Welcome to the Pegasystem's Fourth Quarter 2016 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to your host, Mr. Ken Stillwell, Chief Financial Officer. Thank you. You may begin.

Thank you. Good evening, ladies and gentlemen, and welcome to Pegasystem's Q4 2016 earnings call. Before we begin, I would 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, 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 FY17 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 2016 earnings and the Company's recent filings with the SEC, the Securities and Exchange Commission. 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.

Thanks, Ken. Starting with the financial highlights, Q4 was a good quarter, capping off a solid year for Pega. We're pleased to see the interest in our applications continuing to accelerate. Ending the year with our Business divided about equally between the front office, customer-, relationship-management space, and the more back-office, operational excellence-type projects. In looking at the overall progress on the Business, I'm really pleased with the advances we've made in increasing the recurring cash elements of our Business. For those of you who are new to Pega, we historically have offered clients software licenses in three ways. One is on a perpetual basis, where they pay a large amount upfront and then pay annual maintenance. The second is a term license, where they pay for the software by paying over a committed term of months, most typically between three and five years. And the third way is through a license on our Pega cloud platform. While we think offering all of these license options to clients makes sense, we have been encouraging our Sales Teams to lead with the recurring model, which we feel has advantages for us and is increasingly popular due to the rise of the cloud. We continue to grow recurring license and cloud revenue by 30%, up as we've done for the past three years. And we ended the year with the biggest license in cloud backlog we've ever had in the Company's history by far. Up 26% year over year, and $108 million of which we added in Q4. So this is a tremendous number, and as I say each quarter, we look at the performance of Pega by evaluating the combination of our revenue, on net change-to-deferred, and the net change in license and cloud backlog. So this just highlights Pega's strong…

Thank you, Alan. Just a couple highlights before I get started. We added some additional information related to recurring contracts and revenue. We've tried to improve the -- and make it a little bit easier, the understanding our Business. We've also added some additional disclosures that we provided in the press release. Our 10-K will be filed over the next couple of days so that will be available for you. JMP and Morgan Stanley are two conferences that we are presenting at, so we look forward to seeing many of you next week in San Francisco. So getting started, our Pega's Q4 and full-year 2016 results reflect great performance at a really exciting time here at Pega. I'd first like to hit some highlights for the quarter and for the year that is just really exciting for us. We experienced record license and cloud commitments, with significant growth in both Q4 at 32% year over year and full-year 2016 at 19% growth against 2015. We increased our revenue to over three quarters of a billion dollars. Our backlog soared by over $100 million for the year, with most of that growth coming in Q4, which is not unusual for us. We had continued growth and recurring license in cloud revenue of well over 20%. And currency adjusted total recurring revenue growth of approaching 20%. This was in the face of significant currency headwinds of about 4%. We signed three whales in Q4 alone. Five for the year. A record. By the way, all of those whales were recurring contract arrangements. To remind everyone, our definition of a whale is a client license and cloud commitment of greater than $10 million. I'm sure it will also be helpful to help bridge our top line revenue results with our previous guidance. Given…

[Operator Instructions]. Our first question comes from the line of Steve Koenig with Wedbush Securities. Please state your question.

I just wanted to ask real quickly, I just want to verify so Ken you said the duration was consistent, didn't really change so, are we correct if we interpret that 32% year in year growth in license and cloud bookings to be pretty representative of the business activity standardized for duration. So your growth for that is a representative result for Q4 growth?

Yes Steve, so let me clarify. Its 19% year-over-year its 32% for Q4 but if you think about the 19% growth which is 420 million of backlog last year to 528 that is not skewed by a noticeable change in the duration. So yes, you are correct with your assumption.

Okay. So the 19% is not skewed. So that's a good kind of trend number to look at basically as it represents the year.

Right.

Okay if I could slip look for it if you don't mind. I would like to maybe ask a little bit about operating margin mix. So the implied operating mix from your guide is about 14% even down a little bit from fiscal 2016 I think once I calculate all my numbers, is the mix -- is that because the mix is inflicting faster or are you investing more, I mean it sounds like you're keeping cost control pretty well. So maybe help explain that to us and by the way, do you have a mix target for the recurring revenue in FY '17'?

So, there's a couple questions in there. So let me touch on couple of them. The first question you talked about was the margin. So if you think about, as you move to a higher percentage of recurring client arrangements, you have that compression. The compression hits the bottom line. It doesn't immediately fix itself in a subsequent year but our margin will improve with our mix adjusted from year-to-year. So we are seeing margin improvement -- our cost growth for next year is -- I don't want to say significantly but I would say less than what it has been in previous years so that's a good trend. But we are still seeing a lot more recurring deals than we have in the past as opposed to perpetual. Now in terms of, when you said what's our kind of guided mix, we don't have a per say guided mix but I would say that we are seeing the business become more equivalent between recurring client arrangements and one-time type perpetual arrangements which is a change from where we were say three, four years ago when we had a much a much greater amount of perpetual.

A lot of is driven to be frank by client choice which is an important part of our go to market and I think that makes us appropriately reticent about trying to pick an exact percentage because you get a couple of whales in there and if you feel one or two of those whales could trivially than perpetual deals and then we would be having a very different conversation about Q4. It's hard to know. We do incent the recurring cash deals better because we think that that makes sense even though it provides obviously a negative -- it's very, very slight or somewhat negative impact on margin in the year the deal is sold all. It's terrific in future years which is I think what Ken is alluding to.

Our next question comes from the line of Greg McDowell with JMP Securities. Please state your question.

Just a simple question. For investors it's often tough to reconcile the headline license number from the income statement and just to understand some of the nuances with what's going on with backlog, so I thought the way I would frame my question just to be entirely clear that you guys were satisfied with Q4 performance, because it looks and sounds like you guys were just based on backlog growing by over $100 million. Could you sort of characterize your level of happiness with the sales team, the sales team performance in Q4 and maybe characterize your enterprise sales force performance compared to more of the global 2000 sales team performance in other words were you happy that people made their bookings quotas [ph] and was it widely dispersed across the sales organization?

Well, so, a couple of things. First, I would tell you that we have I believe a record number of people going to club this year I think in Hawaii. And this is a big deal business and not everybody can perform every year. I'm not a guy who is routinely, I'm not sure that I am generically unhappy as Bill Belichick [ph] is. No one is going to say that I run around raving about anything less than what I think we ultimately could perform and I generally feel that we can perform better. We're going to continue to work hard, and continue to do it. But, if you go back to any of the previous scripts for new folks who were here, every quarter we talk about the need to add together the revenue number and the deferred number and the backlog number. Every quarter weather its good for us or sometimes we said we're disappointed because the revenue number was good but we had backlog. I think only by looking at those three numbers in concert can you actually -- have even a rudimentary understanding of the business and that's part of what makes our business I think requiring good analyst who can actually do the math and write it up. But it's on the face of every call that we've done both quarters in which we been overtly disappointed because the revenue was good, backlog was not and quarters like this where we got a real massive shift in backlog and it requires understanding what really happened to the top line.

So Greg I will just add one comment to just give you like the other extreme of this. I kind of think about it simply to say, if we would've had flat backlog, and you added that $108 million just without currency now, [indiscernible] we would have 860 of revenue just as an example so you can think about that’s like the other extreme right where we actually didn’t have an increasing amount of term and cloud type arrangements. So when you think about it, that's kind of what Alan was touching on. You can't look at one or the other, you really have to look at them in concert.

We had a more characteristic 30 million to 40 million in backlog we would have an 830 top line number.

Yes, and so that’s the kind of the way to think about how we think about of the total annual commitments. The good thing and actually Steve was on this question a second ago, we would be happy if our license grew because we're moving the average duration from 4 to 5 years, that isn’t actually really building value, that's why I highlighted that statistics because I think it's helpful.

That's helpful and since you brought it Bill Belichick I just have to point out that Tom Brady is a Bay Area native on the patriot and super ball, one quick follow-up question, you know the three whales, should we think about those deals as being your typical three to five-year on premise type projects but under term license arrangements. And maybe how does that compare if you look at, the whales you did in the year ago period, you know, what was the mix between term and perpetual, you know in the last couple of years.

So, let me take -- yes, they are all term, yes three to five-year is a good assumption right, just think about that four year -- it's a good number to hold to they were all term arrangements and, we have not had a year that I contract where we didn't have a perpetual whale. So this is the first time. So that, I think is almost like a byline for what happened this year which is a lot of term and all of our big deals term.

Our next question comes from the line of Mark Schappel with Benchmark Capital. Please state your question.

So Alan, starting with you the company has been trending toward term and cloud for about 18 months or so now, but it took a notable shift towards term licenses this quarter and I was just wondering when in the quarter or when during the year did you really start noticing customers really hitting the inflection point and expressing a desire for term licenses,

Well I will tell you what's interesting because customers will often foot back and forth but what we really started promoting our cloud choice message in the second half I think we really clarified how important it was and what a differentiator it was from one of the sort of captive clouds companies that are some of the alternatives and I think that's increased customer's awareness and intention. The other thing is a bunch of these termed whale deals actually also then follow-up with some component of cloud. You know they will use our cloud for dev test for example development testing and other things of that point. So it's interesting, some of them could [indiscernible] further use of our cloud going forward so we would still characterize it as a term deal because the customer always has the right to be able to pull it on premise.

I'd like to just add one piece of color to that market, in 2016, I think we really became committed to focus on our revenue and our backlog combined. As opposed to trying to drive customers to a perpetual deal where we would rather have a long-term recurring, so for instance if we were really tied out to what was our revenue number in the quarter we might actually take a customer that wants to buy [indiscernible] cloud and try to encourage them to buy a perpetual to meet a earnings number and we just felt like that really doesn't make a lot of sense as we run the business, so we have really focused doing the right thing for the long-term health of the business and understanding that all of you get that -- because we disclosed this operating backlog like a lot of companies do not do but we do. It's very easy to connect the dots there. And so we just had faith that the market would see that what we're driving to is longer-term value, predictability and the right type of structure for the client and not trying to force things into say hit a top line revenue number as some companies may focus.

And moving on a little bit, Alan in your prepared remarks you touched in your corporate market sales group and you've been in the Board for about two years now, I think you said that in your remarks reports that you plan to expand that group over to year. What are the changes do you expect on this group in the coming year?

We're going to continue to grow it. I'm pleased in two ways actually. We found that it's both a great way to get a bunch of new names which are really big companies that we can then treat in a more traditional enterprise weight as opposed to the -- the corporate markets group is more direct response, it's more transactional as opposed to the traditional heavy-duty enterprise view. But we've also found that it's a really good place to build a farm system for more junior enterprise and so we're going to use that increasingly as a way to bring staff into the company, let them prove that they can sell the transactions and find the right ones who are able and want to grow into the enterprise rep. So I wish frankly we had done it three years ago.

Our next question comes from the line of [indiscernible]. Please state your question.

Just curious, on what your historical perpetual license deal would have typically looked like in the past regarding the percentage of perpetual license that would have been recognized in that quarter. So in other words, is it typical in the past that you had some percentage of perpetual that was either put in a backlog, or deferred because it was tied up to a deliverable like services or--

It could be, but I would say that that would typically not even rise to 20%. You sell a perpetual, and the rights transfer to the customer, you take revenue there. So, I think that you should really think of the perpetual as stuff that 80% - 90% of it happens in the quarter.

So I can give you an easy way to think about that is that we actually disclose in our future cash receipts we actually talk about perpetual versus [indiscernible] cloud which is essentially the revenue that hasn't been recognized basically delayed revenue. If you look at that over time, Steve, it's actually lower in absolute dollar amount now that was four years ago, right. So we actually have more perpetual deals four years ago not get taken in the actual quarter in which it was committed. So, as our backlog has grown interestingly enough the percentage of actual perpetual in the backlog is shrinking in absolute dollars. So there is actually in our investor deck there is actually a chart that you can see our total backlog trend and our term and cloud backlog trend and naturally the GAAP is perpetual. You can see that it used to be 80 million to 100 million and now its more like 60 million. So that might help you think about we don't have as much of that delaying into future periods.

Got it. And just looking at a term license customer, the decision they would make to maybe go cloud. Just wondering about contractual, term links that would be typically associated with a term license versus contractual obligations to going at it with your cloud, there are commitments for duration sometimes to those and I guess the second part would be are there price differences as well to kind of push them towards the cloud term versus cloud.

Well obviously, if you're buying or they are licensing the software on a recurring basis to a term, and then we're providing the Pega cloud capability and service, obviously that's going to be an uplift addition to what they would pay for the term price. So, and by the way, if they adjust to a term license the agreements will often or might not have the standard cloud language in it, you get that when you actually indicate that you're interested in the cloud capabilities. So contractually we would typically have a separate in those cases it would simply be a separate addendum for them getting the ability to run the term license on the cloud for additional fees.

Maybe one more in on the term license contract, there's the ability for the customer to renew. I'm just wondering is it typically a price escalator built-on matter or can they continue on at the same times?

Yes. I mean that’s one of the factors. The extent to which they escalate is one of the factors that is negotiated but in reality escalation really occurs because they in effect by more, right, the escalation doesn’t -- I know there are some companies that go around jerking around their customers with magic 20% increases and I just think that's bad form. We really like our escalation to occur because the customer finds additional use, rolls it out to additional users, and finds other purposes. So that’s the way you should think of our increases. We don't lowball the numbers for the first year or two so we can zap people in years three or four.

We do get typical CPI or very small increases just to deal with escalating costs but most of it what Alan said is that there is upsell Steve and just highlighting our investor deck is on the website page 23 is the chart that shows our backlog trends and it shows the term license and cloud and then total so the gap of course is the perpetual and if you just look year-over-year, you could actually see the trend of how we're getting a much higher percentage of term and cloud in our backlog versus perpetual. That would help if you just want to see it visually.

Our last question comes from the line of Matthew Galinko with Sidot. Please state your question.

If we think back a year or two ago I think there was some level of effort to get more linearity to deal sources kind of having them bunch up in the fourth quarter obviously with the level of whales in the fourth quarter here, maybe linearity didn’t come in quite as evenly as hoped but can you just talk about getting those spread out a little bit more through the year, is that still an effort, do think it's possible to get it, a little more linear?

We're trying. Part of the thing that exacerbated this year, was that in 2015, if you will remember, the Q4 was also just a staggering blow out. We had stuff that chimed almost surprised us actually in some ways right, and that means is that we had to do a bunch of -- and we talked about actually the beginning of the year, we had to do some pipeline for building in the first half, so, I think that was exacerbated. I will tell you that, if I look year-over-year from the end of 2015 to the end of 2016 the aggregate pipeline is up very, very nicely well over 20% so I think we're in a better position to try to achieve linearity but I would be foolish to tell you that this is not in some ways a lumpy business because, that is the truth we have reconciled ourself to., by the way as we get bigger, now more than three quarters and 1 billion of revenue, as we get bigger, I think we do become more predictable because individual whales don’t have just the same massive effect that they did you know when we were even a couple of years ago.

And Matt, naturally the more that we moved to recurring arrangements, where we actually build a higher amount of predictable cash flow as a percentage of our revenue, that will help us as well.

So, I think we are ready to wrap up at this stage. I would like to thank everybody for spending the hour with us. We are very excited about how the company is doing and we want to put a final plug-in for PegaWorld including the Investor Day which is the first day which less people see the keynotes, see the 70,000 square foot technology pavilion and then spend some lovely time digging into the numbers. So, feel free to reach out to Ken if you guys are interested in that and thank you all. I hope to see many of you on the road next -- I guess we'll see a bunch of you next Tuesday, Wednesday. Take care all.

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.