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Pegasystems Inc (NASDAQ:PEGA)

Q4 2013 Earnings Conference Call

February 26, 2014 6:00 PM ET

Executives

Rafe Brown – CFO

Alan Trefler – Founder and CEO

Analysts

Steve Koenig – Wedbush Securities

Raghavan Sarathy – Dougherty & Company

Mark Schappel – Benchmark

Jim Gentrup – Discovery Investment Research

Quarter Earnings 2013 call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]

I would like to turn the call over to your host, Rafe Brown, Chief Financial Officer. Please go ahead.

Rafe Brown

Good evening, ladies and gentlemen. Certain statements contained in this presentation including but 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 anticipates, projects, expects, plans, intends believes, estimates, targets, forecasts, and could and other similar expressions identify forward-looking statements, which speak only as of the date the statement was made because such statements deal with future events that are subject to various risks and uncertainties.

Actual results for the fiscal year 2014 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 Q4 2013 and fiscal year 2013 earnings and in the company’s filings with the Securities and Exchange Commission, including its annual report on Form 10-K for the year ended December 31, 2013, 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 floor over to Alan Trefler, Founder and CEO of Pegasystems.

Alan Trefler

Thank you, Rafe, and welcome to everyone. This call is quite special for me. in 2013, Pega passed many important and exciting record milestones. Accustomed to the tremendous success that clients are having in their use of Pega software while even more significantly for the call, I want to talk to you about Pega’s go forward strategy and we believe can take advantage of a tremendous opportunity.

First, let mebriefly reflect on 2013, Pega has now surpassed $0.5 billion mark, this record revenue was achieved despite an environment of great economic challenge in every part of the world and business shake up in almost every industry we serve. In becoming a $0.5 billion business, we achieved record profits earning $1.50 a share on a non-GAAP basis, which was a 38% increase over 2012. We surpassed the 2500 head count milestone, and we achieved a record level of license backlog by adding $58 million of license backlog in Q4.

You may remember that on our Q3 call, we pointed out that while the revenue was strong to that point of the year, we had consumed $27 million of license backlog. Not only do we make up that deficit within Q4, we increased total backlog by $31 million on a year-over-year basis.

As Rafe will discuss, we saw a lot of ratable business in Q4, which we actually prefer as it contributes to the increasingly impressive committed license backlog numbers over time, and that should improve on quarterly revenue consistency, but please recall that offering both perpetual and ratable models to our clients does increase the lumpiness of profitability as well as revenue as the selling effort and expense stay in the period even though the revenue moves out. The effect can be significant. For illustration, if the full increase of $31 million committed backlog has instead come in as upfront perpetual licenses, it would have kicked our 2013 17.5% license revenue growth to over 36%.

So, obviously that revenue wouldn’t then be available to fuel growth in future years. Given this interplay between revenue and backlog, I think it’s helpful to consider both the revenue and the committed license backlog changes in tandem to understand the fundamental sales and margin results of the business.

Now, some of the improvements to sales management practices appear to be starting to help mitigate our lumpiness. For example, in 2012, the standard deviation of license revenue across our four quarters was approximately $19 million. This dropped to $11 million in 2013. We are going to continue to work to bring more balance to our quarterly results, though I expect significant lumpiness will continue until the increasing size of the business and an increasing base of recurring revenue more significantly mitigates the volatility.

Looking at the mix of business, the results of 2013 were nicely balanced across our verticals, geographies, and deal size. Our 2013 business growth was accomplished with much less dependence on whales than in past years, again an indication of increased balance.

Our geographic mix also strengthened this year with growth in all geographies. The particularly strong performance in Japan and APAC are from investments in sales and marketing we have made there in recent years. Japan is particularly satisfying as we saw what had been a meaningful three-year investment trend very positive, and we grew significant business at a time when we know other software firms have been reporting softness there.

While achieving record financial results, we also dramatically strengthened other elements of the business in 2013. We released our seventh major version of Pega’s industry-leading unified platform with terrific advancements in user interface, navigation, ease of use, state of management, and case automation.

And our Q4 acquisition of leading mobile application platform provider Antenna Software obviously strengthens our capabilities and expertise in the highly strategic mobile technology area. We are already seeing a terrific capability in technology and increased mobile related deals in the pipeline. As we did with our 2010 acquisition of Chordiant’s Analytics technology, we expect to tightly integrate the technology and the teams during the year with the technology benefits emerging strongly in the second half.

Consistent with our strategy of creating capacity and options for delivery, we have been working even more extensively with partners. Our delivery ecosystem is now exceeding 15,000 certified architects and growing. In 2013 alone, we had over 12,000 new and returning students take training through our Online Pega Academy. Completing over half million classes, I might add that Pega Academy is built on Pega’s unified platform and is running on Pega’s multi-tenant Pega 7 software in the cloud.

Our position within key system integration partners also strengthened significantly in 2013 with Pega being recognized as having strategic importance to several key partners. We have increased meaningfully the senior relationships with some of the world’s leading management consulting firms to see the unique power of Pega software is able to help their clients achieve their vision of enterprise digitization. For example in 2013, we had Accenture’s CTO speak at PegaWORLD about Accenture’s vision that “every business must become a digital business.” And they highlighted how Pega technology aligns with additional strategy and the needs of their clients. And to preview a bit of our upcoming PegaWORLD, we will be featuring a [Mackenzie] (ph) partner on the emerging needs of digital enterprises and how they have seen their clients use Pega to transform them and simplify.

These messages dovetail with topics I’ve been mentioning over recent earnings calls. We’ve talked about the evolution from clients buying specific technology solutions that they have to piece together to engagement around a broader business agenda. In Q4, we saw an acceleration in both interest and sales of attention to the broader agenda. An organization showed interest in the digital concept across our verticals and our geographies. For example, a large healthcare plan, a Blues Plan made their first purchase of Pega software in Q4 to be their sales and underwriting platform for the future.

Now, perhaps a few years ago, they would have bought a sales force automation application and a rating and underwriting application and stitched them together with the stack vendor in middleware piece or maybe they would have customized some cloud offering, they did some portion of this end-to-end function, but now they are saying that in the current world of healthcare, they need to become a digital business and leverage software that handles all of the aspects of member acquisition and servicing in an agile digital way. They need a platform that gives them differentiation and a runway for growth. They chose Pega because it was a better way to use software to become a digital healthcare insurance company.

A large global bank bought Pega’s software in Q4 because their customers and their internal business operations were demanding a digital way to engage. They knew the experience is personalized to the expectations of large and high network clients. Now, they’ve already played with and even purchased a raft of alternative technologies and decided that Pega was the only viable alternative, [Anthony Aboud], their COO and Global Head of Business Transformation has signed on to keynote at this year’s PegaWORLD Conference. And in Q4, leading technology manufacturer increased the use of Pega software in the transformation to become an agile digital enterprise. They realized that the traditional way of coding software programs for each customer engagement channel and the traditional model of buying applications for each unit in their supply chain was outdated and ineffective. They chose Pega and are continuing to extend the Pega footprint throughout the organization using it to digitize and compliment their systems of record and their point cloud solutions.

All these examples and many more I could sight, reinforce the potential that Pega offers to our clients and shows that there is much bigger than simply an extension of the past. Over the last six months we stepped back and thought about what we’re seeing and where we should go from the previous examples we’re hearing from across our clients that they are frustrated by the inefficiency when coming to purchase and see the benefits of clients seeing advances in computer power and connectivity differently. Market reality is dictated that they become digital enterprises to win and retain empowered and connected customers, to simplify and streamline operations and to embrace the accelerating pace of change.

Now our clients acknowledge huge returns and great success is from the historical years of Pega’s industry leading software in individual software markets. It gets described as Business Process Management or BPM or Business Rules Management Systems called BRMSs or CM for Case Management, KM for Knowledge Management, CRM for Omni-Channel Contact Centers, DM for Decision Management or PaaS for Platform as a Service applications or MAM for Mobile Application Management and more. But this alphabet soup of technology oriented silos of capability misses the heart of what customers need to become successful digital enterprises. Increasingly, our client see us as much more than these piece parts, they see Pega software is the platform on which they can accomplish their transformational journey to become a digital business, to become a better business.

They realized that today software is central to business execution. This is not the world of no software but as Marc Andreessen said software is eating the world because most software uses mired in 60-year old practices going from manual specks to manual coding, that is why the unique unified Pega Build for Change platform delivers the principle of model based execution to transform businesses. This enables our clients to implement a vision of change which is shared by all stakeholders. Business people and IT staff collaborate using a visual language that models the requirements and design in a way that everyone can see and understand and wants to find this way. The finished application and its documentation are generated and immediately ready for use. The Pega approach bypasses the [indiscernible] and time-consuming process of manually translating requirements into code. The software is automatically created directly from the model closing the costly gap between vision and execution.

We see that it is this convergence, the digital business imperative of the businesses must run better and the emergence of all Build for Change platform that can deliver the power of new approach to software that together delivers the vision of what we call better business software. This brings clients three huge advantages. First, the power to engage, to engage customers, prospects, partners and staff so that every interaction is valuable for everyone involved. The power to simplify to make operations and technology easy to access easy to use and to have an end-to-end philosophy on how you’re going to run your business and the power to change making agility a strategic advantage to help firms take and defend positions of stride in the market place. This is a new way to think about software and now there is a way to describe which would make sense to business people, better business software.

We see the emergence of a new business focused and model based approach to software that can provide a platform for digital enterprises and we see that happening rapidly, it’s an enormous opportunity for Pega bigger than all the individual markets we have historically served combined. We have unique and differentiated technology to meet this need which is why so many consultants and integrators are rapidly building our Pega practices. The two alternatives to using Pega’s unified model different architecture for becoming a digital enterprise are trying to do in hand curved custom software trying to buy function specific apps and stitching them together. We see these falling apart short and see ourselves in unique and exciting position.

We know that we’re off to something that could be big transformational for our customers and a huge opportunity for us. Taking full advantage of this vision will require great execution. In October, we brought on Rafe Brown as our CFO, Rafe you’ve been a terrific addition to the management team. And yesterday we announced that a new Chief Marketing Officer Robert Tas will be joining us to drive our new vision. Robert has an outstanding background for the role having started in enterprise software sales and sales management, it’s still a variety of high-tech marketing firms and then most recently as the world wide head of digital marketing for JPMorgan Chase. What’s great about both Rafe and Robert is they bring key skills highly well of an experience and a passion for helping out clients transform their businesses.

We plan to be the leader in this large format of market towards that end you will see a continued investments in R&D and investments in sales and marketing. While we’ll be thoughtful about spending as we demonstrated in 2013 we will also be smart about being aggressive in winning. There is huge potential we plan to turn that into very exciting growth for Pega.

And it concludes, let me invite each of you to PegaWORLD 2014 held June 8 to 10 at the Gaylord National in Washington DC. You can go see for yourself how the world’s leading organizations are achieving digital transformation to Pega’s better business software. And with that Rafe back to you.

Rafe Brown

Thank you, Alan. Let me take you through our fourth quarter and year end results starting with revenue. We reporting both GAAP and non-GAAP income which captures among other things the impact to the Antenna acquisition accounting, a full reconciliation of all GAAP to non-GAAP measure is provided in the financial tables of the press release issued earlier today and is available online on our website.

As we have discussed in the past, quarter-to-quarter comparison do not generally reflects that underlying momentum of our business due to the timing of when our large transactions close. What is most important from our view is how our business performs and more over trendy on a full year basis, and our future outlook which I will discuss in detail in a momentum.

For the full year, 2013 non-GAAP revenue was $511 million up a 11% year-over-year. This includes the contribution of approximately $6 million from Antenna, which we acquired on October 9 of this last year. Most importantly full year non-GAAP license revenue, was $192 million up 17% over the prior year even as we meaningfully increase backlog.

Over the course of 2013, we generated a higher mix of license and maintenance revenue relative to services revenue. As a percentage of 2013 full year non-GAAP revenue license and maintenance revenue stood at 69% up from 64% in 2012. In dollar terms non-GAAP services revenue were $161 million in 2013 down slightly from the prior year. As we have previously discussed this change in mix of revenue is consistent with the company’s stated strategy to focus on growing the number of implementations performed by our partners and clients.

Looking forward, our strategy of building a vibrant partner ecosystem will lead us to grow services at a slower rate than license revenue which allows us to focus our resources on market gain and scaling the most profitable aspects of our business.

Looking at our results on a geographic basis, non-GAAP revenue in North America grew 7% to $300 million for the full year 2013 and stands at 59% of total revenue. Revenue from EMEA was up 5% to $166 million with particular improvement in our continental European business where we have been focused on investing in distribution capacity and technical expertise. Key wins in the communication and insurance sectors help to grow the business despite an overall economic climate that remains challenging.

Our fastest growing region was Asia Pacific, which grew 72% during the year to $45 million of non-GAAP revenue. Continued sales and marketing investment within the region produced strong traction within the insurance and banking sectors and we know that particular traction in both Australia and Japan.

We noted last quarter that we are working on a number of large transactions whales as we have referred to mainly in the past. During the quarter, we closed two such transactions generally defined as those that are greater than $10 million. In addition to these large transactions, we were pleased with the growth in the overall number of license transactions. While large transactions are important to our business, we are also focused on building a flow of smaller and more easily repeatable business.

In terms of the dollar mix of license deals during 2013, the portion of ratable recognized deals jumped in the fourth quarter compared to the fourth quarter of 2012 as we have discussed the mix between perpetual and term or ratable licenses is to a great extent dictated by the needs of our customers, so the company does somewhat prefer term license deals.

Turning to the rest of the income statement, for the full-year, we posted a non-GAAP gross margin of 71.3% for 2013 up from 68.6% in 2012. This improvement in gross margin was attributable to the improved mix of license and maintenance revenue relative to services revenue in 2013. Annual non-GAAP operating expenses were $276 million up 9% from 2012 with most of the growth in operating expenses coming from the sales and marketing line. Our full year 2013 non-GAAP operating margin was 17.3% up from the 13.6% posted for the full year of 2012, a function of our being particularly vigilant with respect to expense management in the early part of the year given macro-economic uncertainties and are remaining somewhat behind on the hiring goals as of the end of the year.

We have previously stated our intent to continue to balance investment in growth initiatives with the delivery of attractive profits. Consistent with this strategy, we believe continued investment in our sales organization and product development efforts are warranted giving the significant market opportunity before us. This includes further investment related to our Antenna acquisition, as you know this was a business in transition in order to fully capitalize on the opportunity for Pegasytems to become the clear leader in mobile, we will be investing in development and operations related to Antenna during the coming year.

We will continue to invest in our products by expanding our development team, with overall R&D increasing slightly as a percentage of revenue in the coming year. We will also be moving and expanding our real estate facilities in India where we have had success attracting high quality talents that has been key to our ability to rapidly innovate.

Finally, in 2014 we planned to expand our sales and marketing effort. It is essential for our strategy that we have adequate coverage in our target account to ensure the transformational power of Pega’s better business software is fully understood. Overall, we expect sales and marketing to increase slightly as a percentage of revenue in the coming year.

Turning to earnings, we posted non-GAAP earnings totaling $1.50 per diluted share in 2013 up 38% from the $1.09 posted a year ago. For the fourth quarter, our non-GAAP earnings were $0.61 per diluted share compared to $0.65 posted in Q4 last year. Operations from the newly acquired Antenna business were roughly break-even on a non-GAAP business during the quarter.

Now to license backlog. We compute license backlog by adding billed deferred license revenue as detailed on page 59 of our Form 10-K filed earlier today and off balance sheet license commitments as detailed on page 31, which are signed license arrangements that are unbilled and not recorded on our balance sheet.

We finished the year, with $326 million of total licensed backlog up 11% over the prior year. To add some color to the growth in our backlog, it is important to understand that renewals are an important and growing piece of our business. However, year-to-year [indiscernible] business available to renew fluctuate, our renewals also tend to be multi-year commitment. For the most part impact on licensed backlog can be significant and create very challenging compares to future years with less business to renew or licenses were substantial short of renewal periods.

The fact that we had significant renewals in 2012 created a challenging compare for our total backlog metric for 2013 to provide an order of magnitude, our renewals in 2012 were more than twice available to renew in 2013. With this in mind, we are pleased that we were still able to grow our total backlog by double-digit for the full year 2013. As such it is also helpful to look at the current portion of backlog, which is to say backlog which we expect to recognize as revenue in the coming year. And year end, the current portion of backlog stood at $121 million an increase of 24% over the prior year by effectively excluding the impact of multi-year ratable license arrangements including renewals, it is a helpful data point in accessing the underlying momentum of our business.

For the year, the company produced $81 million of operating cash flow an increase of 85% over the prior year. Free cash flow, which we defined as operating cash flow less CapEx was $75 million. We finished the year with total cash to marketable securities of $157 million down from Q3 primarily as a result of the $26 million net cash outflow related to the Antenna acquisition early in the quarter. However, we do expect we will quickly be replenishing our total cash position, as we have a number of large receivables due in the first quarter.

In 2013, the company repurchased 390,000 shares for $12.5 million and at the end of the year we had a balance of $40 million available or repurchases in the coming year. We finished the quarter with total head count of approximately 2600 employees up 22% from the same point last year, of course this figure jumped significantly in the quarter with eth acquisition of Antenna adding approximately 250 employees to our head count figures.

Turning to guidance, as disclosed in the press release issued earlier today, we are initiating revenue and EPS guidance for the fiscal year 2014. And we expect non-GAAP revenue for the full year 2014 to be approximately $580,000. Without getting into the specifics of our revenue details, we do expect licensed revenue to continue growing faster than total revenue during 2014. We also expect services revenue will grow in 2014 but at a slower rate than license and maintenance revenue.

From a GAAP perspective, we expect revenue to be approximately $576 million in 2014. Keep in mind that while we are continuing our efforts to smooth bookings throughout the year this will be a process that takes time. As such, we expect bookings and revenue to be largely back-end loaded in 2014.

Moving to profitability. In 2014, we expect to run approximately $1.56 per diluted share on a non-GAAP basis. This estimate reflects slight headwind from two areas, the federal R&D credit has again expired and thus our estimates exclude any potential benefit, recall that in 2013 the company was able to benefit not only from the 2013 R&D credit but the 2012 credits due to its late reinstatement. On a year-over-year basis, this equates to approximately $0.04 of headwind. If the federal government does reinstate R&D tax credit, we would expect our EPS to benefit as a direct result and we’ll take that into consideration at the appropriate time.

Additionally, we are working to rapidly integrate the antenna operations. We anticipate antenna will be approximately $.06 dilutive on a non-GAAP basis in 2014 with the goal to be accretive in 2015. It is important to understand that we will have built our 2014 – excuse me it’s also important to understand that we have built our 2014 plans with the intention of increasing the proportion of ratable or term license arrangements when compared to that ratio for the whole 2013. An increase in ratable bookings provides a greater future stability in terms of revenue but the shift has a demising effort on revenue and EPS in the current period. GAAP earnings per diluted share for the full year 2014 are expected to be approximately $1.

In summary, we continue to scale our business and advance our market leadership position during 2013 and we are beginning 2014 with solid momentum. We planned to continue investing in growth initiatives particularly in the areas of product innovation, sales and marketing and believe that we are in early stages of a very large and expanding market opportunity.

Before I conclude, I would like to remind our analysts and our investors to save the dates for PegaWORLD June 8th through the 10th in Washington D.C. This is a great opportunity for you to hear from our clients themselves are Pega’s better business software is enabling the digital enterprise. If you’d like to find out more, please contact us through our Investor Relations website.

With that operator, we will open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions). We have a question from Steve Koenig with Wedbush Securities. Your line is open.

Steve Koenig – Wedbush Securities

I wanted to ask you, Rafe, to answer a question and one quick follow-up for Alan. In terms of the term contracts, can you remind us of what’s the average length of the term contract and how much of that contract is usually billed upfront?

Rafe Brown

That’s a great question, Steve. Our term contracts do cover a number of different ranges in life. I would say roughly speaking, the average term is approximately three years. Now, we have traditionally billed not that much upfront, they would often be billed either annually or quarterly, and so that you would find that cash flow coming in over the life of the term contract.

Steve Koenig – Wedbush Securities

And Rafe, when you say traditionally, it is – does that imply is there any shift or is there upfront (inaudible) to shift how you’re billing that term contract at all, lengthen it perhaps or anything different?

Rafe Brown

Well, in terms of the contract life, there is nothing like a long contract to really help alleviate the renewals anxiety one has, so we’re always anxious to do a longer contract life, so it makes sense economically. And in terms of billing terms, we are looking at – watching cash flow closely and so we’ll take advantage of opportunities to bill upfront when that makes sense for both parties.

Steve Koenig – Wedbush Securities

Okay, great. Thanks. And then just one last follow-up for Alan if I may. Alan, I liked your description of the alphabet soup of acronyms, you described some of the silos technology and you’re focused on model driven development. What do you think is necessary in terms of getting that message across to the business buyer? And how is Pega progressing on getting that message out and what are you seeing in terms of your kind of sales cycles as well? Are you still seeing as much in missionary selling that you had in the past, how do you expect that to go?

Alan Trefler

So, relative to the last question, I am expecting at some part, as I said, it’s hard to predict what the point is, but there is a chasm here to be crossed where the market will increasingly turn from the push market to missionary selling to more of a pull market. We see that in some of our customers, and we actually had a recent set of articles about the State of Maine which is now one of our largest customers. There was a customer that actually initiated sort of a whoosh of five different projects last year and self-published this incredible story about how they’ve been getting all this benefit, some folks maybe picked up from the press, from the technology as they try to be customer centric.

Sometimes, organizations that are a little more, what I would describe is forward thinking can adopt this more quickly. With organizations that have large traditional IT shops, we often find that there is going to be missionary work, and I think it’s going to be a lot of education there. Now, in terms of getting the word out, the strategy that we have had is one that we’re following. We started a couple of years ago deciding we wanted to engage a lot more partners and develop channels for delivery that’s both to get the word out and also to make sure that we don’t become an impediment to our own success. We’ve done a lot of work around education. I’m very optimistic that having Robert Tas on is going to really help us dial up our marketing which is something that I figure is going to be key.

And the successful partnerships with Accenture, the Mackenzie, the Cap Gemini, and some of the folks who are seen by their clients as more sort of leaders than just delivery shops, I think is also a terrific vehicle to be able to get the word out. The best thing we can do and we’re going to see us doing a lot more of this is to get great customer stories into mainstream so that people can see what other fronts are doing. And you’re going to see us continuing to leverage with tremendous customer case studies. I think we can do a lot better at being able to get those flowing through the earned media and the rest of the sort of marketing ecosystem. I’m thinking that that’s going to be one of our big missions for this year.

Steve Koenig – Wedbush Securities

Thanks a lot, gentlemen.

Operator

Our next question comes from Raghavan Sarathy with Dougherty & Company. Your line is open.

Raghavan Sarathy – Dougherty & Company

Yes, hi. Good afternoon and thanks for taking my questions. Couple of questions, first one is for Alan. Alan, you mentioned that last quarter, you had number of whales in the pipeline. And then Rafe said that you closed two whales in the quarter. I am wondering whether you closed as many whales as you had anticipated, was there any sort of push out in the quarter? And how does the pipeline look?

Alan Trefler

So, we got about the level of whales than I was – than I was sort of expecting. And we got a couple that are still swimming out there, and we’ve got a few that – as often is the case, sometimes it will turn into a non-whale, so they buy in chunks which I actually think is just fine, as we think about growing our business that in some ways is a lot healthier than being dependent on. I was actually very pleased with the course of the year that we did so well and we’re so balanced throughout the year without the traditional whale – whales alliance. Moving to the pipeline, what I’ll tell us is that we’re going through the ordinary deal reviews. There’s calls that is (inaudible) periodically where the sales force goes through the North America and the European sort of active pipeline. And they have – despite the fact I think they run very efficiently, they’re becoming numbingly long and all the stuff is real.

So, we’re seeing that some of the increases to the sales force that we’ve made is starting to create good results. We’re obviously going to have to change some of our internal practices as we grow the business bigger because we cannot have the calls to be able to continue to grow in early based on the number of deals. I would say, I think the pipeline both quantitatively and – is often very important, qualitatively is quite healthy for the year.

Raghavan Sarathy – Dougherty & Company

And then, second question to Rafe. So, you mentioned that antenna software contributed $6 million in revenue. So, can you give us some sense for the revenue mix, I presume it’s more weighted towards services. And then what is your expectation for antenna software contribution this year?

Rafe Brown

Well, I appreciate that. As we filed an 8-K in December where we have provided the antenna’s financial statements for the pre-acquisition period and if you look at that, they’re heavily skewed towards services. We do expect them to end up with a healthy lane between license and services in the coming year. And obviously the business is in transformational period of time where we’re making some changes to it and also investing in that technology. So, I think in the coming year, they will still have certainly more services in the rest of Pega but that will change over time.

Raghavan Sarathy – Dougherty & Company

Just, so that I understand. So, looking at that filing, you had through September of 2013 $20 million in service, does it also include maintenance or it’s purely service?

Rafe Brown

Yeah. So, their services included both professional service as well as their hosting services. So, some of that lumped together there if you will. I think one way to think about it is their business will be roughly split between license and maintenance at 50% and services, hosting services as well professional services for 50%.

Raghavan Sarathy – Dougherty & Company

Okay. Thank you.

Operator

(Operator Instructions). Our next question comes from Mark Schappel with Benchmark. Your line is open.

Mark Schappel – Benchmark

Hi, good evening. Thanks for taking my call – my questions excuse me. Rafe, you may have mentioned this in your prepared remarks, but maintenance revenue was particularly strong in the quarter. I was wondering if there is any particular reason why that was?

Rafe Brown

That was – we did have a very good maintenance quarter in it’s reflective of the business as a whole growing. I think we did receive one prepayment that allowed us to do that we took as revenue when it’s paid for the quick up to slightly. But, on the whole it is just the run rate of the business that is showing up there, so we feel good about that.

Alan Trefler

I think one of the thing that’s different this year from previous years is we just delivered better results outside of the fourth quarter and a bunch of that ends up reflecting itself in stronger Q4 maintenance.

Mark Schappel – Benchmark

Okay, great. And then, Alan I think couple of quarters ago, you thought that the company needed to ramp up its marketing and its message around at the bigger grant, a grant that you just had somewhere in that area. I was wondering if you just give us a few hints or few ideas what we can expect here in the messaging front in the years to come?

Alan Trefler

Well, I think you’ve heard pieces of it this evening. And if you take a look at where we’ve been going, it actually started little bit over a year ago, we went out and hired a Board Member Larry Weber, who was a very well regarding marketing professional, he was the CEO of SanDisk which was the largest PR firm in the world. And Larry has been really instrumental and helping us to rethink what we need to do from both the messaging point of view and composition of the marketing team perspective. From that we obviously been engaged in a search for CMO, we haven’t really want to ramp up too fast until we have the right person on board and done some of the other light work but I feel we’re really now at a point where between now and PegaWORLD, you’re going to see us become very aggressive about positioning this IT of the Build for Change platform positioning the ITA of the digital enterprise as being the things that we empower which everybody we tested on has really liked it, existing customers et cetera.

So, I think you should see us once again entering June go from the soft launch which we’ve just gone of these concepts as I spoke about the ultimate soup talked about elementary conservation to what we’re doing with combination of partners some things in the media but also a lot of the messaging that you’ll see coming out of the company. And I think you’re going to find the real heavy duty launch is going to be the second week of June at PegaWORLD.

Mark Schappel – Benchmark

Okay, great. Thank you, very much.

Operator

Our next question comes from Raghavan Sarathy with Dougherty & Company. Your line is open.

Raghavan Sarathy – Dougherty & Company

Yes, thanks for taking my question again. So, one thing I notice is the deferred revenue software jumped up 55% year-over-year also sequentially nearly doubled. So, the question is the deferred revenue software that you disclosed is that term or perpetual I think historically I assumed it was perpetual. And then what led to the strong sequential increase in deferred revenue software as compared to historical what we are seeing third quarter to fourth quarter?

Alan Trefler

Indeed of that, that revenue is principally term revenue that has – that is already that is they’ve been build and but has not yet come to the income statement as revenue so our deal could go out for a term arrangement and it creates deferred revenue but that revenue would be recognized over the coming months or whatever period of time of the contract. Also, keep in mind there are perpetual deals where with the complexities of accounting you don’t take all of that revenue upfront and we generally call those ratable deals. So, they’re perpetual in nature but that revenue gets spread out. So, with that almost two detailed accounting answer, we saw some big transactions where we were able to get invoices out early in the contract life which obviously is a good thing from cash flow perspective, it helps jump that number out.

The way as I mentioned in my prepared remarks, I think one of the good ways to look at the business is to look at both deferred revenue which is as to say on balance sheet deferred revenue and then those committed license arrangements that we disclosed in our 10-K where you can really see the details and get a good view of our total backlog change, we even break that out by years to have a good indication of when that income is going to turn into revenue.

Raghavan Sarathy – Dougherty & Company

Okay, great. Thank you.

Operator

(Operator Instructions). Our next question comes from Jim Gentrup – we have a question from Jim Gentrup with Discovery Investment Research. Your line is open.

Jim Gentrup – Discovery Investment Research

Good afternoon. Rafe, we talked little bit about the – can you talk little bit about the cash flow and free cash flow projections or expectations for 2014?

Rafe Brown

Yes. So, we don’t give cash flow guidance and we’ve – we haven’t in the past and we’re not given it out this year. We were certainly pleased with our cash flow for 2013 and so that was a good year for us.

Jim Gentrup – Discovery Investment Research

Perhaps, you could just give us some – just general color then on how about it might improve in 2014, what needs to happen?

Rafe Brown

Well obviously, our hope is that the business continues to grow, the very nice thing with our business is we – it does produce a nice cash flow as the company grows. And so I think we just keep executing on the fundamentals selling and watching our expenses as we have in the past we would expect cash flow to follow into.

Alan Trefler

I think if you take a look at that page I think 59 is the magic page is here. We show that expectations for cash flow and it’s pretty clearly up year-over-year respective year.

Jim Gentrup – Discovery Investment Research

Alan, page 59 on what document? I’m sorry.

Alan Trefler

Well that’s probably…

Rafe Brown

On the 10-K.

Jim Gentrup – Discovery Investment Research

10-K, okay.

Alan Trefler

If you haven’t seen it, we put it in the rates in the team we put our rate details year by year liquidity expectation of commitments.

Jim Gentrup – Discovery Investment Research

Okay. And – thank you for that. And Rafe, did you have a CapEx number expectation for this year?

Rafe Brown

Yes, we don’t break for 2014 we do not break that out.

Jim Gentrup – Discovery Investment Research

Okay. And then Alan, I’m just wondering if you could comment on the different verticals and weakness or strength in some of the verticals during the quarter and year for that matter?

Alan Trefler

Government was terrific for the year as a whole and as I kept talked in earlier conversations for several years I had been sort of saddened by the different that we’ll be breaking into government we seem to have cracked the code and are now finding it both the state and federal level and even international we’re having really quite good success there. I think that another one that I was very pretty happy about with healthcare. We gone through some periods of slowness with healthcare I think around the antiquity around the [indiscernible], we’ve now had a number of healthcare providers understand that they’ve got to change what they’re doing. And that puts us some pretty meaningful upticks in relationships and that’s an area where you’re going to see us both investing a lot that can getting a lot of good returns in the healthcare space.

So, I think across the board the verticals are generally pretty strong and we got good potential going into this year. Finally I talked about the emerging vertical for us is manufacturing where we really had not established that as a vertical previously second half of 2013 we actually hired a strong leader for that vertical, we broke it out and started creating some emerging materials and I’m really pleased and we’re seeing ongoing use of our technology and manufacturing. We’re seeing customers trying to use us are not just some of the traditional service settings but in even some of the in and out of things machine to machine quite stuff we’ve actually had some interesting developments there. So, I think that’s going to end up being a very good vertical for us somewhere it’s [indiscernible] institute than some of the other businesses that you’d expect to be further along.

Jim Gentrup – Discovery Investment Research

And then the other question – I appreciate that by the way. The ratable deals I think you mentioned Rafe I believe that your 2014 expecting those types of deals to pick up. And I just wonder what gave you that confidence to make that statement and what some of the things if you can talk about that’s you’re doing to move people more to ratable?

Rafe Brown

Sure. And it’s our intention to have them pick up, there is always two parties every contract and if it makes sense for our customers, we’re going to make sure we do what’s right for that arrangement. So, we do have some ability to influence it, we have that preference out there with the way we compensate our sales team is slightly more favorable on a ratable arrangement. So, there is ways we can influence a process that we think should help us gradually shift that mix more towards ratable.

Jim Gentrup – Discovery Investment Research

And finally if I may ask one more, when you even talked about these different verticals Alan if I go back to that for a minute. Are you seeing kind of the first strings being loosened up here little bit more or with kind of all these areas may be willing to spend more or is it still you’re taking market share from the incumbents?

Alan Trefler

Well, we’ve always been in a position where in additions to market share from the incumbents. We can get things live fast enough but sometimes okay from the selves within the same fiscal year. And since 2008 that’s been a big, big part of our ability to grow that we can actually save them enough money, they can start in chunks and then build up to some of these more enterprise digital sorts of platform. And that can be a pretty important model. I think that frankly the recovery is choppy, we see some evidence of improvements in some areas but it’s not something we have a lot of confidence in. Having said that, we haven’t seen growing our sales force faster than our license revenue really if you look at the – if you look at it. And I think it’s time for us to start doing that because there is a lot of accounts still even in the Fortune 300 that we don’t think we’re covering fully.

And as I talked about in the past it’s our intention over the next two years to start to open the opportunity and begin to create a much greater level of coverage. We got the partner ecosystems who can help us deliver, we’ve got the real time online training that can help us educate the customers themselves. You’re going to see us I believe with Robert put out a real push around digital marketing and all of these things ultimately should make it possible for us to leverage ourselves so we’re not as constrained as we were say two, three years ago and so that’s when we talk about doing some investments, I think it’s going to be something we can be very successful at opening that opportunity.

Jim Gentrup – Discovery Investment Research

Okay. Thanks guys. I’ll get back in queue.

Rafe Brown

Thank you.

Operator

And this ends the Q&A portion of the day. I’ll turn it back to management for closing remarks.

Alan Trefler

Well, I’ll just end by saying that we were pleased with the way 2013 ended. We feel incredibly excited about this new positioning about the ability to go after the other opportunities as digital enterprise. We’ve got a team that’s working really hard and is very engaged. And I would like to thank you all for investing and listening. Have a good night.

Rafe Brown

Thank you.

Operator

Ladies and gentlemen, thanks for participating in today program. This concludes the program. You may call disconnect.

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