Pegasystems' (PEGA) CEO Alan Trefler on Q4 2016 Results - Earnings Call Transcript

| About: Pegasystems Inc. (PEGA)

Pegasystems, Inc. (NASDAQ:PEGA)

Q4 2016 Earnings Conference Call

February 23, 2017, 17:00 ET


Ken Stillwell - SVP, CFO, and Chief Administrative Officer

Alan Trefler - Founder, CEO & Chairman


Steve Koenig - Wedbush Securities

Greg McDowell - JMP Securities

Mark Schappel - Benchmark Capital

Matthew Galinko - Sidoti & Company


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.

Ken Stillwell

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.

Alan Trefler

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 position.

Ken will talk more about our financial performance shortly, and while these dynamics matter in evaluating the true performance of our Business. I want to move on to a brief strategy overview. As we review 2016 and look forward to 2017, I would like to paint a bit of the context of our Business. Now, since I founded the Company, Pega has focused on inspiring organizations to think differently about how they build, deploy and evolve enterprise applications.

We're excited about the returns the clients obtained through the use of our software, both in terms of their revenue growth and their increased productivity or cost reduction. It's common to hear clients say that in addition to increasing their differentiation of the market, they look to get staggering business returns through their use of Pega software. Now another constant for the time period has been change, which we think plays wonderfully to our technology and our position. Our vision for how software should be built, deployed and evolved has allowed Pega and our clients to capitalize on change, really reinforcing our tagline of build for change.

Today, our clients' businesses are being driven by a number of trends that will continue to require organizations to adapt more quickly. Shifting regulatory environments, global volatility, rapid change in their customers' demands and major advancements in technology. I think of things like digitalization, mobility, cloud, artificial intelligence and robotics. These trends are compelling enterprises to think differently about the need to deliver an always-on personalized, customer-engagement experience. And to achieve increasing levels of operational excellence and cost savings. We've adjusted our go-to-market strategy and evolved our offerings based on what our clients and customers need, and what is happening in their respective industries. As a reminder, we're in a transition to take advantage of this environment, by delivering industry-leading applications, together with the world's best case-management software for customer engagement and operational excellence.

What helped us win in the back-office is now helping us win in the front office as well. Our leadership in case management, real-time decisioning, what today is the heart of what's referred to as artificial intelligence. And business process management has propelled us to a leadership position in CRM, customer relationship management. No other vendor can provide these capabilities on a unified platform, allowing our software to work end-to-end, yet within, clients' existing legacy software. Another unique Pega capability that is resonating with clients is that we give them cloud choice. Due to the design of our architectures, customers who purchase Pega are not subjected to a single vendor's complete cloud lock-in. To the contrary. They can run Pega in their own private cloud, run it on Pega's cloud, or run it on another third-party cloud. And move it back and forth across those different clouds based on their own business needs.

The cloud becomes a model that organizations are increasingly choosing. And more and more of them are seeing the benefits and the importance, strategically, of having cloud choice. We believe this combination of best-in-class software with client-focused choice has been key to our success to date, and will continue to help us win in the market. And remember, we do very significant things for our clients. The work we do for Ford is a great example. We recently had the director of warranty present at a Pega event. Ford wants to be a leader in connectivity, mobility, autonomous vehicles, customer experience, big data and analytics. Their goal is to transform the customer experience by combining great products with great experiences. The customers want end value.

Working with Pega, they created an integrated one-warranty system that improves accuracy and agility across the warranty operations. The new system provides earlier insight into any design and production problems, significantly decreases the potential for fraudulent claim payments, reduces the time it takes for customer in deal of feedback to reach the company, provides dealers with an Amazon-like user experience to track the process and progress of any claim. And ultimately, the new system is improving the experience with dealers and customers while saving millions in annual operating costs.

So let's talk a little bit about how we're executing on our strategy. There are four aspects to this. And I'm going to go through them, two of which are really focused on product and two are focused on go-to-market. From a product perspective, we continue to enhance the Pega platform, our core unified model-driven application-development cloud platform. It's the foundation on which everything from Pega is built. It is our unique, competitive differentiator, and provides industry-leading and analysts recognize business process management, robotic automation, case management and artificial intelligence.

We continue to receive leadership recognition from industry analysts, like Gartner and Forrester, including most recently receiving the highest scores in all use cases in Gartner's 2016 critical capabilities for BPM platform-based case management. It provides the industry's first end-to-end automation platform that intelligently optimizes how work gets done. And we continue to see a lot of interest in our new robotics capabilities from our 2016 purchase of OpenSpan. It's very attractive to existing customers and also new cross-industry customers like Edison International, Sun Life and Nestle. Our robotic software is beautifully aligned with our BPM offering. Clients are seeing that it's far more sensible to think about robotics in the context of processes.

In 2017, we will focus on extending our unique model-driven capabilities with artificial intelligence, mobility, robotics, bringing enhanced platform capabilities to our entire product line. These will continue to drive improvements in the horizontal and vertical applications, as well as providing a strong base for customers who want to roll their own. The second product perspective is involved in actually working on those applications. We made a commitment to having beautiful, finished, out-of-the-box applications for customers to use and really drive rapid wins in marketing, sales, automation and customer service, as well as a couple industry-specific items we offer. These are all built entirely in the Pega 7 platform, but they win their own kudos. They're being recognize on their own by top-tier industry analysts and by clients. We received top leadership rankings in many, many places, including leading rack leans in our CRM applications for Forrester and Gartner. Most recently last quarter, Gartner named us a leader in CRM's suites for enterprise organizations.

Our unique, customer-decision hub also won a number of industry-product awards this year. It leverages AI and adaptive analytics to provide advanced real-time decisioning capabilities with adaptive responses across all of our applications. For example, it makes the most relevant marketing offer at places like PNC Financial Group. It predicts if a sale will close, which is what AI Japan is doing with Pega. And it automates and streamlines workflows, like Alliant Health does with our technology. No other CRM provider delivers a single unified platform that supports this type of complete end-to-end customer experience.

I want to talk about one other client for a moment, which is Transavia, which is a great example of a customer using our entire suite of applications in the Pega platform, all on Pega cloud. They're a member of the Air France KLM group which was, itself, a Salesforce customer, and specialized in offering affordable European flights. They bought our software a little more than a year ago. And earlier this month presented at our Customer Engagement Summit in Paris. Transavia has built a new platform, what they call the Transavia Interaction Platform, that they see as a strategic differentiator as they face-off in the stiff competition that is characterized with low-cost carrier space. This allows them to offer best-in-class proactive and personal digital services to customers, while allowing employees and partners to work collaboratively.

They are looking at the entire customer value chain. They chose Pega over Salesforce, in particular, because of our ability to provide a unified solution. And they are already reporting better customer experiences with more personalized digital service and reduced costs and improvements in operations. They will also be presenting at PegaWorld in June. So you can come and hear from them directly there. In 2017, we will continue to focus on improving value to our clients, increasing implementation speed and enhancing ease-of-use across our application products. Will focus on taking, and further leveraging our proven AI capabilities to the next level, really making our system smarter and driving further competitive advantage there.

For example, earlier this week, we announced our new Pega Self-Service Advisor. This is a new AI-powered capability that enables businesses to provide customers with intelligent data advisors, anywhere on their web and mobile channels. Which gives concierge level service while bypassing the scattered navigation experiences that frustrate customers negatively and impact the bottom line. Now those are our first two product-based strategic initiative areas. The next two are really go-to-market. The third is we're really going to focus on bolstering and boosting our marketing and our digital selling to bring clients and prospects closer and more aware of what Pega does. Under the leadership of our new CMO, Tom Libretto, we're going to continue to SOP in how we market ourselves to customers and prospects, and strengthening our digital presence to make it easier for clients to engage with us. We have actually accomplished quite a bit.

Major enhancements already include, we now have digital content available in 10 languages, we have guided product tours for our suite of CRM applications on our site, we have online pricing for our cloud products, and we have Pega Express, which is a try-before-you-buy capability that continues to be popular and it accelerated in our sales cycle. In many ways, for the first time we are selling software without actually having to physically meet prospects in person. And in 2017, we're going to continue to build out all of these digital capabilities, improve the express experience and really look to get our client engagement, our client engagement, up to a whole next level.

Now finally, we're going to invest in broader market coverage. We've started with our corporate markets initiative to open up the aperture on who we talk to and who we sell it. We're going to go deeper inside enterprise accounts that we cover under the count basis and we're going to add sales teams focused on opportunities, further opportunities, in the Global 3000 as we expand our ecosystem to support growth.

We see tremendous growth potential across our entire range of prospects. We believe that even in our top 10 long-term customers, we are no more than 25% penetrated. It leaves a lot of room for expansion, particularly with our applications that are relatively new to our market. Now, in the past year, we saw major expansion with existing clients; companies like PayPal and Sprint, Standard Chartered Bank and Deutsche Bank and Express Scripts. At the same time, we're seeing an increasing rate of new logos, with wonderful clients such as Facebook or Digital Federal Credit Union. This last one was acquired in Q4 by our Corporate Markets Team, which calls on that Global 3000. And these are historically customers we would not have engaged with. And we have a lot of potential because they have needs that are perfectly addressed by our technology. So, this is how we continue to broaden our market. And it actually creates an entree for us into many companies that we will then choose to treat in a more mature enterprise-engagement fashion. Some of these companies are companies like Nielsen, Hitachi and Anheuser-Busch.

In 2017, we're going to be expanding this into Europe because we are happy with the progress that we've made, working on the program here originally in North America. We're also going to build out our ecosystem further to ensure availability of the necessary resources to support customer use and increasing demand. In 2016, the ecosystem grew by more than 30%, including certified partners, customers and independent developers. Our Pega Academy now has 300 online self-study courses. And we passed the 50,000 mark in the number of students trained through Pega Academy. We introduced a new university program to also accelerate the training and certification of Pega resources. We now have 20 universities enrolled in North America, Europe and Asia-Pacific. And we started this really in 2016 and graduated about 500 students. We're expecting that in 2017 we're going to move that number into the thousands.

We've also launched a new technology partners program, to add complementary capabilities for our clients, so that we're not building everything. So our economy of about 35 technology partners, including great firms like Box and Hoover's and MuleSoft and Adobe and Experient and AT&T. So in summary, good Q4 in 2016 and we're excited about the opportunities ahead of us. We're pleased with the continued recognition we get from our clients, of course, and from industry analysts. And we think that Pega is well-positioned as a leader in software for customer engagement and operational excellence, which is at the heart of what businesses want to do to digitally transform themselves. We appreciate -- we anticipate continued momentum from what we're doing to differentiate competitively, and see lots of long-term growth opportunities.

We're going to continue to invest, to leverage and take advantage of these. But as Ken will talk about, we're also really looking to get our staff to understand how they should think about increasing operating leverage as we scale long term. With think we're very well-positioned to continue to adapt to a world of accelerating change. And I'd also like to take this final moment to further mention PegaWorld. This year, we're again in Las Vegas at the MGM Grand from June 4 to the 7th. It will be dominated by client presentations. It's the best opportunity to hear firsthand about great work the customers are doing; clients like UnitedHealthcare, British Gas, Qwest, Virgin Media, British Airways and others. The agenda is up on and we're finalizing some really exciting keynotes to further it in the coming weeks. We're also going to have an investor day on June 5, which we would welcome the attendants of investors [indiscernible]. I hope you will all join us.

To provide more color on financial results, I'm going to turn this over to Ken Stillwell our CFO.

Ken Stillwell

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 that we have two very significant factors occurring in 2016. First, through the year, we have mentioned currency fluctuations have created headwind. This impacted our revenue by approximately 4%. This means that our revenue was lower by about $30 million, solely driven by a strong US dollar against client contracts denominated in other currencies, primarily the British pound sterling.

The second and just-as-significant factor was that our mix of license and cloud contractual commitments shifted roughly 10% toward more recurring arrangements of term license and cloud from what we saw in 2015. This has an incredibly positive long-term effect of increasing the amount of recurring revenue and cash flows. But, as all of you know and I mentioned last quarter, there is a short-term compression that happens on the top line as you shift to more recurring license arrangements. At a high level, the impact of this 10% shift in 2016 is estimated to be roughly $40 million of what would have otherwise been recorded as perpetual license. Given that we would get some amount of that revenue from term and cloud arrangements in the actual year of receiving the commitment, depending on when the timing was, the approximate impact-to-revenue from this shift could be reasonably estimated to be around $30 million for FY16.

So when you hear our actual results, as detailed in the second, you need to consider that they would have been roughly $60 million higher on the top line when you consider these two factors. That would have put our revenue over $800 million for 2016. Was just a fantastic result. The bottom line impact is a little more complicated because our foreign subsidiary expenses act as a natural hedge of the currency effect of somewhere over 50%. There would have been no impact in the timing of cost recognition from normalizing this mixed shift, because the costs do not change, regardless of the client commitment was term, cloud or perpetual. So when you factor in the bottom line effect of the revenue compression from the two factors noted, and you take into account a reasonable estimate for the offset of the natural currency hedge, the impact would have been at least $35 million to $40 million, or 4% headwind to non-GAAP operating margins. At the same time our firm-wide, financial-awareness program has begun to reap benefits. As our Q4 year-over-year cost growth was in the single digits for the first time in a while.

Since we haven't yet discussed in detail our financial-awareness program is intended to reinforce certain fundamental business principles, and at making sound and fiscally responsible decisions on investments, trade-offs, et cetera, while still ensuring that we capitalize on our market opportunity and growth of the Business as a high priority. As I mentioned, it's exciting to see this evolution of growth and margin balance and deeper accountability in the Firm. In fact, our 2017 corporate incentive plan has operating margin as a much higher component compared to prior years.

When you look at the overall picture, as I mentioned earlier, I'm really excited with our success. Growing our Business in a way that helps create long-term consistency, and increasing predictable cash flows through higher recurring streams of term, cloud and maintenance, coupled with an increased Company-wide financial awareness. This will ensure we continue to grow and improve margins as we scale. For full year 2016, we are reporting both GAAP and non-GAAP results. A full reconciliation of all GAAP to non-GAAP measures is provided in the financial tables of the press release issued earlier today, and is available on the investor section of our website.

In our view, year-to-date results, which is the full-year results, provide the most meaningful look at how our Business is performing. We're pleased to report that year-to-date non-GAAP revenue was $752 million up 10% year over year. But we have to pause and remember that our non-GAAP revenue was negatively impacted by approximately $60 million, from currency headwind and our mix shift to recurring client arrangements of term in cloud. So just think of our revenue as with those adjustments being over $800 million. Full-year 2016 non-GAAP recurring revenue, which includes maintenance cloud and term license, was 53% of total revenue compared to 50% of total revenue in 2015. I want to highlight that we offer our clients cloud choice, as Alan mentioned earlier. When making a technology investment in our software, including perpetual term and cloud arrangements.

We have observed increased interest in licensing our product under reoccurring revenue and cash flow models over the past few years, with a noticeable increase in the second half of 2016. This trend has been accelerated as we expand into the CRM space, where other vendors have established recurring revenue models as the norm. We're also seeing an increase in term license arrangements correlating to more customers adopting Pega technology in fluid cloud environments. Some customers adopt using the Pega Cloud, which is our SaaS offering. Still others leverage the flexibility of Pega's deployment options to deploy our technology and cloud environments such as AWS, Asher, or even solutions such as Pivotal Cloud Foundry for their private cloud initiatives.

So when assessing Pega's relevance in the cloud, remember cloud choice. And therefore, you should consider not only the Pega cloud revenue line, but also this trend of higher recurring term arrangements were cloud choice i.e. the flexibility to allow our customers to pick their cloud environment and to move from on-premise to cloud or vice versa, is enabled with Pega. This trend can lower expected revenue in the near term. But the long-term annuity stream from these recurring arrangements, coupled with our significantly high client retention rates, will drive higher recurring cash flow streams into the future. Typical software companies that have moved through a transition to more recurring revenue streams have seen this transition take somewhere between three and five years before the impact is neutralized. We've seen a shift to recurring over the past 18 to 24 months. And the impact to our top line has not been a significant as we've observed at other companies. Many companies were actually experience revenue decline as they transition to recurring. But we have not experienced this effect and do not anticipate this shift impacting us that significantly. We do anticipate some additional headwind to our top line growth number in 2017, as a result of the continuing trend of more recurring arrangements than perpetual arrangements with our clients. That said, I think when you hear our guidance for 2017, you will be excited to see the growth rate, given that we are moving through this shift.

Of course, we love this trend. And we hope it continues. But I must reinforce we are not forcing customers to move. We fundamentally believe that providing clients options and cloud choice is critical for their success. Non-GAAP consulting services revenue for 2016 was $202 million, an increase of approximately 20% over the prior year.

In the future, we expect to continue growing our consulting services business at a high single to low double-digit rate. Consistent with our strategy to have customers and partners deliver the majority of our implementation services. However, when we have significant clients where they request greater involvement from Pega, our services revenue could be a little higher than typical.

Looking at our geographic non-GAAP revenue split for 2016, the Americas, inclusive of the US, Canada and Latin America, produced 65% of total revenue while non-Americas international generated the remaining 35%. Approximately 14% of our total revenue is generated from the UK. The geographic mix is impacted by the strong US dollar compared to other local currencies. The bottom-line impact of currency headwind and our shift to more recurring types of arrangements likely impacted our non-GAAP gross and operating margins by an estimate of more than 4%. Turning to earnings on a per share basis, our non-GAAP fully diluted net income was $0.77 per share compared to $0.81 per share for the full year 2015.

Once again, you have to consider the impact of the over $35 million margin headwind that we talked -- that I talked about related to currency and the revenue mix. And when you consider those two factors, it would have put our non-GAAP fully diluted net income over a dollar for the full year 2016. Moving on to backlog and the balance sheet, we compute license and cloud backlog by totaling two components. Deferred license and cloud revenue on our balance sheet and license and cloud contractual commitments that are contractually committed, but not yet on our balance sheet. As a reminder, you can find these details in our press release. Probably the most notable result is our change in license and cloud backlog. We finished 2016 with $528 million of total license and cloud backlog. Backlog grew over $100 million from the end of 2015, 26% growth year over year, significant growth in the back half of the year.

In a typical year, we've seen backlog grow by $30 million to $45 million. So we have never seen this kind of massive increase in our backlog. The shift to more recurring revenue streams and our strong business momentum are the drivers in the growth. Our weighted average contract client commitment -- excuse me, our weighted average contract commitment term continues to be approximately four years, consistent with previous years. Adding three more whales as mentioned in Q4, making it five for the year, all of which were recurring license arrangements, certainly impacted this growth in our backlog. As a result of the movement to recurring, we have more term and cloud revenue than perpetual revenue in 2016 for the first time in quite some time. As all of you know, recurring cash flow streams where the client is committed for extended periods, for example, four years, combined with our significantly high retention rates helps us have high confidence looking out for the predictability of our cash flow streams in the future.

From a cash flow perspective, we produced $19 million of operating cash flow within the quarter, leading to a year-to-date operating cash flow of $40 million compared to $68 million in 2015. We finished the period with total cash and marketable securities of $134 million. Many of our maintenance renewals land late in Q4, coupled with Q4 being our largest quarter of new client commitments. Accordingly, our accounts receivable balance at the end of 2016 reflects our largest quarter ever of billings, approximately a quarter of a billion dollars. Through today, we have collected over $150 million of our accounts receivable so far in Q1, which is consistent with Q1 being the largest collection quarter in our year. So we're likely on pace to have a record quarter of collections in Q1, 2017.

In 2016, we repurchased approximately 1.1 million shares for $27 million. As of December 31, we had a balance of 39 million available for repurchase through June of 2017. On headcount, we finished 2016 with approximately 3,900 employees, up 18% from the end of 2015. The growth in headcount is skewed higher due to the lower cost geographies as we expand our global client base and enter new markets. We're excited to announce that our guidance for full-year 2017, GAAP and non-GAAP, is projected to be approximately $860 million, a 15% increase over FY16, even factoring in more recurring client commitments than perpetual commitments. GAAP diluted EPS for the full year is expected to be $0.43 and our non-GAAP diluted EPS for the full year 2017 is expected to be approximately $1.

Highlighting the increase in predictability of our revenue in cash flows as we start 2017, the amount of our guidance, revenue guidance that is subject to backlog runout and renewals is over 50% for the first time. When you add professional services, which have strong visibility, this percentage grows to approximately 75%. That means 75% of our guidance revenue is really in a very clear line of sight. This is up from 70% when we started FY16, which is just an awesome trend and a reflection of the increased predictability in the Business. Additional operating metrics surrounding annual contract value for recurring arrangements will be provided in fiscal 2017 to add some additional perspective on this exciting trend. In summary, we're excited about our Business momentum, which is not fully reflected in our reported results.

Our results should be viewed in conjunction with the currency headwind and our continuing mix shift to recurring types of arrangements. The mix shift is a welcome trend that helps us build an increasingly larger amount of highly predictable cash flow streams into the future.

And with that, Operator, we will open the call to questions.

Question-and-Answer Session


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

Steve Koenig

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?

Ken Stillwell

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.

Steve Koenig

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.

Ken Stillwell


Steve Koenig

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'?

Ken Stillwell

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.

Alan Trefler

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.

Greg McDowell

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?

Alan Trefler

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.

Ken Stillwell

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.

Alan Trefler

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

Ken Stillwell

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.

Greg McDowell

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.

Alan Trefler

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.

Mark Schappel

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,

Alan Trefler

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.

Ken Stillwell

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.

Mark Schappel

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?

Alan Trefler

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.

Unidentified Analyst

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--

Alan Trefler

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.

Ken Stillwell

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.

Unidentified Analyst

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.

Alan Trefler

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.

Unidentified Analyst

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?

Alan Trefler

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.

Ken Stillwell

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.

Matthew Galinko

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?

Alan Trefler

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.

Ken Stillwell

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.

Alan Trefler

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.

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