Good day and welcome to the Pegasystems Second Quarter 2019 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ken Stillwell, Chief Financial Officer, Chief Administrative Officer and Senior Vice President. Please go ahead, sir.

Thank you. Good evening, ladies and gentlemen, and welcome to Pegasystems Q2 2019 earnings call. Before we begin, I'd like to read our Safe Harbor statement. Certain statements contained in this presentation may be construed as forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. The words expects, anticipates, intends, plans, believes, will, could, should, estimates, may, targets, strategies, intends to, projects, forecasts, guidance, likely and usually or variations of such words and other similar expressions identify forward-looking statements, which speak only as of the date of the statement was made and are based on current expectations and assumptions. Because such statements deal with future events, they are subject to various risks and uncertainties. Actual results for fiscal year 2019 and beyond could differ materially from the company's current expectations. Factors that could cause the company's results to differ materially from those expressed in forward-looking statements are contained in the company's press release announcing its Q1 2019 earnings and in the company's filings with the Securities and Exchange Commission including its annual report on Form 10-K for the year ended December 31, 2018 and other recent filings with the SEC. Investors are cautioned not to place undue reliance on such forward-looking statements and there are no assurances that the matters contained in such statements will be achieved. Although, subsequent events may cause our view to change, except as required by applicable law, we do not undertake and specifically disclaim any obligation to publicly update or revise these forward-looking statements whether as a result of new information, future events or otherwise. And with that, I'll turn the call over to Alan Trefler, Founder and CEO of Pegasystems.

Thank you, Ken. At mid-year I'm excited with the progress we're making. We showed strong growth in ACV and remarkable growth in Pega Cloud, which was 60% of our new business for the first half. I'm pleased with how our strategy is playing out as we continue to gain traction in seizing the huge opportunity in front of us. At the same time, our cloud transition makes it harder to easily understand our progress by looking at revenue, which is why we focus on ACV metrics that more accurately reflect the health of our business. Ken will provide more context on this in a few minutes. Now, I spend a lot of time with clients and prospects talking about what's working and what's not as they pursue their digital transformation initiatives. It's clear that the level of hype regarding some technologies is intensifying and creating confusions and missteps in the industry. Now over three plus decades in the software industry, I have seen how easy it is to get distracted by what's trending. My focus is always on what's going to work for clients now and in the long run. The emerging and accelerating markets scenes we see regardless of geography or industry are representative of what clients want to be successful and to demonstrate tangible value, start fast, but be able to pursue full and broad digital transformation. We deliver several key technologies that significantly drive digital transformation by leveraging them correctly as part of an end-to-end strategy. Now, let's start with process automation, which is interesting that many have equated with so called RPA or robotic process automation. Now, RPA can provide value to an organization interested in automating isolated tasks. But the amount of hype and confusion in this market is staggering. We believe that RPA needs…

Thanks, Alan. We're very much where we wanted to be at this point in the year. We've experienced strong growth in ACV, a solid increase in new license in cloud commitments and the continued shift to cloud arrangements. We continue our transition from a business that's largely sold at software on a perpetual on premise basis to a much larger company that sells the majority of our software on a recurring cloud basis. ACV growth continues to be the most important metric that reflects the successful execution of our strategy. Total ACV is the sum of recurring Pega Cloud and client cloud commitments representing the recurring annual spend by our clients. For the first half of 2019, we experienced fantastic momentum with licensing cloud ACV up 33% and Pega Cloud ACV increasing an amazing 65% from the first half of 2018. During the same period, total ACV increased 21% on a constant currency basis, reaching 613 million an increase of over $100 million from one year ago. This growth reinforces our confidence in our long-term targets. And it's even more impressive given that we didn't change our sales model until the first quarter of 2018 when we moved from a total contract value or TCV approach to an ACV based one. Our continued positive momentum in ACV growth reflects solid demand around the world for digital transformation solutions. We continue to see companies engaging in digital transformation to modernize technology, so their customers have a favorable experience and they build efficiencies across their organization. Pega continues to be at the center of this digital transformation, a massive market opportunity growing at an accelerated pace. So let me take a few minutes to update you on how well we're executing our plan to transform our business to a recurring model. We…

[Operator Instructions] Now we'll take our first question from Rishi Jaluria from D.A. Davidson. Please go ahead.

Hey, guys, thanks for taking my questions. Appreciate the time. Let me start by talking a little bit or asking a little bit about partners. I think one thing that impressed me at PegaWorld was kind of the size of the practices that a lot of your partners have, so wanted to get a sense with as you've had more of this Pega Cloud business. How is the reception from your partners been? Have the embraced it? Or is there a worry that with more out of the box that that maybe – it's a headwind to the size of their Pega practices?

Yeah, I don't think that Pega Cloud is in any way a negative, I think it's only a positive, because it's allowed us, as you could just tell from the size of this PegaWorld and number of organizations compared to the past. It just made it easier for us to penetrate new organizations and that's what they like, they like to get for old some replacements, they like build it up. And in reality, the sort of messy stuff around software on premise implementations, those weren't really done by our partners anyway. Those are typically done by the company's IT teams. So we haven't really replaced that. So we're seeing and I'm sure you saw it, and I'm sure you did reference that to partners, a tremendous amount of excitement across the board and we're looking to turn that into having them make even greater investments in building out their practices, which is can be several thousand trained and certified Pega people deep.

Great, thanks, Alan. That's helpful. And I think going to maybe a couple of the numbers, starting out, now you've got two quarters of this breakout of Pega Cloud versus client cloud and seems for two quarters in a row, we're now about 10% type growth for the client cloud and then Pega Cloud obviously a lot faster than that. Is that kind of a normal way to think about how the growth rates of those two components of ACV are going to be? Or is that – is it not fair to extrapolate from, I guess, a little bit of history you have so far of that?

So Rishi, if the mix of bookings that we're seeing, which is largely 60% Pega Cloud, 30% client cloud, 10% kind of perpetual licenses, if that mix stay consistent, I do think your assumption is more right than wrong because you would see the Pega Cloud growth accelerating much faster. And you would see the term licenses, so to speak component of our bookings, be something kind of slightly below our overall bookings growth because cloud is a much more dominant piece.

Okay, that's helpful Ken. And then Alan, another one for you, I wanted to go back to some comments you made in the prepared remarks. You talked a little bit about cutting through the noise. I mean, obviously, you've got people out there or competitors out there talking about low-code, which you've been doing for a while, you have competitors playing up the RPA capabilities, which is, a hot space now. Just want to understand from your perspective, what Pega do to help customers' kind of cut through that noise and really get some clarity in terms of which technologies are real and which ones are a lot of marketing behind them?

Well, I think it's a multi-pronged effort. One thing we need to do is continue to get some of these stories out there and continue to publicize some of the things which weren't quite sure are correct. And which we're seeing some receptivity from people who are understanding that. Sometimes this hype machine is not all that it's cracked up to be. A big part of it is continuing to invest and increase our on the ground footprint and make sure that we have more people who are both, sellers and supporters of sellers, who can go out and engage with the clients and engage with the partners and get them to be bought in to these sorts of concepts. So we have a lot that we can do. And we're working hard on doing it. We just came off of an internal several days planning process, which is going to influence the work that we do this quarter as well as into next year. And being able to tell that RPA story in the right context I think is really key. When you talk to customers and you say, would you ever use a robot when there was an API or computer application programming interface available? They universally say never. I mean, why would you in effect scrape screens, when you had a more reliable, faster and an auditable better way to do it, so you wouldn't do it. So the notion that you're building your systems around these robots, people actually are starting to understand that that's backwards, which is why I was really sort of amazed last month, when – it's caught on to the point that Gartner in its picture showed RPA in its current form as crashing down to what they call the trough of disillusionment. If you go through what they call the peak of heightened expectations and then the trough of disillusionment and what they call their hype curve. So it was just pretty amazing to see that. I would have figured it would have been probably six to 12 months out, before people were catching on. This thing is a lot of hype, on top of some good stuff, but a lot of hype.

And then last one for me, I'll just hop off. Ken, I wanted to just ask about cash flow. Looks like it was a little bit of a light quarter in terms of collections, right, if we look at the networking capital, just anything in particular to call out and how should we be thinking about cash flow for the full year? Thanks.

Yeah, so we didn't think it was a light quarter, we fully expected that cash flow – billings, let's say that way, Billings will take somewhat of a hit during this big movement to cloud away from perpetual and so we're in only the second year of that movement. So we fully expected billings to be kind of lighter, similar to the way that revenue would actually be reduced as you move away from those larger upfront billings. I think in 2020, it's an important inflexion point for us. 2020 is the time period when you start to really see ourselves coming out of that movement into cloud. And so I think that you should expect the cash flow for the full year would be lower in the year that you're making such a big movement to cloud and away from upfront billing. So that wasn't a surprise to us.

Great, that's helpful. Thanks, Ken. Thanks, Alan.

Thanks, Rishi.

See you Rishi.

[Operator Instructions] Now we'll take the next question from Austin Williams of Wedbush Securities. Please go ahead.

Hey, guys, thanks for taking my question. This is Austin on for Steve Koenig. Just wondering if you guys are sensing any change in spending trends? I know there's been a lot of concern over some of the macro backdrop particularly in Europe. Just kind of wondering if you're seeing any softness there or any change?

Yeah, look, it's hard not to be a little concerned about everything that's going on around the world. And Europe is a little softer than we'd like. But there's no concern that's changing the rate at which we are looking to go-to-market and to invest. There's a lot of businesses out there and we have a bountiful pipeline.

One comment just to add a little bit of color to that Austin. Brexit is certainly being talked about more as the date approaches. We can't say that we've seen a noticeable shift in buying patterns because of it. But certainly Brexit is something that people are watching. We do not have a noticeable business in China, right. And so some software companies are different and they do have very large. So that impact of what's going on doesn't hit us as much as some other software companies.

Yeah, it barely touches us.

Okay, that's helpful. And another one for me, just are you seeing any kind of – any particular strength in certain verticals? And I'm also kind of curious, just with Pega Cloud adoption, how does that vary for industry?

So it's pretty much across the board, some of our largest Pega Cloud customers are some of the world's largest banks. A couple of years ago we did not actually contemplate doing something on the cloud and are now becoming much more enthusiastic. You'll also, other industries that you think of as being tough industries, like healthcare, are also really good adopters of Pega Cloud. So we're seeing across the board, I'm also just very excited that the government has very assertively moved to consider cloud. We recently got our fed ramp certification, which is a really exciting and very positive accomplishment. And I think government modernization is enormously promising in general, but especially for Pega Cloud.

And an interesting vertical that you wouldn't expect to adopt cloud is the public sector. And we just hired our Chief Information Security Officer, Carlos Fuentes who we announced started a few weeks ago. He was essentially in a similar role at the Federal Reserve Bank of New York. And his feedback was that not only is the government encouraging cloud, but they actually are requiring it because they believe that cloud is a more secure environment and a public cloud is a more secure environment than the old traditional lock things in rooms on servers. So I do think that that's not a vertical you would expect to adopt, but it's very logical why they are.

Okay, great. And then just one last one, in terms of M&A activity, I think we've seen, I think two this year so far, just kind of wondering your approach to M&A at this point, are you looking to grow the product offering in organically through tuck-in's at all, going forward or should we not expect any more of that?

We're continually looking at things. We have a high bar because, two things are very important to us. One is that we'll be able to do a really good job of incorporating whatever it is that is required into our models of an architecture, that's a very important part of our decision criteria. Because we think the strategy of a lot of our competitors or other companies out there, which is they buy all the stuff, they unify it in their marketing messages and then they stitch it together isn't a very good or sustainable way to provide high quality product to customers. And the second part is we are very sensitive to firms that have people who have great cultures, who really want to work with us and that we really want to work with them. And those two things make us highly selective. So M&A is not central to our strategy, but it's something that we look at continuously.

Okay, great. Thanks, guys. Congrats on the quarter.

Thanks.

Thanks. See you Austin.

We'll now take the next question from Pat Walravens from JMP Securities. Please go ahead.

Hi, this is Nazibur [ph] for Pat. Thank you so much for taking my question. So just want to touch on sales capacity, I think in PegaWorld you mentioned that for this year you're going to increase coverage of enterprise customers. So just want to get a sense of the progress there? Yeah.

Well, I'll let Ken talk to the numbers to the extent he's willing to and I'll talk to the sort of qualitative matters. We're putting a lot of effort into recruiting talent and it's not just in sales, it's across the company as a whole. And I'm finding enormous receptivity in the talent pool, to come talk to Pega. You can get a sense of this easily and objectively or just going on to LinkedIn, and seeing the people who are coming to us from the other people you would think of as being in our competitive sphere. And I'm both very impressed with the level of talent that we're finding, extremely interested to come to us. And we as I said, have to really dialed up to that engine and intend to continue doing it not just for sales people, but for the entire go-to-market support ecosystem that you need to be able to pull that off.

So the only piece of maybe qualitative comments that I might add to what Alan said is, we have very aggressive plans to grow our go-to-market team. And we've talked about at the beginning of the year and it is a competitive environment and in the hiring landscape. And so we view the fact that we're able to achieve our hiring plans as just a great positive, given how competitive the hiring market is, so seeing great people, we're getting great additional capacity and so we're continuing to move ahead.

Okay, thank you. And just one last one, I was wondering if you can provide maybe some of the most common use cases for government that is you Pega Cloud and how's the adoption there?

Yeah, sure, so the government is just a terrific place. It's interesting because we've got great examples of where they both use our cloud, but also, they use client cloud as well. And they're choosing to run it on their own cloud infrastructure. For example, in the Department of Commerce, they've got a very large implementation there that they're running on client cloud. One of the great sheds around Pega Cloud environments that we have is in the area of what's called grants management, in which you're trying to control how these organizations distribute money, how they figure out who is qualified, how they get the right sort of approvals and review processes internally, how they follow up. And I would describe that – I would describe huge swaths of government as being just enormously rich examples of case management process automation tied to rules and intelligence to try to make things not just control, but efficient. And given how old some of the existing systems are, it's a very rich environment in which to be hunting. And we're continuing to build that team out for your certificate as well.

That's all for me. Thanks, guys. Thank you.

Thank you,

It appears there are no further –

I was just jumping in. So let me tell folks that we're working hard on their behalf that we see enormous opportunities here. I'm really excited that we're making lots of good progress and look forward to seeing you all soon and talking to you in three months. Have a good day.