Pegasystems Inc. (PEGA) Q3 2016 Earnings Report, Transcript and Summary

Greetings and welcome to the Pegasystems’ Third Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Ken Stillwell, CFO and Senior VP of Pegasystems. Please go ahead.

Thank you. Good evening, ladies and gentlemen, and welcome to Pegasystems’ Q3 2016 earnings call. Before we begin, I’d like to read our Safe Harbor Statement. Certain statements contained in this presentation, including but not limited to, statements related to future earnings, bookings, revenue and mix of license revenue may be construed as forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. The words expects, anticipates, intends, plans, believes, could, estimates, may, targets, strategies, intends to, projects, forecasts and guidance, and other similar expressions, identify forward-looking statements, which speak only as of the date 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 the fiscal year 2016 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 the forward-looking statements are contained in the Company’s press release announcing its Q3 2016 earnings, and in the Company’s filings with the Securities and Exchange Commission, including its quarterly report on Form 10-Q for the quarter ended September 30, 2016, its Annual Report on Form 10-K for the year ended December 31, 2015 and other recent filings with the SEC. Although subsequent events may cause the Company’s view to change, the company undertakes no obligation to revise or update forward-looking statements, whether as a result of new information, future events or otherwise, since these statements may no longer be accurate or timely. And with that, I’ll turn the call over to Alan Trefler, Founder and CEO of Pegasystems.

Thank you, Ken. I’m pleased it was a strong Q3, overall. Q3 is generally provide limited visibility given vacations and schedules especially in Europe. And I had spoken about Brexit on the last call and I’m pleased to say that concerns have not materialized with the exception of currency of course. And I’m pleased to see the continued progress we’re making towards having less lumpy quarters despite the inherent lumpiness of this business, even in the face of those currency headwinds. Those currency headwinds caught a couple of points off of our results. But nonetheless, our year-to-date non-GAAP license and cloud revenue grew 18% year-over-year to $239 million. And our year-to-date non-GAAP total revenue grew 15% to year-over-year about $552 million. While we continue to make investments to leverage growth opportunities, we are committed to improving operating leverage as we scale long-term. So – which brings us, I think, to a recapitulation of our strategy. To summarize, we continues – continuing on focusing on delivering the world’s leading business process management and customer relationship management software. Enabling our clients to realize dramatic business agility and positive business outcomes by combining insight, action and the ability to evolve that our software makes possible. We’re looking to broaden our market reach to both digital marketing and to our expansion to the Global 3000 and this continue to gain traction, as I’ll talk about. We focus on giving choice in how clients acquire and deploy our technology, which is a message that is resonating. And we provide value to clients whether they are in growth mode or efficiency mode depending on business and economic conditions. Our software can help customers retain and expand their customer base through our customer decision hub, and our case management to create differentiated experiences. And yet at the same time, we reduced cost by improving operational efficiency using our business process management, our case management and now the robotics we can offer as a result of the OpenSpan acquisition earlier this year. So in this strategic column, we have four major initiatives to product focus, to go-to-market focus that I’m going to touch on. First from a product perspective, we continue to enhance our unified model driven platform Pega 7, which is the foundation on which our applications are built, and a critical competitive differentiator. It’s truly a platform for digital transformation. It provides a unique capability in case management BPM and real-time decisioning, which coming together, bring that insight and action to the four. And this distinctive positioning of having one platform continues to gather industry recognition and delivers for us and our clients. Unlike our competitors, this unique architecture gives them flexibility and choice and deployment. Customers can move seamlessly between Pega Cloud, which we host and take care of, third-party clouds, private clouds, hybrid clouds or traditional on premise. And the ability to accommodate client individual business needs, not just as they exist today, but as they might exist in the future, is we think far superior to stuffing clients on some multi-tenants SaaS system. And we are seeing organizations understanding how digital transformation itself may transform in the future as really hungering for that level of flexibility and choice. Also I mentioned OpenSpan, less than six months after the OpenSpan acquisition, we launched our robotic automation is fully unified with Pega 7 and CRM applications. It allows us to apply OpenSpan’s 15 years a machine learning expertise to Pega clients. And it’s a unified offering that really snaps in beautifully with our business process management capabilities. Because what we’re really happy about is this isn’t just about letting a bunch of robots loose on a client. It’s about plugging them into a way of thinking about finishing and completing work, which is we believe a highly differentiated and far better way to think about both automation and robotics. Now regarding industry recognition, this August, we were designated as a leader in the Gartner Magic Quadrant for intelligent business process management suites. A leader we’ve been recognized in this report every year its inception in 2006, and being evaluated 15 vendors and we were really pleased with the way our picture looks, shall I say.. But last year in another very attractive picture, we were also named the leader in the Gartner MQ for PBM platform based case management frameworks for the second consecutive year. And I think when you realize that we have one architecture that brings these two capabilities together you’ll start to see that we can do end to end things that our customers and our competitors find both appealing and threatening, on a retrospective basis. Now we continue to deepen the capabilities of our customer engagement applications as part of our strategy number two, which is to create really well finished marketing sales automation and the customer service capabilities. We’re focusing to make these solutions of greater value to buyers, to improve implementation speed and increase ease of use. And once again this is where having a unified architecture approach really means we can provide a seamless way to handle a service request, or the customers on a service call to advance the sales opportunity and have every interaction advancing the customer journey using our customer decision hub, which is part of this always on customer brain at the center of our technology. With lots of companies hyping AI, an artificial intelligence solutions today, I just want to remind you that our customer data hub doing tremendous decisioning intelligence to our CRM apps, driving it and really supporting true advanced capabilities. It continuously learns from data interactions to how our experiences across an enterprise in real-time and its scale. And this is real, this is not a vision or some bolted together Frankenstack of purchase products. We’ve been doing this for years and customers with real and dramatic results who come and talk about them at PegaWORLD, not as things that are going to be, but it’s things that are fundamentally changing their business. So being the only CRM where sales service and marketing are unified in this environment versus an integrated environment where they are just kind of glued together, means you don’t have to write NPI code integrations between apps and lots of things that are hard in other businesses as they scale up become easy in ours. So being able to guide customers and being able to provide this capability, so you don’t have to train people, that’s something we do far better we believe than any other of the competitors. And then regarding the apps, we have also been announcing significant enhancements to many of our application areas. Most recently for example our customer lifecycle management and know your customer applications, which provides a unified solution for managing both corporate and personal banking customer journeys as banks seeks to bring on new customers. And in a world where organizations are worried about the process through, which they open accounts being able to bring decisioning and process to that point of engagement. We think is especially appealing and especially important. We’ve also been able to work into our product important advances with some of our partners. So for example, we work with our partners to advanced cloud-based capabilities such as voice recognition, SMS messaging, and quick to call functionality to run our customer service platform using software from Stark and Tropo, which are Cisco companies that we partner with. We actually demonstrated these at Cisco Live and at our recent healthcare summit. So being able to bring together a unified platform with important partner solutions now available in many cases on our application store inside our platform itself is really one of the things that makes I think our technology special. We also by the way see – we can bring this technology into markets that are really quite new and get leveraged. For example, we fairly recently have been entering the German market for healthcare. And I’m pleased that DAK is a new healthcare client that has bought sales automation for the statutory healthcare functions that are German specific. And SVK, which is the largest company health insurance provider in Germany also jumped on Board and being able to create these rule driven regional specialized solutions really gives us we think a lot of power, and a lot of sticking power in going after important new functions and markets. The third strategy talks about go-to-market, and from a go to market perspective we’re really looking to increase our view and our management depth about how we’re going to do digital buying and improve awareness to bring prospects and clients to our technology. We recently hired our new CMO, Tom Libretto. He started about a month ago and he’s building on great marketing momentum we’ve developed over the last two years. Tom had over 20 years deep B2B and B2C marketing in CRM experience and some of the world’s most recognized brands. And he most recently comes to us from JPMorgan Chase. And I think that you’re going to see wonderful things coming out over the next six months as Tom and the team are energized to really drive a true digital marketing agenda. And earlier in the quarter we added Dianne Ledingham to our Board of Directors who’s a leader in Bain’s Customer Strategy and Marketing practice and a senior partner in the Telecom, Media and Technology practices. She is very experienced and helping companies create and implement high impact growth strategies and we’re excited about what she is going to be able to do with us. Our fourth area of strategy we’re also investing in broader market coverage. A deeper within our enterprise accounts where we go-to-market vertically and with the addition of sales forces focused on opportunities in the Global 3000. We’ll also continue to expand the ecosystem partners to support our growth. This quarter we continued across the Board add new logos across verticals. And I’m going to call out a few. We’ve seem great traction in the public sector globally, as government entities focus on modernization, working to improve efficiency, reduce costs and enhance service. For example the State of Vermont is now using Pega on the cloud to deliver their next generation licensing platform to the Office of Professional Regulation, which is responsible for enforcing 44 different professional occupations across Vermont. And in a very, very different sort of use case the U.S. Marshals Service is doing an agency wide modernization project to create modern digital business processes for case management, prisoner management, fugitive investigations and court security management. I’m hoping to never personally have one of my record in their system, I’m happy to say. But I’m not just in America, but globally the Dutch Ministry of Economic Affairs, our first work with the Dutch government is using us to be able to support health inspections and other functions from a supervisory perspective. And moving to another continent the Australian Bureau of Statistics is developing data collection systems for business and household service. So once again, we’re seeing really interesting government use cases, which I think is fascinating and also I think going to be very promising as we go forward. We also see good momentum in our key target industries and to pick out a couple of there, I would highlight for example Scotiabank, which is using the power of our agile delivery to increase their speed to market, delivering contextual next best actions to online and mobile channels. And we’re part of the bank’s overall digital transformation initiatives. Having just placed another vendor and very, very quickly using our technology to drive broadly across the bank. And at a notable win at a very large Pelco, where we’re in over 36,000 service desks. We’re being part of that broad digital transformation really looking to improve service and automate end to end customer journeys. So that somebody can start in one channel finish in another. The Pega vision if there ever was one. I’m also pleased to say that the corporate markets team they’re still small continues to do well. We’re pleased with the performance year-to-date and brought in a variety of new logos ranging in size and industry from Nielsen to Credit One to Hitachi to Bayview Financial. So look, these are all examples I think of how the growth in the business was pretty strong across the Board this year, and something we’re looking to try to accelerate as we go into next year. We continue to grow the ecosystem and we’re doing it both by direct access to partners and also creating some new programs, for example our new university program, which has run at four universities and we’re going to now put out to close to a dozen to be able to train graduating seniors in Pega technology both for our clients and our partners to be able to pick up. I’m going to call out one final customer experience that I was excited about and actually blogged about on LinkedIn if you guys want to look at. It’s about a customer I visited recently also in Holland is Rabobank, which is the largest vendor to Dutch businesses. They wanted to really launch an innovative FinTech challenging approach to how they dealt with small business customers. And they came up with the idea that if a small business could go on to their website and fill out a pretty comprehensive set of forms by noon. The next day they would meet with them and give them a thumbs up or a thumbs down on a loan of up to €1 million. And I’ll tell you this is about 10 days faster under competition and completely revolutionary. What I’m thrilled about is, we’re not their website, but when you go to that magic page on Rabobank, sitting right in the midst of that is a Pegasystem, directly connected end to end. To be able to help the right questions get asked to be smart and contextual and to really make this brilliant process work well. Very exciting to be able to work with clients like this. And we think that as you look at our website you see the customer storage, you really see a rhythm of success developing across the industries that we focus on. So in summary, good Q3 and year-to-date results, we’re really pleased with the recognition by clients and industry experts. And the work we’ve done to unify the OpenSpan product and people are really has shown that’s already going to be a terrific, terrific merger in extension of our family. And we continue to be confident in our continued momentum and competitive differentiation. So with that, let me turn it over to you, Ken.

Thanks, Alan. Pega Q3 results reflect our momentum as we enter our busiest quarter of the year. Highlighted by strong year-over-year revenue, license and cloud growth, progress towards achieving our full year EPS guidance and backlog growth from quarter two of 2016, it is higher than any typical quarter that Pega sees in our Q3. Our strength in generating significant value for enterprise customers with evidence by two license arrangements that we call, whales in Q3. Both of these whales were term license agreements, which contributed to our backlog. To remind everyone our definition of a whale is a customer software commitment of greater than $10 million. Based on our current currency exchange rates and our anticipated revenue mix for fiscal 2016, we’re clarifying the approximate full year impact of currency fluctuations that we mentioned in our Q2. Our topline revenue should see currency headwinds of approximately 3% or $20 million to $25 million. We have an approximate 50% natural hedge in currency such as the pound and euro, as we do incur expenses in these currencies which help to offset revenue headwinds. Given the visibility we had to the currency headwinds, we’ve done a good job of managing our cost to help offset some of the earnings pressure that could occur from a currency headwind. Our year-to-date growth of non-GAAP fully diluted EPS of 32% is evidence that we’ve been successful in managing the bottom line impact of this currency headwind. At the end of Q2, we highlighted some concern around the short-term impact to Brexit and so far the impact has been limited to the currency impact mentioned as Alan said earlier. For the third quarter of 2016, we’re reporting both GAAP and non-GAAP results. A full reconciliation of our GAAP to non-GAAP measures is provided in the financial tables of the press release issued earlier today and is available on the Investor section of our website. As we’ve discussed in the past quarter-to-quarter comparisons do not necessarily reflect the underlying momentum of our business as the timing of a small number of large transactions and the mix of license types can significantly impact quarterly results. In our view, year-to-date results provide the most meaningful look at how our business is performing. As Alan mentioned earlier, we’re very pleased to report that our year-to-date non-GAAP total revenue of $552 million, which is up 15% year-over-year. Foreign currency negatively impacted this growth rate by approximately 2% to 3%. Our year-to-date non-GAAP license in cloud revenue was $239 million, up 18%, also negatively impacted by currency. Year-to-date through the third quarter of 2016 non-GAAP recurring revenue, which includes maintenance, cloud and term license was 54% of total revenue, growing from 52% for the same period last year. I want to highlight that we offer our customers choice when making a technology investment in our software including perpetual turbine cloud arrangements. We have absorbed increased interest in licensing our product under recurring revenue models over the past few years. This trend is accelerating as we expand into the CRM space where other vendors have established recurring revenue models as the norm. To highlight this factor, both of the whale deals I mentioned were multi-year term arrangements where revenue will be recognized overtime. In fact, in Q3 four of our largest deals in North America, our largest arrangement in EMEA and our two largest in APAC were all term arrangements. This trend can impact expected revenue in the near-term, but with the long-term annuity stream from these arrangements coupled with our above 90% retention rates will drive higher recurring cash flow streams and better visibility in the future. We continue to expect that our business will shift away from perpetual license toward recurring license revenue streams of term and cloud. Although the timing of a small number of large value perpetual transactions would continue to impact our license mix in the foreseeable future. And I also want to highlight again, that we are giving our customers choice as oppose to forcing or encouraging them to move to recurring revenue streams. Non-GAAP consulting services revenue year-to-date through the third quarter of 2016 was $144 million an increase of approximately 18% over the prior year. In the future, we expect to continue growing our consulting business, but at a lower rate such as high single to low double digits. Consistent with our strategy to have customers and partners deliver the majority of our implementation services. Looking at our geographic non-GAAP revenue split, year-to-date through the third quarter of 2016, the Americas inclusive of the U.S., Canada and Latin America produce 65% of total revenue, while non-Americas international generated the remaining 35%. Approximately 14% of our total revenue is generated from the UK. The geographic mix is impacted by the strong U.S. dollar compared to other local currencies. Turning to our non-GAAP gross margin. We finished year-to-date through the third quarter of 2016 with gross margin of 70%, up from 69% in the prior year. Non-GAAP consulting services margins year-to-date through the third quarter were 12% up from 5% during the same period in 2015. The margin year-to-date through the third quarter of 2016 benefited primarily from two large projects for which all or a significant portion of the associated cost were incurred in the prior year as we’ve mentioned in previous quarters. If we adjusted for this timing difference, our consulting services revenue would have been approximately 11% consistent with our expected run rate of about 10% for full year of 2016. Our year-to-date 2016 operating expenses totaled $318 million on a non-GAAP basis, an increase of 17% over the prior year. Our year-to-date non-GAAP operating margin improved to 13% compared to 12% for the same period of 2015. This improvement occurred despite currency impact, our continued investments in building our strategic apps, improved the digital engagement for our customers and increased expenses that we mentioned earlier related to our increased attendance at PegaWORLD user conference in June of 2016. In terms of other non-GAAP operating expenses, we’ve increased sales and marketing headcount by 168 year-over-year, the majority of which were in sales. We are pleased with the continued progress we are making that sales and marketing capacity for broader market coverage. R&D costs continue to run at about 18% of revenue, we expect this rate of investment to continue through the remainder of 2016 as we continue to enhance our leading Pega 7 platform and expand our application offerings. Turning to earnings, on a year-to-date basis, we posted $46 million of non-GAAP net income. On a per share basis, our non-GAAP fully diluted net income was $0.58 per share compared with $0.44 per share through the third quarter of 2015. Moving onto backlog and our balance sheet, we compute licensing cloud backlog by totaling two components. Deferred licensing cloud revenue, as posted on our balance sheet; and licensing cloud contractual commitments that are signed, but have not yet been recorded on our balance sheet. As a reminder, you can find detail of both elements in our 10-Q and a summary table on our press release, both of which were filed earlier today. We finished the third quarter of 2016 with $420 million of total licensing cloud backlog. Backlog grew $27 million from the end of Q2 2016 and $40 million from the end of Q3 2015. We’re pleased with this momentum in a calendar quarter where we typically experience a reduction in backlog and we’ve seen strong currency headwinds in the quarter as well. Adding two whales as mentioned, both of which were term license agreements certainly assisted in the backlog growth. From a cash flow perspective, year-to-date the company has produced $9 million of operating cash flow within the quarter leading to a year-to-date operating cash flow of $17 million compared to $55 million through the third quarter of 2015. We finished the period with total cash and marketable securities of $130 million. Year-to-date through the third quarter of 2016, we repurchased approximately 1 million shares for $26 million. As of September 30, we had a balance of $41 million available for repurchase through June of 2017. On headcount, we finished the period with approximately 3,800 employees, up 20% from September of 2015. In summary, we’re pleased with our year-to-date results through the third quarter of 2016. The fact that we were able to grow non-GAAP revenue by 15% and diluted EPS by 32% in the face of currency headwind and a significant shift to term license arrangements is a true indicator of the business momentum. And with that, operator, we will open the call to questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question today comes from Steve Koenig of Wedbush Securities. Please go ahead.

Hi, gentlemen. Thanks for taking my [indiscernible] for Q3. If I may, I’m curious to know your thoughts on – for the booking results, how does that translate into – relative to your guidance, which I know you don’t reiterate. But if we look forward kind of a higher probability of making that number for the full year, or kind of unchanged sort of view on chance of making that number up? How would you characterize that? And then I’d also just love to get a little bit of color on those whales what the industries and were any bookings related to the U.S. Census Steel instrumental in the quarter as well?

So I will talk about a couple of those things. So first of all, historically we pretty much hit in backlog and breakeven with backlog to the first three quarters, if you go back and just look at the last several years. And we’re pretty pleased that in Q3, we were able to actually makeup some of the shortfall we experienced in the first half. It still means the fourth quarter as this traditionally true is obviously very, very intense, but relative to sort of historical norms. We were pretty happy with the way Q3 looked. That doesn’t mean there is not an enormous amount to shop between now and the end of the year. In terms of the whales, we don’t normally go into a lot of detail about their composition. But they were I would say in some of our traditional spaces that you would expect and the census was not reflected in one of the whales.

Okay, thanks. Alan. If I may do a follow-up, curious to know, kind of your view on the evolving competitive landscape in CRM, we know you’ve been bumping a little bit more into the multi-tenant SaaS vendor that is dominating kind of the package to stock base if you will. Is that trend continuing and how are you feeling in those competitions, is that normal if you guys bump into then? And more broadly speaking when it comes to CRM who are you competing with most?

Well. So look, if you think about what our strategy was a couple of years ago, we decided we would just take the business and very forcefully steered into the front office. By building out finished apps as opposed to complimenting what people did, which is historically what we’ve done. And I’ll tell you that we’ve steered into that front office pretty hard and going well. And I think we’re competing with the guys expect us to compete with Salesforce and Microsoft, and we routinely doing it. We’ve got a terrific story about a unified platform, about choice, about doing things that are good for the customer. The things that’s a miracle in the multi-tenant SaaS world is that these guys are such a brilliant marketers and frankly, they truly are. They convinced customers that are running a multi-tenant cloud environment is in the customer’s interest. Now that’s only true if the customer is like a 50 person company, because frankly that’s the only way they can afford it. But once you get up to having several hundred users of a system, there’s no real advantage, no advantage at all frankly to the client to being living in a world where his stuff can’t be personally encrypted, where it’s got a be in one of these multi-tenant databases with governors to prevent the tenants from crashing each other’s parties. So that story about the cloud as a virtual private cloud coupled with the story that you can bring this in-house we see as enormously powerful. And I think that ultimately it’s not just in-house, it’s really how the customer not become a slave to one particular SaaS based cloud provider, but have the choice to move to whatever cloud makes sense. I think we’ve got a really strong competitive story particularly since we’ve really only been hard in this business for a couple of years. So I’m really happy with our positioning, where we are, and we have reason to believe that we are on these other guys’ radar.

Hey, Steve, this is Ken. I wanted to add one piece of color on your first question, just so that you asked a question about should we feel more confident or less confident with our full year revenue guidance.

Yes.

I think the way to think about it is we don’t know what the mix of our deals are going to look like in Q4. What we do know is that our Q3 had a larger mix of term deals, which is really fantastic for the long-term of the business and we were still able to achieve a pretty respectable revenue number. Naturally, if a lot of our deals in Q4 go the way of term, I think that you all understand what that does to short-term results, and the way to look at that is to look at a combination of revenue and our backlog of course. And that’s the way to think about our business, so I would just point back to that. I’m sure most of you get that but just to highlight that point.

Yes, that’s very helpful. Okay, thanks guys, I’ll leave it at that.

Thanks, Steve.

The next question is from Mark Schappel of Benchmark. Please go ahead.

Hi, good evening. Thanks for taking my question. I start out by saying nice job in the quarter especially in the license line. A couple questions on OpenSpan. Ken starting with you, I just want to if you could give the contribution of OpenSpan in the quarter?

So we don’t report OpenSpan separately and quite frankly, it is integrated now as a product offering. However, we originally estimated that the contribution from OpenSpan will be approximately $20 million for the full year. And I think if anything we are seeing more demand for OpenSpan than less. So we feel confident that OpenSpan will be a nice contributor for the year.

Great, thank you. And then Alan another question on OpenSpan for you, but I think Ken may have answered it a little bit here. But I was wondering if you just talk in general terms about the kind of growth and demand you are seeing for the OpenSpan’s robotic automation technology.

Sure. You know it’s interesting, because robotics have become pretty hot, though if you actually think about it, a lot of folks are positioning things in a pretty weird way. Our positioning here is unique. If you go, take a look at the other market, the guys in the market. If you want a couple of standalone robots, they go and throwing some part of your operating. We can do that. However, now that OpenSpan is beautifully integrated and connected to our BPM in case management. Those robots can actually now has an audit trail that describes what they do. If they need to talk to some things to robotics, and just to folks know, robotics in a lot way is kind of simulating keystrokes kind of like a sort of – think of it is a fast non-human typist going into the front door of a system. Anything that’s pretty sophisticated is typically going to merge some of those robotic capabilities with things that you think of is more conventional system to system interfaces and to a multiple systems, you really want to make sure things are in sync. Typically you’re not just going from our excel spreadsheet into one system. Typically you’re going between systems and doing that sort of stuff. And that’s the scenario in which our BPM heritage and roots, and the OpenSpan technology just beautifully complementary. And so we’re seeing customers who are just looking for robots to try to make things go faster. Now understanding you’ll get a lot more leverage, if they think of their robots as being part of a process as opposed to standalone entity. So I think it’s turned out nicely strategically, I think the teams get along together really well and we’re really happy with it is a nice complement to what we had done historically.

Great. And then one final question here. And it has to do with your marketing initiatives, in the beginning of the year, the company made a conscious decision to kind of ramp up the marketing spend and what you’re doing in the marketing area. I was wondering if you could just talk again in general terms about how do you think those activities are going, and maybe just give a couple of examples of what you are doing in that area?

Sure. So I think that Tom is putting together the plan for next year, he has got a very good team. They are bringing their thoughts together for what we want to do. But there is no question in my mind that Pega historically was just meaningfully under marketed. If you think about it we were a company that really originally only sold to a couple dozen of the world’s largest firms growing that maybe 500 or 600. Now that we are talking to more firms and getting more visibility. We are seeing companies that we never would have talk to, I mean think of firms like Nielsen, and firms that absolutely have these needs. But they were not in one of our highly specific target markets. And so we’re going to continue to invest, and really work to get both more visibility but also make it easier for customers to digitally buy. What that means is that they need to be able to find the right stuff on the website. That we need to have the materials out there both directly and through our partners to make it so that the engagement that is now expected makes sense. So I think very rational folks that looking how we do this. But I am pleased that the commitment we’ve made to marketing was a wise one, and one that we want to continue.

Great, thank you.

The next question comes from Greg McDowell of JMP Securities. Please go ahead.

Great, thank you. And it’s wonderful to see backlog grow in that manner. Couple of questions. The first one, I guess with respect to Steve’s earlier question, I’ll push it a little bit harder on the whales. And if you could just I know you don’t want to get into too much detail on industry in such, but if you could just talk about whether these were sort of new logo wins or existing clients where they competitive wins, was it more BPM or CRM or case management focus. Just any additional sort of details you can provide would be helpful I think.

Well. So I think both of these would be characterizes being of combination something new and something old. And so it’s not uncommon for us to having had a success with the client to do a significant amount of follow-on business, follow-on business with them.

And then Ken, one for you, a lot of that’s are coming out some recent earnings calls, where there is some similar term license commentary and maybe more explicit fears on operating margin compressions as a result of moving to term licenses. And I was just wondering maybe longer-term how we should think about that mix in 2017 and 2018? And sort of – at least being somewhat careful with our models taking into account the mix shift to more term licenses and the impact on margins. Thanks.

Yes. So it’s a good question. So the simplest way that I can explain it Greg is that if you think about a company that’s going through a rapid shift from a perpetual to a term model is going to have margin compression in an extreme way. A company that is doing it in a slower manner, naturally, you probably may not see much margin compression are notice that. I think the thing that we’ve highlighted for the recent past is to really pay close attention to our backlog because it is difficult to connect the meaning of our non-GAAP operating margin without thinking about the amount of term license, and when that’s coming in. So I think what we’ve seen over the last few years is that our recurring revenue has grown from in the 40%s up now to 54%. And with that our margin has been – non-GAAP operating margin has been at that kind 15% range. And I think it’s easy maybe to speculate that’s a performance issue but the reality is – some of that is related to revenue not matching expense. So that naturally is probably something that you are commonly hearing. I think the important thing to think about is that, that as the term revenue continues to grow you get through that trough. And we have not seen a real trough in margin. We have not experienced that. What we’ve seen is margin that has not grown to the extent that the Street expects it to grow. But I think what’s important is the amount of recurring revenue that we have is growing, and I think that’s a really important thing for us to make sure that you understand because that’s part of the reason that our margin hasn’t expanded over the last few years. And I just don’t think we’ve done a tremendously good job of maybe being transparent or clarifying that to you.

Got it. Thank you, that’s helpful.

The next question is from Matthew Galinko of Sidoti. Please go ahead.

Hey, good afternoon, guys. Thanks for taking my question. First one on the Rabobank deal, Alan, you called out your strength and decisioning and being quite a bit more effective than who you are going up against there. So could you just maybe talk a little bit more about that when – why you ended up so far ahead of your decisioning competitors and maybe you just talk about more broadly I think you touched on this earlier, but a little more broadly in decisioning why you’re coming out ahead.

Yes, so one of the things that we do which is interesting. And by the way one of this relates to one of the whales where we got a major follow-on piece of business. That sometimes we end up being in a head-to-head match against with decisioning. And I think that’s good. I think the fact that our real-time decisioning is rated by Forrester as absolutely best-in-class in terms of capability. The fact that if we’ve got a client who just wants to figure out what the right product is to be most suitable or most appropriate for customer and we’re absolutely best-in-class and then I think that’s fabulous. But the stuff really comes together when you don’t just want to make a good decision. You actually want to operationalize it. You actually want to fulfill it. You actually want to be able to take the loan application make an initial decision in the system. But then run that through some loan committee and actually take some steps. And then on Board a customer, that’s where the decisioning really marries up with case and process. Because the decisioning wants to lead to an outcome like case [indiscernible]. And the process is how do you execute this, how do you do it in conjunction with the customer system. We are I think differentiated purely in decisioning because the engine is so powerful. But if you actually want to move beyond intellect, to actually put some muscle into it, that’s where you’ve got to go put some Frankenstack together with the other guys. You got to do it only in their environment as opposed to being able to make it work both in a cloud environment in which your systems up close and personal. That’s where we really shine. And I think that’s a pretty significant and sustained differentiator for us.

Excellent. And then in terms of the whales you closed the pipeline here, can you comment at all what the sales cycle is like, what you would have expected it to be before or is it picking up a little bit?

I think the sales cycles in Q3 is a hard to gauge. Because Q3’s are just weird, it’s like until September nothing much is happening in many ways. So I don’t think that the sales cycles have really particularly worsened, though I don’t have a statistical basis, that’s just kind of being out there in the field. I will tell you there’s a lot of activity going on for Q4. It’s going to be frantically busy, which is – I think we think that’s a good thing, right, Ken?

So Matt, to touching on that as well, to your specific point to whales, I don’t think that we anticipate that – it closing a whale is any less or more intense in terms of the sales cycle. Those are big transactions. And so as you can imagine they involve an adequate amount of sales activity. So I think our time to close on those is probably unchanged from history.

Historically, so…

Fair enough, right. Maybe one last one for you, if you didn’t call out government as nice sector for you – with some wins this quarter. Do you see any incremental investments you’ll need to make in the coming quarter or year or so to get deeper into government, do you feel comfortable with where you are? Do you see any need for investment, I guess on the engineering side and product side, or on the sales effort [indiscernible]

There is some things that are incremental investment. For example, in the federal government space there is something called FedRAMP, there are some called GovCloud. There is some additional investment that we have been making to be able to support government specific environments and practices. There also some either government specific or government mandated audits that can cause hundreds of thousands of dollars to get done to demonstrate things. But frankly, it’s not enough I think to really significantly move the cost needle unreasonably. The core product itself turns out to be extremely well suited to the government space. I think years ago people would ask me what I was unhappy about it. One thing I said is, I really don’t think we’re doing a very good job getting into government. I was very candid about that. I am obviously feeling a lot better now about that the national that’s federal and the state of local levels. So we’re pretty pleased. We just have to share – the State of California is a government client of ours. And one of the things that they did fairly recently is the California Franchise Tax Board, which is what does all of the corporate taxes put in a Pegasystem with one of our partners to really help run a lot of the govs of the tax calculations. And we’re so thrilled with the results that they hosted an event on their premises of 250 other workers from other government agencies. To show off what they did. And we had some of the other government agencies talking about what they accomplished. And what I like about this is unlike some of the other vendors where if you actually listen to the presentations it’s not actually clear what they did. Our customers when they talk about it tend to be really very specific and very tangible. I think we’re starting to see really happy critical mass gathering in terms of these government organization.

One additional comment, Matt. That if you think about our partner ecosystem that’s very congruent with public sector as well, right. A lot of our partners actually have good public sector practices, et cetera. So the actual execution of engagement is really our ecosystem supports that vertical or that sector as much as any.

Got it. All right. Thanks, guys.

Thanks, Matt.

There are no further questions at this time. I’ll now turn the floor back over to Alan Trefler for any closing remarks.

Certainly. Well, thank you, everyone. We’re really pleased with the quarter and that the year is moving ahead really solidly and it’s trilling to be able to report those customer wins and also importantly customer successes. I want you guys to know that we got a lot of work to do and we are working hard on your behalf. So thank you very much everybody and all the best from me and Ken. Bye, bye.

Thanks, guys.

This concludes today’s teleconference. You may now disconnect your lines. Thank you for your participation.