandemic?

So it appears to me that there were 2 things that happened early. The first thing that clients did were, they just tried to make sure that they could keep business moving, right, things like Zoom and WebEx and Teams and all the investment in the communication tools. So that, I think we've kind of avoided a catastrophe there as an economic society. The second piece of that was trying to understand and be thoughtful about what the work environment looks like. Like what is the nature of work? Are people going to continue to work remote? Are they going to be living in different parts of the world? Are they going to have offices or not? I think clients have put a lot of thought into that. Our clients tend to be larger organizations where it is, I would say, they are less dynamic in terms of changing like where they have long-term leases, have a history of having people together. So they're trying to think about flexibility that can accommodate that. We're past those 2 now. And of course, making sure that people are safe and that they are tracking when people were in the office in terms of contact tracing, et cetera. But we're kind of past the pandemic-related responses now. Then I think it's all about, how do you build an environment for interacting with your consumers, whoever they may be. It may be a government and your consumers are your constituents. It could be a company and your consumers are actual people walking on the street. How do you interact with them and how do you allow them to self-service their own exploration, whether they want to walk into a mall, whether they want to go to a website or whether they want to go to some tour, some place where they can communicate through a social channel, right, to be able to connect social channel interactions where your brand is present there as well. And a lot of the interactions that you've seen with the whole kind of the Reddit situation with some of the interesting transactions that happened in retail trading. But if you think about, you go to those chat rooms, there's a lot of conversations about brands in those rooms, right? And if your company isn't there being able to mine that data, know when things are being said about your brand and actually have the right types of interaction channels in that venue as well, it's a very different style that the different generations take, right, depending on the generation of someone in their 50s or you have someone coming right out of college. You have to be able to serve all of those. That is the biggest challenge that I think big brands have. If they don't address it, they will lose market share to the new slick brands that have figured out a way to get consumers in a more efficient manner.

Okay. That makes sense. I just want to touch on something on the last call. It really kind of felt like there was a tick up in the focus on kind of low-code and kind of what you're doing on the automation side on the call. So I guess kind of what are you seeing from customers? What are they asking about that's, I think, leading to that low-code adoption kind of in the past year or so or in the past quarter?

So there's, I kind of think about it, there's 2 dimensions on how you can build an application. You can buy an application off-the-shelf that cannot be configured and it is what it is, right? It's a package solution I'm using. That is one extreme. And the other extreme is where you sit down, hands on keyboard and you write code to actually run certain activities, right, or certain scripts that are run. Those are the 2 extreme. I don't think in many companies either one of those are acceptable, right? They buy something, they buy XYZ solution, they need to make it their own. They need certain integrations, but they also don't want to start from scratch. So the beauty of what low-code as kind of an approach does in companies like Pega, where we have a low-code platform, or as we call it, model driven, right, which is really around taking this out of the box kind of starter configuration of, I want to do XYZ. I really want to do it my way. And I want it to be iterative. And I don't want to have to write code. And I want to be able to change it over time as my business needs change, as my use case changes. That's the beauty of kind of maybe that balance between the flexibility of writing code and the consistency and repeatability and scalability of what companies sell as an "out of the box". So I think what we try to embrace is that, have as much structural kind of best practice as you can, but you've got to have that flexibility because clients do want to iterate. Now to think that you're just going to start by writing, putting into a low-code simple platform and just start building together a set of rules and that somehow will emerge into like a Salesforce automation replacement that's going to take out Salesforce, that's a little bit far-fetched. But to think that you can ideate on those small environments to be able to then scale to enterprise with a product like Pega is actually something that we do think is possible. The challenge, I think, is making sure that you do have the product to support the enterprise use cases. And that's where I think a lot of the low-code discussions really are not platforms that can scale to enterprise, right? They're more kind of sandboxes to ideate in for very small kind of edge use cases. And that's what clients are trying to assess, right? Because they don't just want to build something small kind of as a test. They sometimes want to figure out if it can scale to production, and that's where Pega plays.

Right. So I just had a question come in on the line. I think it's somewhat kind of relatedly. I guess, where are your customers in terms of education around difference between RPA and intelligent automation and some of the DPA stuff? How does Pega see itself as distinct from those vendors who either lead with RPA or intelligent automation?

Sure. So we view RPA, robotic process automation, as a tool in a toolbox, right? But we believe our clients need the work to get done across from start to end. So if you think about intelligent automation, we get the work done from the start of something, an activity, onboarding a customer or a ticket or a return or a dispute, the whole way through until it is remediated, until it is closed out. And quite frankly, that may actually go into the customer record and may be used for upsell and marketing and communication later, NPS scores, et cetera. So we view that as the total kind of life cycle. Where RPA fits in is it is a tool to create kind of an efficient way to share data typically with applications that don't have APIs or to other databases, Excel files, static files, places that you may not be able to quickly connect those solutions together. And that does happen. So we view RPA as a nice tool to be able to bridge the gap in that scenario. Companies that have, for instance, numerous ERP systems over the years that are very old, outdated and you're trying to connect, like you're trying to copy and paste data between those different applications, I could see RPA being very relevant in that environment. If you're thinking about clients that have more modern solution stacks, I think RPA is kind of a tool in the toolbox. I think the misunderstanding is that RPA is somehow solving a workflow or a work automation problem in totality. And it isn't. It is really a tool that could be used to help augment that entire journey.