PEGA

Pegasystems Inc. (PEGA)

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Pegasystems Inc. (PEGA)

Q3 2010 Earnings Call

November 10, 2010 9:00 AM EST

Executives

Craig Dynes – CFO

Alan Trefler – Chairman and CEO

Analysts

Richard Davis – Canaccord Genuity

Laura Lederman – William Blair

Nathan Schneiderman – Roth Capital

Brian Murphy – Sidoti & Company

Raghavan Sarathy – Dougherty & Company

Steve Koenig – Longbow Research

Martin [ph] – HIIG [ph]

Edward Hemmelgarn – Shaker Investments

Brees Sparker [ph] – 451 Group

Presentation

Operator

Good day, ladies and gentlemen, and welcome to Pegasystems Inc. third quarter 2010 earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session with instructions following at that time. (Operator Instructions).

And as a reminder, this call is being recorded.

And now your host for today’s conference, Craig Dynes, Chief Financial Officer. Please begin, sir.

Craig Dynes

Thank you. Good morning and welcome to Pegasystems 2010 Q3 earnings conference call. With me here in Cambridge is Alan Trefler, Pegasystems’ Chairman and CEO. Before introducing Alan, I will start with our Safe Harbor statement and then provide my financial commentary.

Certain statements contained in this presentation may be construed as forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. The words anticipates, projects, expects, plans, intends, believes, estimates, targets, forecasting, could, and other similar expressions identify forward-looking statements which speak only as of the date the statement is made.

Because such statements deal with future events, they are subject to various risks and uncertainties. The actual results for fiscal year 2010 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 Q3 2010 earnings and in the company’s filings with the SEC, including its reports on Form 10-K for the year ended December 31, 2009 and other recent filings with the SEC.

The company undertakes no obligation to revise or update forward-looking statements as a result of new information since these statements may no longer be accurate or timely.

Q2 was another history-making quarter for Pegasystems. For the first time, the company exceeded $90 million in GAAP revenue in a single quarter. I say GAAP revenue, because due to the complications of purchase accounting, we provided non-GAAP financial information in our press release.

Like other software companies, we’ve excluded acquisition charges, amortization of intangible assets created as a result of purchase accounting as well as equity compensation charges. This allows easier comparison to other software companies as well as to analyst models to use these non-GAAP business measures.

GAAP or non-GAAP, Q3 was our 13th consecutive quarter of record revenue. Non-GAAP revenue of $95.4 million was up $30.6 million or 47% from Q3 2009. Our business is typically much stronger in the second half of the year. And as expected, 2010 is proving to be a very backend loaded year.

As an example, license revenue on a non-GAAP basis was $36.5 million, up $7.2 million or 25% from just last quarter. Q3 license revenue was driven by a significant increase in new license signings and an increase in average deal size compared to the first half of the year.

In addition to higher bookings, there was a slight swing to perpetual license bookings in Q3. For the first half of the year, new license signs or bookings were mostly evenly split between term and perpetual licenses. While in Q3, perpetual licenses accounted for mostly two-thirds of new license signings. The mix between perpetual and term licenses is driven by customer circumstances and can cause quarterly license revenue to be lumpy and somewhat unpredictable. Both term and perpetual new license signings were much higher in Q3 than they were in Q2.

Similar to last quarter, on a year-to-date basis, new license signings are higher this year as compared to last year in every vertical other than US healthcare. Our healthcare vertical was slower in the first half of the year due to the temporary uncertainty related to the Federal Healthcare Reform Act. However, there is now very strong activity in this vertical. The value of healthcare license signings was up significantly in Q3 and there is a very good pipeline for Q4.

While we concentrate our sales efforts on target or named accounts, we are also growing our customer base. Through the first three quarters, we have closed more than five times the number of license arrangements with new customers as compared to the first three quarters of last year. With the additional sales people we have brought onboard, we’re covering more accounts, more geographies and more partners.

Partners continue to be an important part of our revenue growth. Partners are associated with about 38% of all active opportunities in the pipeline. Partners are not just inducting in the market by sending consultants to take up training, just subsequent to the quarter, Accenture one of our platinum level partners acquired a smaller partner whose business was built entirely on Pegasystems. This demonstrates how serious an investment partners like Accenture are making in our business.

Our integration work with Chordiant is sufficiently complete that is impossible to talk about Chordiant versus Pegasystems deals. With one marketing organization, one management team, and a sales force that is integrated in the vast majority of our geographies, a pipeline deal flow on license signings are largely due to the combined team. So other than maintenance revenue, very little license revenue can be directly attributed to the Chordiant organization that we acquired back in April. Lastly, we had no 10% customers in the quarter.

Maintenance revenue was $26.1 million on a non-GAAP basis in Q3, more than double what it was in Q3 last year. $6.7 million of the $13.6 million increase is due to the amortization of the deferred maintenance agreements acquired from Chordiant, while the balance of the increase almost $7 million is due to the continued growth in our customer install base just about all of our customers subscribe to every new annual maintenance agreements.

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