Good day everyone and welcome to the Pegasystems' first quarter 2020 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ken Stillwell, CFO. Please go ahead, sir.

Thank you. Good evening ladies and gentlemen and welcome to Pegasystems' Q1 2020 earnings call. Before we begin, I would like to read our Safe Harbor statement. Certain statements contained in this presentation may be construed as forward-looking statement, as defined in the Private Securities Litigation Reform Act of 1995. The words expect, anticipate, intend, plan, believe, could, would, should, estimate, will, may, target, strategy, intends to, projects, forecasts, guidance, likely and usually, or variations of such words or other similar expressions, identify forward-looking statements, which speak only as of the date that this 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 2020 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 2020 earnings and in the company's filing with the Securities and Exchange Commission, including its Annual Report on Form 10-K for the year ended December 31, 2019 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 the forward-looking statements, whether as a result of new information, future events, or otherwise. And with that, I will turn the call over to Alan Trefler, Founder and CEO of Pegasystems.

Thank you Ken. I am pleased with our results for Q1, especially given the pandemic. Our results are indicative of the success of our strategy around accelerated growth and continuing our shift to a recurring model. Our total ACV, the best indicator of our future revenue growth, increased by 21% for the quarter year-over-year and 95% of our Q1 commitments were cloud with more than 50% of them being Pega cloud. Now, it's impossible to talk about Q1 earnings without acknowledging the unprecedented circumstances we are in and the effect on our business as well the lives of billions of people around the world. This includes our staff, clients, partners. And we are laser focus on taking care of them and making sure they have what they need. For us, build for change isn't just a tagline, it's in our DNA. And we have navigated through many challenging times before and have always come out stronger on the other side. Our software and corporate culture are all about change and sometimes that's about accommodating change and sometimes it's about driving change and sometimes it's both. And that's what we are seeing right now. On the client side, the crisis is levying a profound toll on those businesses with avalanches of customer service calls working to support remote workforce, adjusting to new government policies and simply figuring out how to triage new and existing work. I have been on video calls nonstop with senior executives of many of the world's largest and most successful brands. And I expected they would be focused exclusively on their most pressing and immediate challenges. And while most are mobilizing to solve the acute need that's near and now, a large number are also thinking beyond the next mode and understand that this is time for…

Thank you Alan. I want to start by echoing your opening comments that our number one priority right now is taking care of our employees, clients and partners. The global spread of COVID-19 has disrupted the lives of billions of people and we recognize the reality of much more challenging economic environment. I am sure you want to know about the impact of COVID-19 on our business. In Q1, we did not see any meaningful disruption to our financial results. Overall, I am pleased with how our business has responded. Prior to the pandemic, 30% to 40% of our employees regularly worked remotely. And today, almost all of our employees are working remotely and effectively, I might add. Our sales team continues to engage and acquire customers. Our customer support and cloud teams continue to provide high level of support to our clients and partners. And our development team continues to enhance and improve our products. Our business is resilient and I remain confident in our ability to deliver on the long term strategy to be the leader in digital transformation. Let me shed some light on why I feel this way. We have made some pretty significant decisions over the last few years that, well, you could choose to call that timing lucky or smart, but by the way, these things position us well in the current environment. First, we started our transition to a recurring business several years ago. As a result, most of our business is now recurring. To be specific, our business was about 50% recurring revenue several years ago. And it's about 75% recurring revenue today which is supported by our very high net retention rates. If you include Pega consulting revenue, which is highly predictable, we have about 90% visibility into our 2020 revenue…

[Operator Instructions]. We will take our first question from Steve Koenig with Wedbush Securities.

Hi gentlemen. Thanks for fitting me in and congrats on the quarter. So I have been following you guys enough quarters that I know how your guidance approach works and I expect you guys to stay consistent with it. I am looking though for maybe some color. And I guess when I think about it, given the transition that you have made to recurring revenue and now to cloud, my thinking is you can still layer on additional ACV and grow that ACV line pretty nicely even if your new bookings were down substantially year-on-year. And I would like to avoid guessing my questions, but am I thinking about that the right way? But then beyond that, can you guys give me any color on how you are thinking about the pace of sales achievement and how it could layer in over the year? Nobody can predict the pandemic, but how are you guys planning for internally? As you said, you are hiring as you adjust your quotas in the plan for the year. So any color there would be much appreciated.

Hi Steve, this is Ken. I will take a stab at that. There are going to be some things when there's an impact, but the impact will be immediate. For example, if professional services engagements scale down, that will have an immediate impact to revenue in 2020. So that would be an example of something that is, if there is any impact, it will impact revenue in the current period. Perpetual licenses, although we only have 5% of our new incremental commitments perpetual in Q1, perpetual naturally convert into revenue. New client cloud deals that are like term licenses, for example, may have revenue in the current period. But if you think about the majority of our bookings being Pega cloud, you are right, that any booking impact wouldn't have as much revenue impact in a recurring world. So even if you did have softness in bookings, there wouldn't be as direct a correlation to revenue reduction like there would be if we were a perpetual business. So you are absolutely thinking about that aspect, right? And there is real short term risk on professional services to the extent that you couldn't execute some of the work and also any billable travel that maybe is a component of professional services, which naturally some of that, a small amount of that does become revenue, people aren't traveling right now. So there are things that are real risks in revenue. But if you think about a recurring business, the booking trend tends to stay with you over multiple years as opposed to an immediate impact in quarters or even within the year. So that does insulate us somewhat as a recurring business. So hopefully that helps.

It does. If I could ask one follow-up, it would be a financial follow-up here, which is thinking about as bookings potentially gets impacted, what that would do to your ACV? And the long term target of 20%, even if that was still solid, which I presume it is, if your bookings were down and even if they were down significantly, could you still grow? Is it possible to grow ACV double digits this year, for example, if your new and expansion bookings were, let's say, only half of what they were last? Maybe an extreme scenario, but to the extent you can help us think about those numbers and the impact on ACV, that would be helpful, too. And that's all I have for you guys and congrats again on that solid Q1.

Thanks Steve. So let me take that one. So I am going to do just a simple math, which is if we didn't book $1 in a year, theoretically, our ACV would be flat. Let's just assume that we had 100% retention, which we don't have 100% retention, but we are very close. So naturally, any bookings will help to grow the total ACV number. So you could see a haircut in bookings that was a reasonable percent, but still have a respectable ACV growth. But I would not suggest that we could grow ACV at 20% per year with having a significant reduction in bookings, if that helps. But certainly, there is some level of sensitivity that you can withstand to bookings shortfall and still stay above our long term target.

I will jump in for a second. I think it's fair to say that the intensity and the continuation of the engagement with clients have been very reassuring. We are finding that customers are taking meetings. They are spending time with us. They are engaging. And so I am personally not expecting any sort of catastrophic decline, particularly because we are in the business of making people more efficient, which is going to be important and helping people work from home and helping an organization that has become disaggregated, where their people are spread out more. We manage the flow of work and the automation of that work. So it's not surprising to me actually that customers or prospects are still willing to engage. I think that Ken's comments about the characterization of our customers as being the stable ones, we are in a very different situation, I think, than if we have lots of SMB businesses, global customers. We have a couple. But historically, we really have been very concentrated because I think you know in the echelon of organizations that are going to make it through this and they are going to want be more efficient.

That's great. Thanks Alan. Thanks Ken.

We will move next to Rishi Jaluria with D.A. Davidson.

Hi. Thanks for taking my questions. Nice to see continued strength in the business and glad you are all staying safe at Pega. A few questions from me. First, I wanted to, Ken, you did hint that the customers are looking for something like extended payment terms for some businesses and bottom line is, you will work with them, I think, makes a ton of sense. Just wanted to get maybe a little more getting on that in terms of deals. Are you seeing customers asking for something more like contract restructuring, doing things like ramp or doing a multiyear Pega cloud deal that may be a much a smaller thing than you want and then have it ramp up year two, year three? And then maybe just the financial impact, if there is something like that, specifically on the Pega cloud side, is that something that you would normalize for when giving us the Pega cloud ACV numbers, just given that ASC 606 will theoretically smooth out the ramp on ramped deals like that?

So Rishi, a couple of parts with your question there. The first one is, which types of clients would ask for, say, delayed payment terms? A very low percentage of our traditional customers in our verticals are going to be in that situation. It does happen. We are not insulated from that. But if you think about the types of clients that we have, we are not in the most susceptible verticals. So it does happen. It is not a widespread occurrence. And it isn't at this point and I wouldn't suspect that it would be unless there is some massive change to the economic kind of climate even worse than what we are looking at now. So I think that's point one. Second point is, we have had very little discussions over the years with our clients asking to cancel or restructure contracts within the contract period but quite frankly, even at the end of the contract period. And that I don't suspect or have not seen noticeable discussions with clients suggesting that that's different now. And the question that you asked about clients wanting to ramp deals or have certain accommodations that really, independent of COVID-19 or actually any economic cycle, that is a reasonable request for clients as they implement the system and start to see value over time that naturally, they increase the usage over time and they expect to pay increasing amounts over time. So that particular phenomena is not unique to the situation right now. That is part of being kind of a recurring business. The one thing that does help us in this environment, that Alan kind of touched on a little bit with the SMB comment a second ago, is that because our average duration of a contract is multiple years, we don't sell, say, month-to-month or quarter-to-quarter with small businesses, those are the most vulnerable relationships, anything that can be canceled within a month or a quarter. And since most of our clients are thinking about us and using us for very strategic long term projects, we hope and we have not seen a significant change in the relationships that our clients have with us. And so we believe our resiliency will help us a lot there.

Okay. Great. That's helpful. Then I wanted to ask about your product gross margin. So you saw hit the 60% mark this quarter. Some nice margin expansion versus last year. Just wondered if you could give us a little bit more color on what you are seeing on the product gross margin side outside of just the accounting treatment of having cloud start to lay it on itself?

Well, if you remember, last year I talked about how when you build a cloud infrastructure, quite frankly, any technology infrastructure, the investments do happen in kind of stair steps. It's not a linear progression. And we were ramping the cloud infrastructure and quite frankly, still not completely. And we aren't yet at this point completely optimized with the Pega cloud infrastructure, but we are getting better. And I think what you are starting to see now is you are starting to see us really get some of that operating leverage as we get a larger Pega cloud business. So I think really, quite frankly, it's as we had planned for it to be. We thought we would actually do better even in 2019, but as I mentioned, because of the significant investments with FedRAMP and other initiatives in 2019, it's kind of that operating margin expansion really is being pushed into 2020. So this was kind of what we had hoped and expected to see in the margin for cloud.

Got you. Thank you. And then just with your contact center, your clients, whether using Pega on the contact center, given that everyone, even the contact centers are working remotely, working from home, maybe help us understand how is Pega better enabling those customers to work remotely? And especially, I mean, even if things start to open up, it's probably not going to happen all at once. There might be some on-off that's a little bit longer lasting. And maybe alongside that, with all the rise in remote work and people working from home, is that maybe accelerating the pipeline or inbound interest or demand for Pega cloud relative to before?

So we are seeing good pull on Pega cloud as we talked about. And I think that's exciting and it should be able to let us continue to grow that business which obviously is a huge source of value for us and our investors. The thing about working at home, we have had contact center workers work using Pega from their homes for a decade. So this is not a new phenomenon for many of our customers. A lot of our customers historically have wanted, even if they had a large contact center which of course many of them do, they want to do, for example, overflow work at home so that they can tap up a group of part-time workers or people who are staying home with children who can work a couple of hours a day and help take the load at peak times. So we are very well equipped to be able to support that. The thing that is appealing, I think, to our clients and to our prospects, is that because we do a better job of automating the business processes and building that literally into the system itself, it just makes it easier to train new workers and to tap into a new workforce and to also frankly make them more efficient. So I think all of those are going to be good pull for us going forward outside of this immediate window as well.

All right. Got it. And last one from my end and I will hop off. But without giving the formal guidance or anything like that, just want to get a sense, anything in this environment that would make you change your thought process of your 2022 targets that you have laid out over the past couple of years, $1.3 billion of ACV, $1.6 billion in revenue?

Yes. As you, I think, may know, it's never been our practice to update our guidance during the year. I think that quarterly guidance can trap companies into really short term thinking and bad negotiations with customers. So we just don't do that. So not in a position to really comment on that. I can tell you that the tenor of the business is strong and obviously there are disruptions. Ken said something interesting which is, obviously, the part of services revenue is billable expenses, which accounting makes you put into revenue for some reason. That's obviously not going to happen if people aren't extrapolating it. But that's better for the customers actually. It makes it easier for them to take advantage of it. But I don't think we are prepared to make any specific updates.

Okay. Got it. Thank you so much guys. I appreciate it.

Next we will move on to Steve Enders with KeyBanc.

Hi guys. Thanks for taking the question. I hope everyone is staying safe in this crazy environment. I just want to get a best sense of how the pipeline is shaping up now? I know that you mentioned some deals getting delayed and some deals may now get canceled. Just kind of wondering how you see that kind of shaping up for the rest of the year and how much new pipeline is currently being generated?

So I can tell you there's a lot of new pipeline being generated and the year-over-year pipeline is up quite materially. Obviously, all of that has to be rescrubbed and reconsidered. But we have been through a part of that process and there's lots of new opportunities that are being recorded and a very, very, I would say, intense cadence of activity between us and our prospects. So it's a mess, right? I mean so who knows exactly what's going to happen but we see a lot of energy because of what our software does and because of the value it has to clients.

Okay. Great.

Steve, I would add one just quick comment on that. The thing that I think has been most interesting and I am sure that many of you on the call can attest to this. The amount of activity in business that continues to move on through this work remote is quite frankly shocking. Like I mean I am surprised that we are able to do it at Pega. I am surprised that you guys are able to do it. So I mean, it is really promising to see people really just kind of trudging along through this in a big way. And that's really encouraging, quite frankly, to see the infrastructure hold up, the networks hold up and the people really continuing to move on with their businesses. And so that's one promising thing that we have seen through this.

Okay. That's good to hear. And I just want to ask about bringing on Hayden. What are kind of the key initiatives that he will be kind of tackling as he gets ramped up and where is kind of the most worthy job to kind of transform the business?

Well, I think he's got a lot of experience of growing a business in the sectors that we operate in and turning it into a more than $3 billion business and doing that at pace. So I think it will be terrific to work with him. We have done a lot. It's frankly quite amazing to hire somebody you have never actually physically met. But we have spent an awful lot of time together. And I think he's going to work terrifically and the team's all met him. And I am anticipating that he will hit the ground running and really help us accelerate our go-to-market, which is what this is all about.

Okay. Great. Thank you.

[Operator Instructions]. We will move next to Yun Kim with Rosenblatt Securities.

Thank you. Hi Alan and Ken. Congrats on a good quarter. It seems like you guys are doing a lot better than most out there. It sounds like some of your parts of your business is actually benefiting from the current environment. Alan, just to kind of better understand where you are seeing some of the positives in your business? Can you describe, is there more of a smaller incremental projects and deals that you are seeing some of those deals where you are making progress? Some of those that are already closed in the month of April? Are they with existing customers? Are they part of a multiyear project that's ongoing and it's just the next phase of the project that just got signed? Just trying to get a better sense of which parts of your business that's tracking well versus obviously there are other parts that's probably not doing as well. Thanks.

Well, if you think about it, there are use cases that are immediate and that people are really trying to get something done to help them as in some of the examples that I gave with some of the governments and some of the large companies that are trying actually to respond to the issues that are in hand. And so those obviously can really close at pace and they are happening. But I have been actually pleasantly almost surprised a little by two things. One, the willingness of senior leaders to frankly make themselves available. One of the things that I found as interesting is my productivity, I think is, soon our workday is up. My productivity is up because I no longer have to coordinate meetings with senior people in different countries. They are very, very open and I think hopefully that's going to continue even after we are able to travel. So there's a real receptivity to talking about what the right business architecture for the future is. Now this has put such pressure on their businesses, I think people have realized that they are going to have to think differently about things. I think some organizations are frustrated by the amount they spend on IT and they realize that they are not going to be able to program their way out of where they are into a digitally transformed environment. And a lot of organizations are realizing that they are going to have to remarket and recapture customers, some of whom may not be able to continue doing business with them. So we are seeing a lot of energy in what I would describe as a business architecture discussion. And one of the things that I think is cool relative to the team's ability to adapt is we used to do these design thinking sessions, like I mentioned in my script. We call it catalyst. That can be very effective in either a couple of days or two weeks to get organizations to think completely differently. We have been able to completely virtualize that which I had thought would be quite difficult, but have been doing and getting a lot of receptivity of catalyst sessions. And it's actually easier to set up in some ways because all of those customers don't have to travel to the same place to meet as a team. So there's a huge amount of energy in the selling motion and we just need to work hard to see if we can convert them into all the business we would like to have with them.

Okay. Great. And Alan, you mentioned in your prepared remarks and also regarding the set of industry-specific solutions that you guys introduced early in the month. What has been the response so far? And is this kind of a blueprint on how you may navigate your go-to-market, at least in the near term?

Yes. It certainly has caused those teams, my industry teams, in particular, but also my horizontal teams, to think differently about how they want to bring their thinking and thought leadership to market. And this will definitely have an approach. The teams rallied together and in literally less than a week, they had pooled together the framework for how we wanted to bring solutions to the market and how we would evaluate them. And I am just really impressed with the work and the agility that they pulled off. And you can go check them out on pega.com. It's something that's generating interest from customers. Interestingly, not just in those areas, but also in other areas once you begin having the discussion about how do you create truly a virtual organization, which our customers understand they now need to be.

Okay. Great. And then Ken, in terms of the current model transition and obviously, there's a great level of uncertainty out there, is there any variables in the model that we should take note just because of the uncertainty that we are going to enter this year due to COVID-19? For instance, do you expect like a Pega cloud bookings mix? If that mix comes in much higher this year, would that actually impact your ARR from ACV growth?

Yes. So just the way to think about the business is, the first is, I think I have mentioned a few times that I think there's probably some risk on fully delivering the amount of professional services through the year that we would have hoped. I am just trying to be practical about the fact that you cannot do everything remote, even though you could do most of it. And overall in majority, there's still some impact there. And I think if you assume that the cloud mix is the same, I would think that there would be, most companies in software would think that there was in current environment, more kind of downside pressure on their bookings plan than upside opportunity, I would say, in the short term. I think that's a reasonable thing that we are hearing in the market. But if you think about the cloud mix, could we move more to cloud because the environment is more conducive to Pega cloud? I think that's a great opportunity for us. And certainly if that happens, every 1% movement to Pega cloud away from kind of a 50% that is what we actually talked about at the beginning of the year, has about a $3.7 million impact in short term revenue. So I think so you are thinking about the revenue pressure from more cloud, which will be a good thing in the long term, I definitely think there's something there. In terms of ACV growth, whether a deal books Pega cloud or client cloud, there is not a significant change in the ACV growth based on a few percentage points difference within the year. That is not a material component of ACV growth.

Great. Thanks for that clarification. Thanks Ken.

Sure. And just while I have, before the next question, I just wanted to clarify. I was made aware that I mentioned PegaWorld as December 2. And I made an error. I apologize. I said December, I meant June 2. So we welcome you to join us on June 2 for a free registration at pega.com. So I apologize for the misstep there.

We will move next to our next question in the queue from Mark Schappel with Benchmark.

Hi. Thanks for taking my question. And I will start off by saying, a good way to start off the year and good job in the quarter. Alan, a question for you. Could you just provide some additional details around the IRS deal that you mentioned in your prepared remarks? For instance, maybe how long the deal was percolating in the pipeline? And is this a Pega cloud deal?

Well, government deals tend to go on for quite some time, as you may know. So this has been going on. It's been highly competitive, as you can imagine, a transformation of the IRS. And it's obviously going to come into revenue over years. It is not a Pega cloud deal. We are expecting that it will be a client cloud implementation. Lots of these folks really want to, in effect, move their entire data centers to the cloud. And if it makes sense for us to be a part of that, to be able to get the right interfaces to the right systems easily, then that's, from our point of view, just fine.

Okay. Great. And then the healthcare vertical is a vertical that the company has increasingly focused on here and you mentioned that in your prepared remarks. And in the headlines, you are seeing a lot about the move to telehealth as being one of the healthcare technology trends that's, at least, captured recent attention. I was just wondering if there's ways of tapping into that trend. Maybe you can just speak to some of the other trends you are seeing in healthcare that you are able to enable?

Yes. We have shown for actually, a couple of years ago, we showed how Pega and our care management solution can work beautifully with the Cisco Video environment and as well as others. And so I think that frankly telehealth is going to require more systems to coordinate and manage. And so it's going to be I think ultimately it's going to be quite good for us when we get through the other end of this.

Okay. Great. That's all for me. Thank you. Good job in the quarter.

And I think we have run to the top of the hour. So I think, perhaps, it's time for us to thank you and say goodbye. And now we are working extremely hard and I think we are doing all the right stuff. So with that, thank you very much everybody and have a great evening.

Everyone, we do thank you very much for your participation today. That does conclude our call. You may now disconnect.