Please stand by, we're about to begin. Good day and welcome to the Pegasystems Third Quarter 2017 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Kenneth Stillwell, Chief Financial Officer, Chief Administrative Officer and Senior Vice President. Please go ahead, sir.

Thank you. Good evening, ladies and gentlemen, and welcome to Pegasystems Q3 2017 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 statements as defined in the Private Securities Litigation Reform Act of 1995. The words expects, anticipates, intends, plans, believes, could, should, estimates, may, targets, strategies, 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 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 2017 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 that are contained in the company's press release announcing its Q3 2017 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, 2017, its annual report on Form 10-K for the year ended December 31, 2016, 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 will turn the call over to Alan Trefler, Founder and CEO for Pegasystems.

Thank you, Ken. Though there are many achievements this quarter and year to date, we didn't execute it as well as I feel we should have in closing some key Q3 deals. And I know we can do much better. As I've said, we're making enhancements to our sales approach and team. And it's taken some more time for some to adopt than we anticipated. I'll discuss some of these changes as I go forward, and I remain confident in our long-term strategy and ability to execute. We are also seeing faster than anticipated moves to the recurring/cloud revenue model. This is a very desirable long-term benefit. The result is some short-term downside pressure in our quarterly revenue. If the mix shift hadn't happened as quickly this quarter, our numbers would have looked much better. Nevertheless, we're happy to see the shift accelerate and you can see its benefits as well. Ken will provide additional financial details later. Now, with Pega, our motto is Build for Change. And we're actively making changes to improve execution, to finish the year as strongly as possible and set us up for success in 2018. For example, we're simplifying processes and ensuring we have crisp alignment in our sales approach that enables us to execute with greater success and velocity. We are increasing our awareness campaigns. You'll be more likely to see us positioned as the real CRM alternative. For example, we got an aggressive field marketing campaign running now in San Francisco in conjunction with Dreamforce. We're making our products easier to try and to buy, and making it easier to do business with us. We continue to grow the Pega community to support the growth and demand for our products, and are especially pleased to see the continued increase in training, since…

Thanks, Alan. So we discussed in previous earning calls that we always look at the performance of the business on a year-to-date basis, because it's the most relevant view of our performance. The longer the timeframe, the more it reflects the true trends and business performance. As Alan suggested earlier, we're really only addressing a fraction of the market opportunity that's in front of us. That said, there are many positive outcomes that we've seen through the first three quarters of 2017. On the surface, our top and bottom line results are solid, but we know the opportunity is much greater than we've captured so far in 2017. So our go forward execution against this opportunity is our primary focus. There's just too much opportunity to ignore. Let me take us back for a moment to how we progressed through the year on a recurring mix. We started off 2017 planning for 50-50 mix of recurring term and cloud versus one-time perpetual commitments, and we're actually pretty close to that through the first quarter of 2017. We then saw an acceleration to recurring in Q2 where we had somewhere close to 60% and then we finished Q3 with an amazing 79% recurring. While year-to-date we're at 62% recurring, which is a pretty big shift from where we modeled 2017. As I said before, I hope that we could get to a much greater amount of recurring than 50%, so this is great news on where Q3 and year-to-date landed. To remind everybody a shift of 1% away from 50% would impact full-year 2017 revenue by approximately $3 million. Although, we can't predict where Q4 will land and the impact to the full-year mix, it is likely we will land 2017 full-year with more recurring commitments than one-time. Whether we land…

Thank you. [Operator Instructions] And our first question will come from Steve Koenig with Wedbush.

Thank you very much. I've got a few questions, so I'll ask these, and if there's still time on the call I'll jump back in the queue. So Alan, you talked a little bit about the sales changes that are going on and execution improvements that you're working on. So your actions to remediate the Q3 execution are welcome, but they suggest that there is more than just lumpiness, there's something a little more systemic that you need to tweak at least. Can you give more specifics on maybe in the quarter what areas were weak, any areas better? What sorts of issues are you seeing that you're working on? And I'd love to get color on a little more specifics on what changes you're making.

Yeah, sure. I think that we've talked about how we've been moving from the traditional relationship model that often works very much with the folks we, frankly, in many cases, knew for long periods of time and was very much geared on having a customer share what their challenge is, what their issues are and from that, us really crafting a solution that would sort of meet your needs. That's the basis of traditional relationship selling, and it is how the business largely grew up. Starting probably about a year ago, perhaps a little more, we really started rolling out much more of a challenger messaging. The idea in challenger is you got much more out-of-the-box value props. You need to, frankly, be more assertive about finding and talking to people you, to be honest, may not know. And the style is what I would describe as much more proactive and much more engaged. I think that we perhaps under realized how the traditional model of some, certainly not all, but some folks to really rest on a behavior pattern of talking to the people they already knew. And we need and should have the opportunity to talk to whole collections of new people who are responsible for these front office functions around service, sales, marketing where we know we've got a winner. I mean, the fact that we've got a winner is proven by the fact that we won a lot of business against well-established and well-known competitors. But some of our behaviors were not, I think, as assertive as they needed to be. So we welcomed outside folks in from some experts in challenger selling. I've been optimistic this might have clicked a little more than it did, to be very transparent. And we, instead, decided in the…

Okay. That's very helpful, Alan, I appreciate that. Maybe just following up on that explanation, can you tell us a little bit more about what is it that you're hoping will make the challenger methodology and the new people contributing in Q4 to make Q4 a lot better? Is it a matter of the new people ramping or is it a matter of getting that challenger methodology accepted culturally through a broader part of the organization? And specifically, can that happen quickly and how can it happen in Q4?

Well, couple of things, so one, we've got a tremendous amount of business queued up to close into Q4. We've had in terms of the late stage of our pipeline cycles, what we refer to as decision in legal. We have massively more in there than we had historically. And we, typically, are quite successful in closing that sort of business. So I'm not counting on new heads coming through the door to cause us to execute in Q4. And Q4s have always been really quite big for us, and I'm hopeful that this will be the case as well. However, I'm not settling for Q4. I've been doing this for a long time, and I'm committed to changing the velocity of this business. And my management team has recommitted to changing the velocity of this business. And that means, we got to get out of the sort of current envelope of velocity into one that's really much more suited to what we can do for our clients. And so, that's what these changes are about more than anything else. It's really about making sure we get a strong launch into 2018. And I can tell you that, in doing work and preparation for that sales kick-off, you're going to see us coming in with a very assertive new set of messages that build on what we've done historically but are consistent with the energy level that I'm hopefully conveying.

Okay. Thank you very much, Alan.

And next, we'll take a question from Greg McDowell from JMP Securities.

Thank you. Good afternoon, Alan and Ken. Couple of questions and then I may get back in the queue like Steve and ask more. But first, I want to drill into the year-to-date headwind. As you called out in the press release, it's around $40 million. And if I just walk through some remedial math here, the original guidance was $860 million, I take $40 million out, I get $820 million. So I'm just sort of wondering what is that Q4 incremental adjustment to - that I should make to the what feels like the new baseline of $820 million? How is it feeling? These big deals in the pipeline, how do you anticipate those deals will be structured, term, license versus perpetual license? So basically, two-part question first. Thanks.

So I think, I mean, your math is right. I mean, that's logical, what you said. This is the way - so let me kind of tell you the way I'm thinking about it. We, as most software companies, we do have deals that close, close to the end of a fiscal quarter, right? No big surprise to you. And so we will have a lot of activity in the month of December like every other kind of enterprise, especially because it's the end of our year and salespeople get into accelerators, all the normal behavior that you would see. That said, we are absolutely committed to recurring deals. We are at 62%. That's a pretty reasonable jump over 50%, and we'd love to see Q4 come in above 62%. I think that would be great. And if that happened, naturally, we even - have even, if they came in, say, at 65%, we have even a little bit of incremental headwind. And so the way we're looking at it is that, that is a perfectly fine trade-off for us to make if that happened and then we would have kind of less revenue but more ACV and more backlog build in that scenario. Now here's the catch. The catch is we can't predict where these deals are going to fall. And deals change, I mean, literally right up until the last part of the negotiation in some cases where customers will decide to go cloud, they'll decide to go term, and so more perpetual. And so, when we think about that, if we had a scenario where, say, Q4 was 62% perpetual and 38% recurring like exactly the opposite, you can imagine that we would - our revenue would go up closer to at or above guidance or et cetera. So that's kind of - in my mind, it's hard for me to gauge where we're going to land. But I will tell you, I'll absolutely take a tradeoff of a higher recurring for short-term revenue at this year, and I hope everybody kind of understands why I say that.

A bunch of this is gut feel if you would ask me. I mean, this quarter was shockingly term given where we were…

Term and cloud, yeah. 79%.

Term and cloud was 79%. It's hard for me to envision that that will repeat. But it's clearly not going to swing all the way back to 50-50 for the year. I mean, if anything, I think the year-to-date average, probably represents, as a former statistician, probably represents the highly varied and the best sort of guesstimate that one could expect.

Got it. That's fair. And then you talked about a strong launch in 2018, I want a strong model in 2018. And I was looking back to the slides from the June Analyst Day and just trying to think through the framework between growth and profitability. I don't want to say we can throw that out the window now based on the accelerated shift to recurring, but it certainly feels appropriate that it - there may need to be some fine tuning given the accelerated shift. So maybe it's a little premature to ask about 2018 and sort of early glimpse of how we should think about 2018, but I'll ask anyway.

Well, we haven't backed away from the thought of being fiscally responsible. Yeah, obviously, if the shift to recurring happens faster, the math just tells you that that creates a bit of a setback relative to short-term margins. But relative to the actual strength of the business, it's an enormously positive particularly with the level of exposure we give - where we're so complete in showing what the backlog is by year. I mean, we really try to create a lot of visibility here as well. But the financial awareness work that Ken brought in when he took over, and I think is very much festive in the company, I think has been well adopted by the culture. You're going to see us trying to make sure that we can be a responsible and profitable company by spending our money wisely. In fact, we have certain advantages, big advantages in that we're not trying to glue together or advance a Frankenstack of 15 products that are unified in name only. We've got some very, very positive things that should be able to help us as we sort of cross the $1 billion threshold we expect. But I do think it's premature for us to put a form of it [ph] for next year, but we look forward to doing that.

Let me give you one thing to think about it, Greg, and for those listening because this will probably be a common question. When you go through a transition shift, it doesn't hold forever as you know, right, because you hit the points where everything that you're losing in a shift, you're actually gaining from the recurring from pre [ph]. So we're a good, solid two years into this shift, and most shifts take somewhere between three to four years till you kind of normalize that. So I would say that although 2017 has a - let's say, we landed at 62%, right. We had two years in a row, where we had a pretty good move to recurring. The assumption that we would then move to 80% or 90% in future years is probably pretty aggressive in the model, right. So I'm not - that's not giving you any guidance, but just giving you a perspective. So I kind of look at it like at some point, the shift starts to normalize for you, right, and we just happen to be through two years, where we've been fairly dramatic in that shift.

Okay. Thanks, gentlemen. I'll get back in the queue.

[Operator Instructions] Next we'll take a question from Mark Schappel with Benchmark.

Hi, good evening. Thank you for taking my question. With respect to the execution issues or missteps in the quarter, were they felt mostly on the CRM side or on the BPM side of the business?

I think, it was mostly on the CRM side. I think, we're fresh coming in that market. We are not as, frankly, known or experienced in talking to some of the front office type folks. We know that when we engage in the front office, we do extremely well. But I think to be honest, we may have overestimated the confidence and level of training that some of our staff selling to the front office have internalized. And we've doubled down on fixing that, and we've complemented it with some really good role models, which seems like the right combination to do.

Thank you. And then, Alan, staying on the execution theme, was it related to a particular geography that you saw some difficulty?

Europe was a little stronger than I expected, to tell you the truth, and parts of North America were a little weaker. So this is where I used the L word, which is lumpy. It's really hard to know. I think that - and parts of Europe are very different from other parts of Europe. I think that, we as a company, I'm proud, what I've done with my management team and more broadly in the firm, is had us recommit to execution as opposed to great strategic initiatives as what we need to do to drive not just the rest of 2017, but really being the center point of 2018. And I'm pretty comfortable that strategically, we've done and are doing the right thing. So I don't think that there's any one part that is so great, because I feel it's all perfect and so horrible that I'm terribly panicked about it. I think we need to improve execution across the board.

Okay. Then, one final question, Alan, Q3 is usually a strong public-sector quarter for the company. I was wondering if you could just comment on if you had difficulties in that particular sector.

I would say we had difficulties. Q3 can be reasonably strong. Things are weird in Washington, as you know. We did close a nice public-sector business. I spoke a little bit about it during my presentation, but there was nothing extraordinary there.

Thank you.

And next, we'll take questions from Matthew Galinko with Sidoti.

Hey, good afternoon, guys. Just a couple for me. Alan, you talked about kind of the AI model transparency switch. Just curious sort of how that came about and if that's - something that's kind of emerging as a differentiator as you go to market with these products. Or is it not quite there yet?

No, no. It's fresh. It's new. It really just hit the market this quarter. And so people are still learning about it, but there's a tremendous amount of interest and excitement. If you want to understand this, and I think this relates to the whole sort of non-DS [ph] aspects of understanding AI, the PegaWorld presentation by Dr. Rob Walker, who's been with us now for - working on this now for 15 years. And I think he is one of the real thought leaders in the space, he did a brilliant presentation on the Tuesday morning on the importance of transparency in AI and how organizations can accidentally, very easily violate laws by asking sensibly innocent questions or gathering together innocent-sounding information. You can do things that either violates redlining laws from a racism, a whole collection of things. And it's real thought leadership elements. And because of our architecture, we've been able to implement this, tie this to process so it's not just making the decision, to making the decision at the right place and the right channel, and bring this to market. I would strongly recommend anybody interested in AI to spend the half hour and listen to that presentation. It's really insightful.

Got it. Thanks. And then also you talked - I think it was a 40% increase in the number of year-to-date deals closed versus last year. Can you line that up kind of against your concerns on the sales execution, where that metric could have fallen if you feel you're firing on all cylinders?

Yeah, I think - I'm not sure I would believe it would have been meaningfully higher. I think, we would've gotten a couple of more deals that we thought were important. It is interesting seeing the business that the velocity of the business system, frankly, be put under that level of pressure. It's also given us some insight, not just in the sales organization, but in Ken's organization and other parts of the business, about ways that we need to take a bunch of things that we used to be able to sort of get away with as one-offs and really start to make the things that will be important for the business continuing to run faster in the future. But I view that is very exciting and very important. If we had closed everything, I wish and had hoped we would close, it would have been up several additional points, and some of those would have been larger, too.

Got it. All right. Thank you.

And next we'll take a follow-up from Steve Koenig with Wedbush.

Hi, gentlemen. Thanks for taking my follow-up. The deals being up 40% and ASPs down, is that coming from the Global 2000 group? Or is that more the enterprise sales organization? And I also just wanted to ask as well, I'll throw this out there and then I'm done, but on Pega robotics, so we're definitely hearing a lot of interest out there in the field, a lot of proofs of concept going on. It sounds like from Q3 that customers are still kicking the tires, or that these deals are smaller based on your Q3 results not being better. So maybe some color there as well.

So I think on robotics, there's a fair amount of tire kicking that's going on, and frankly, there's a fundamental problem in the whole robotics sector. It's interesting, because McKinsey about two months ago, put out a blog titled Burned by the bots about how some of those robotic stuff isn't yielding the returns that, frankly, they were telling everybody to go after two years ago, because I was actually on this observation. The real problem that folks have is that robotics, as the standalone robots running around, isn't the right way to automated business. And we are perfectly positioned to be able to put robotics in the context of end-to-end processes. I mean, that's what we do, and we're the only ones in the space that have a top-rated process automation engine and as well as a top-rated robotics capability. So a lot of the robotics things that will lead to, I think, much bigger deals in the future involve some reeducation. So somebody who thinks that what they want to do is kind of drop random robots on people's desks to do a little task automation needs to understand that that a fine way to begin, but it better be in the context of end-to-end process, we don't have any control, don't see what's going on. So I actually think the robotics still have been smaller than they will be, and I think the robotics deals and the process automation deals are wonderful ways to interplay parts of our business together in ways that will help. And frankly, there's also an interplay there with CRM, because so much of these can be used well in the customer area. Getting back to the other part of your question, yeah, we're seeing a lot of excitement in corporate markets, and whereas that have gotten off to a start but a slow start. We're really seeing an energy building there and that both makes me feel good about building a more efficient business system, which we need to do to support that, but also that we can have a more efficient selling system relative to some of the questions about margin earlier.

Okay. Thanks a lot.

And that does conclude our question-and-answer session today. And I'd like to turn the call back over to Alan Trefler for closing remarks.

Hi, there. So we're working hard. We're very committed and very excited about the prospects for this business. So sometimes there are opportunities to get the organization galvanized, I want you guys to know, because that's exactly what we're doing. And there's a lot of enthusiasm for being a company that can move forward at a faster rate. With that, let me thank all of you, and I look forward to talking to you soon.

That does conclude our conference for today. Thank you for your participation.