Pegasystems Inc (PEGA) 2016 Q3 法說會逐字稿

Greetings, and welcome to the Pegasystems third-quarter 2016 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.

(Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ken Stillwell, CFO and Senior VP of Pegasystems. Please go ahead.

Thank you. Good evening, ladies and gentlemen, and welcome to Pegasystems Q3 2016 earnings call. Before we begin, I 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 and guidance, and other similar expressions, identify forward-looking statements, which speak only as of the date the statement was made and are based by current expectations and assumptions.

Because such statements deal with future events, they are subject to various risks and uncertainties. Actual results for the FY16 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 Q3 2016 earnings, and in the Company's filings with the Securities and Exchange Commission, including its quarterly report on Form 10-Q for the quarter ended September 30, 2016, its annual report on Form 10-K for the year ended December 31, 2015 and other recent filings with the SEC.

Although subsequent events may cause the Company's view to change, the Company undertakes no obligation to revise or update forward-looking statements, whether as a result of new information, future events or otherwise, since these statements may no longer be accurate or timely.

And with that, I will turn the call over to Alan Trefler, Founder and CEO of Pegasystems.

Thank you, Ken. I am pleased it was a strong Q3, overall. Q3s generally provide limited visibility, given vacations and schedules especially in Europe. And I had spoken about Brexit on the last call, and I am pleased to say the concerns have not materialized, with the exception of currency, of course. And I am pleased to see the continued progress we are making toward having less lumpy quarters, despite the inherent lumpiness of this business, even in the face of those currency headwinds.

Now, those currency headwinds caught a couple of points off of our results, but nonetheless, our year-to-date non-GAAP license and cloud revenue grew 18% year-over-year to $239 million. And our year-to-date non-GAAP total revenue grew 15%, to year-over-year about $552 million.

While we continue to make investments to leverage growth opportunities, we are committed to improving operating leverage as we scale long-term. So -- which brings us, I think, to a recapitulation of our strategy. To summarize, we continue -- continuing on focusing on delivering the world's leading business process management and customer relationship management software. Enabling our clients to realize dramatic business agility and positive business outcomes by combining insight, action and the ability to evolve, that our software makes possible.

We are looking to broaden our market reach through both digital marketing and through our expansion to the global 3000. And this continues to gain traction, as I will talk about. We focus on giving choice in how clients acquire and deploy our technology, which is a message that is resonating.

And we provide value to clients, whether they are in growth mode or efficiency mode, depending on business and economic conditions. Our software can help customers retain and expand their customer base through our customer decision hub and our case management to create differentiated experiences. And yet, at the same time, we reduce cost by improving operational efficiency using our business process management, our case management and now, the robotics we can offer as a result of the OpenSpan acquisition earlier this year.

So in the strategic column, we have four major initiatives; two product-focused, two go to market-focused that I am going to touch on. First, from a product perspective, we continue to enhance our unified model-driven platform Pega 7, which is the foundation on which are applications are built, and a critical competitive differentiator.

It is truly a platform for digital transformation. It provides a unique capability in case management, BPM and real-time decisioning, which, coming together, bring that insight and action to the fore. And this distinctive positioning of having one platform continues to gather industry recognition and delivers for us and our clients.

Unlike our competitors, this unique architecture gives them flexibility and choice in deployment. Customers can move seamlessly between Pega Cloud, which we host and take care of, third-party clouds, private clouds, hybrid clouds or traditional on-premise. And the ability to accommodate clients' individual business needs, not just as they exist today, but as they might exist in the future, is, we think, far superior to stuffing clients on some multi-tenant SaaS system. And we have seen organizations understanding how digital transformation itself may transform in the future, as really hungering for that level of flexibility and choice.

Also, I mentioned OpenSpan, less than six months after the OpenSpan acquisition, we launched our robotic automation as fully unified with Pega 7 and OCRM applications. It allows us to apply OpenSpan's 15 years in machine learning expertise to Pega clients. And it is a unified offering that really snaps in beautifully with our business process management capabilities.

Because what we are really happy about is this is not just about letting a bunch of robots loose on a client, it is about plugging them into a way of thinking about finishing and completing work. Which is, we believe, a highly differentiated and far better way to think about both automation and robotics.

Now, regarding industry recognition, this August, we were designated as a leader in the Gartner Magic Quadrant for Intelligent Business Process Management Suites. Our leader -- we have been recognized in this report every year since its inception in 2006, and being evaluated 15 vendors, and we were really pleased with the way our picture looks, shall I say.

Last year, and another very attractive picture, we were also named the leader in the Gartner MQ for BPM, platform-based case management frameworks, for the second consecutive year. I think when you realize that we have one architecture that brings these two capabilities together, you will start to see that we can do end-to-end things that our customers and our competitors find both appealing and threatening, on a retrospective basis.

Now, we continue to deepen the capabilities of our customer engagement applications as part of our strategy number two, which is to create really well-finished marketing sales automation and customer service capabilities. We are focusing to make these solutions of greater value to buyers, to improve the limitation speed and increase ease-of-use.

And once again, this is where having a unified architecture approach really means we can provide a seamless way to handle a service request. Or when a customer is on a service call, to advance a sales opportunity and have every interaction advancing the customer journey using our customer decision hub, which is part of this always-on customer grain at the center of our technology.

With lots of companies hyping AI, artificial intelligence solutions today, I just want to remind you that our customer data hub brings tremendous decisioning intelligence to our CRM apps, driving it and really supporting true advanced capabilities. It continuously learns from data and interactions to power experiences across an enterprise in real-time and its scale.

And this is real; this is not a vision, or some bolted together Franken-stack of purchase products. We have been doing this for years, and with customers with real and dramatic results. We come and talk about them at PegaWorld, not as things that are going to be, but as things that are fundamentally changing their business.

So being the only CRM where sales, service and marketing are unified in this environment, versus an integrated environment, where it is kind of glued together, means you do not have to write API code integrations between apps. And lots of things that are hard in other businesses as they scale up, become easy in ours. So being able to guide customers, and being able to provide this capability so you do not have to train people, that is something that we do far better, we believe, than any other competitors.

Regarding the apps, we have also been announcing significant enhancements to many of our application areas. Most recently, for example, our customer lifecycle management and Know Your Customer applications. Which provides the unified solution for managing both corporate and personal banking customer journeys, as banks seek to bring on new customers.

And in a world where organizations are worried about the process through which they open accounts, being able to bring decisioning and process to that point of engagement, we think, is especially appealing and especially important.

We have also been able to work into our product, important advances with some of our partners. So for example, we worked with our partners to advance cloud-based capabilities such as voice recognition, SMS messaging and quick-to-call functionality throughout our customer service platform using software from Stark and Tropo, which are Cisco companies that we partner with. We actually demonstrated these as Cisco Live and at our recent healthcare summit.

So being able to bring together a unified platform with important partner solutions, now available in many cases on our application store, inside our platform itself, is really one of the things that makes, I think, our technology special. We are also, by the way, seeing if we can bring this technology into markets that are really quite new and get leverage.

For example, we fairly recently have been entering the German market for healthcare. And I am pleased that DAK is a new healthcare client that has bought sales automation for the statutory healthcare functions that are German-specific. And SDK, which is the largest company health insurance provider in Germany, also jumped on board. And being able to create these rural-driven, regional specialized solutions really gives us, we think, a lot of power and a lot of sticking power in going after import new functions and markets.

The third strategy talks about go-to-market. And from a go-to-market perspective, we are really looking to increase our view and our management depth about how we are going to do digital buying and improve awareness to bring prospects and clients to our technology. We recently hired our new CMO, Tom Libretto.

He started about a month ago, and he is building on great marketing momentum we have developed over the last two years. Tom has had over 20 years deep B-to-B and B-to-C marketing and CSM experience at some of the world's most recognized brands. And he most recently comes to us from JPMorgan Chase. And I think that you will see wonderful things coming out over the next six months, as Tom and the team are energized to really drive a true digital marketing agenda.

Earlier in the quarter, we added Diane Ledingham to our Board of Directors, who is a leader in Bain's customer strategy and marketing practice, and a senior partner in their telecom media and technology practices. She is very experienced in helping companies create and implement high impact growth strategies, and we are excited about what she is going to be able to do with us.

In our fourth area of strategy, we are also investing in broader market coverage, deeper, within our enterprise accounts, when we go to market vertically, and with the addition of sales forces focused on opportunities in the Global 3000. We are also continuing to expand the ecosystem, partners to support our growth. This quarter, we continued across the board to add new logos across verticals, and I am going to call out a few.

We have seen great traction in the public sector, globally. As government entities focus on modernization, working to improve efficiency, reduce costs, and enhance service. For example, the state of Vermont is now using Pega on the cloud to deliver their next generation licensing platform for the Office of Professional Regulation, which is responsible for enforcing 44 different professional occupations across Vermont.

And in a very different sort of use case, the US Marshals Service is doing an agency-wide modernization project to create modern digital business processes for case management, prisoner management, fugitive investigations and court security management. I am hoping to never personally have one of my records in their system, I am happy to say.

Not just in America, but globally, the Dutch Ministry of Economic Affairs, our first work with the Dutch government, is using us to be able to support health inspections and other functions from a supervisory perspective. And moving to another continent, the Australian Bureau of Statistics is developing data collection systems for business and household surveys. So once again, we are seeing really interesting government use cases, which, I think, is fascinating, and also, I think, going to be very promising as we go forward.

We also see good momentum in our key target industries. To pick out a couple of there, I would highlight, for example, Scotia Bank. Which is using the power of our agile delivery to increase their speed to market, delivering contextual next-best actions to online and mobile channels. And we are part of the Bank's overall digital transformation initiatives. Having just placed another vendor and very, very quickly using our technology to drive broadly across the Bank.

And a notable win at a very large Pelco, where we are in over 36,000 service desks. We are being part of a broad digital transformation, really looking to improve service and automate end-to-end customer journeys, so that someone can start in one channel and finish in another. The Pega vision if there ever was one.

I am also pleased to say that the corporate markets team, though still small, continues to do well. We are pleased with the performance year-to-day to broaden a variety of new logos, ranging in size and industry from Nielsen, to credit one, to Hitachi, to Bayview Financial.

So these are all examples, I think, of how the growth in the business was pretty strong across-the-board this year, and something we are looking to try to accelerate as we go into next year. We continue to grow the ecosystem, and we are doing it both by direct access to partners, and also creating some new programs, For example, our new university program, which has run at four universities, and will go to now put out to close to a dozen, to be able to train graduating seniors in Pega technology, both for our clients and our partners to be able to pick up.

I am going to call out one final customer experience that I was excited about, and actually blogged about on LinkedIn, if you guys want to look at. It is about a customer I visited recently, also in Holland, it is Rabobank, which is the largest lender to Dutch businesses.

They wanted to really launch an innovative, syntec challenging approach to how they dealt with small business customers. And they came up with the idea that if a small business could go on to their website and fill out a pretty comprehensive set of forms by noon, the next day they would meet with them and give them a thumbs-up or thumbs-down on a loan of up to EUR1 million. And I will tell you, this is about 10 days faster than their competition, and completely revolutionary.

What I am thrilled about is we are not their website, but when you go to that magic page on Rabobank, sitting right in the midst of that is a Pega system, directly connected, end-to-end. To be able to help the right questions get asked, to be smart and contextual and to really make this brilliant process work well.

Very exciting to be able to work with clients like this, and we think that as you look at our website, you will see the customer stories. You really see a rhythm of success developing across the industries that we focus on.

So in summary, good Q3 year-to-date results, we are really pleased with the recognition by clients and industry experts. And the work we have done to unify the OpenSpan products and people are -- really has shown that that is already going to be a terrific, terrific merger and extension of our family. And we continue to be confident in our continued momentum and competitive differentiation.

With that, let me turn it over to you, Ken.

Thanks, Alan.

Pega Q3 results reflect our momentum as we enter our busiest quarter of the year. Highlighted by strong year-over-year revenue, license and cloud growth, progress towards achieving our four-year APS guidance and backlog growth from quarter two of 2016, that is higher than any typical quarter that Pega sees in our Q3.

Our strength in generating significant value enterprise customers was evidenced by two license arrangements that we call, whales in Q3. Both of these whales were term license agreements, which contributed to our backlog. To remind everyone, our definition of a whale is a customer software commitment of greater than $10 million.

Based on our current currency exchange rates and our anticipated revenue mix for FY16, we are clarifying the approximate full-year impact of currency fluctuations that we mentioned in our Q2. Our top line revenue should see currency headwinds of approximately 3%, or $20 million to $25 million. We have an approximate 50% natural hedge in currency, such as the pound and euro, as we do incur expenses in these currencies, which help to offset revenue head winds.

Given the visibility we had to the currency headwinds, we have done a good job of managing our costs to help offset some of the earnings pressure that could occur from a currency headwind. Our year-to-date growth of non-GAAP, fully diluted EPS of 32% is evidence that we have been successful in managing the bottom line impact of this currency headwind.

At the end of Q2, we highlighted some concern around the short-term impact of Brexit, and so far, the impact has been limited to the currency impact mentioned, as Alan said earlier. For the third quarter of 2016, we are reporting both GAAP and non-GAAP results. A full reconciliation of all GAAPs and non-GAAP measures is provided in the financial tables of the press release issued earlier today, and is available on the Investor section of our website.

As we have discussed in the past, quarter-to-quarter comparisons do not necessarily reflect the underlying momentum of our business, as the timing of a small number of large transactions and the mix of license types can significantly impact quarterly results. In our view, year-to-date results provide the most meaningful look at how our business is performing.

As Alan mentioned earlier, we are very pleased to report that our year-to-date non-GAAP total revenue of $552 million, which is up 15% year-over-year. Foreign currency negatively impacted this growth rate by approximately 2% to 3%.

Our year-to-date non-GAAP license and cloud revenue was $239 million, up 18%, also negatively impacted by currency. Year-to-date through the third quarter of 2016, non-GAAP recurring revenue, which includes maintenance, cloud and term license was 54% of total revenue, growing from 52% for the same period last year.

I want to highlight that we offer our customers choice when making a technology investment in our software, including perpetual term and cloud arrangements. We have observed increased interest in licensing our product under reoccurring revenue models over the past few years. This trend is accelerating as we expand into the CRM space, where other vendors have established recurring revenue models as the norm.

To highlight this factor, both of the whale deals I mentioned were multi-year term arrangements where revenue will be recognized over time. In fact, in Q3, four of our largest deals in North America, our largest arrangement in EMEA, and our two largest in APAC, were all term arrangements. This trend can impact expected revenue in the near-term, but with a long-term annuity stream from these arrangements, coupled with our above 90% retention rates, will drive higher recurring cash flow streams and better visibility in the future.

We continue to expect that our business will shift away from perpetual license toward recurring license revenue streams of term and cloud. Although the timing of a small number of large value perpetual transactions would continue to impact our license mix in the foreseeable future. And I also want to highlight, again, that we are giving our customers choice, as opposed to forcing or encouraging them to move to reoccurring revenue streams.

Non-GAAP consulting services revenue year-to-date, through the third quarter of 2016 was $144 million, an increase of approximately 18% over the prior year. In the future, we expect to continue growing our consulting business, but at a lower rate, such as high single to low double digits, consistent with our strategy to have customers and partners deliver the majority of our implementation services.

Looking at our geographic non-GAAP revenue split, year-to-date through the third quarter of 2016, the Americas inclusive of the 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.

Turning to our non-GAAP gross margin, we finished year-to-date through the third quarter of 2016 with gross margin of 70%, up from 69% in the prior year. Non-GAAP consulting services margins year-to-date through the third quarter were 12%, up from 5% during the same period in 2015.

The margin year-to-date through the third quarter of 2016 benefited primarily from two large projects for which all or a significant portion of the associated cost were incurred in the prior year, as we have mentioned in previous quarters. If we adjusted for this timing difference, our consulting services revenue would have been approximately 11%, consistent with our expected run rate of about 10% for full year of 2016.

Our year-to-date 2016 operating expenses totaled $318 million on a non-GAAP basis, an increase of 17% over the prior year. Our year-to-date non-GAAP operating margin improved to 13% compared to 12% for the same period of 2015. This improvement occurred despite currency impact, our continued investments in building our strategic apps, improved digital engagement for our customers and increased expenses that we mentioned earlier related to our increased attendance at PegaWorld user conference in June of 2016.

In terms of other non-GAAP operating expenses, we have increased sales and marketing headcount by 168 year-over-year, the majority of which were in sales. We are pleased with the continued progress we are making, that sales and marketing capacity for broader market coverage. R&D costs continue to run at about 18% of revenue. We expect this rate of investment to continue through the remainder of 2016, as we continue to enhance our leading Pega 7 platform and expand our application offerings.

Turning to earnings, on a year-to-date basis, we posted $46 million of non-GAAP net income. On a per share basis, our non-GAAP fully diluted net income was $0.58 per share, compared with $0.44 per share through the third quarter of 2015.

Moving on to backlog and our balance sheet, we compute licensing cloud backlog by totaling two components. Deferred license and cloud revenue as posted on our balance sheet, and licensing cloud contractual commitments that are signed, but have not yet been recorded on our balance sheet.

As a reminder, you can find detail of both elements in our 10-Q and a summary table in our press release, both of which were filed earlier today. We finished the third quarter of 2016 with $420 million of total license and cloud backlog. Backlog grew $27 million from the end of Q2 2016 and $40 million from the end of Q3 2015. We are pleased with this momentum in a calendar quarter where we typically experience a reduction in backlog, and we have seen strong currency headwinds and the quarter, as well.

Adding two whales, as mentioned, both of which were term license agreements, certainly assisted in the backlog growth. From a cash flow perspective, year-to-date, the Company has produced $9 million of operating cash flow within the quarter, leading to a year-to-date operating cash flow of $17 million compared to $55 million through the third quarter of 2015.

We finished the period with total cash and marketable securities of $130 million. Year-to-date, through the third quarter of 2016, we repurchased approximately 1 million shares for $26 million. As of September 30, we had a balance of $41 million available for repurchase through June of 2017.

On headcount, we finished the period with approximately 3,800 employees, up 20% from September 2015. In summary, we are pleased with our year-to-date results through the third quarter of 2016. The fact that we were able to grow non-GAAP revenue by 15% and diluted EPS by 32% in the face of currency headwinds and a significant shift of term license arrangements is a true indicator of the business momentum.

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

Thank you. We will now be conducting a question-and-answer session.

(Operator Instructions)

Steve Koenig, Wedbush Securities.

Hi, gentlemen, thanks for taking my call (technical difficulty) for Q3. If I may, I am curious to know your thoughts on the bookings results, how does that translate into -- relative to your guidance, which I know you do not reiterate. But do we look for a higher probability of making that number for the full year, or kind of unchanged sort of view on the chance of making that number? How would you characterize that? And then I also would love to get a little bit of color on those whales, what industries and were any bookings related to the US Census deal instrumental in the quarter, as well?

I will talk about a couple of those things. First of all, historically, we have pretty much even backlog, and have been breakeven with backlog through the first three quarters, if you go back and just look at the last several years. And we are pretty pleased that in Q3, we were able to actually make up some of the shortfall we had experienced in the first half. It still means the fourth quarter, as is traditionally true, is obviously very, very intense. But relative to historical norms, we were pretty happy with the way Q3 looked, though that does not mean there is not an enormous amount of wood to chop between now and the end of the year. In terms of the whales, we do not normally go into a lot of detail about their composition, but they were, I would say, in some of our traditional spaces that you would expect. And the Census was not reflected in one of the whales.

Great. Thanks, Alan. If I may do a follow-up, curious to know your view on the evolving competitive landscape and CRM. We know you have been bumping a little bit more into the multi-tenant SaaS vendor that is dominating the package, the SaaS space, if you will. Is that trend continuing, and how are you feeling in those competitions? Is that normal for you guys to bump into them? And more broadly speaking, when it comes to CRM, who are you competing with most?

Look, if you think about what our strategy was a couple of years ago, we decided we would just take the business and very forcefully spirit into the front office by building out finished apps, as opposed to complementing what people did, which is historically what we have done. And I will tell you that we have steered into that front office pretty hard and darn well. I think we are competing with the guys you'd expect us to compete with, that sales force in Microsoft, and we are routinely doing it.

We have got a terrific story about a unified platform, about choice, about doing things that are good for the customer. The things that is a miracle in the multi-tenant SaaS world, is that these guys are such brilliant marketers; and frankly, they truly are. The big -- convinced customers that running a multi-tenant cloud environment is in the customer's interest. That is only true if the customer is like a 50-person company, because, frankly, that is the only way they can afford it. But once you get up to having several hundred users of a system, there is no real advantage, no advantage at all, frankly, to the client, to be living in a world where his stuff cannot be personally encrypted, where it has got to be in one of these multi-tenant databases with governors to prevent the tenants from crashing each other's parties.

That story about the cloud as a virtual private cloud, coupled with the story that you can bring this in-house, we see as enormously powerful. I think that ultimately, it is not just in-house, it is really how do you, as a customer, not become a slave to one particular SaaS-based cloud provider, but have the choice to move to whatever cloud makes sense. I think we've got a really strong competitive story, particularly since we have really only been hard in this business for a couple of years. So I am really happy with our positioning, where we are, and we have reason to believe that we are on these other guys' radar.

Steve, this is Ken. I wanted to add one piece of color on your first question, just so that -- you asked a question about should we feel more confident or less confident with our full-year revenue guidance. I think the way to think about it is, we do not know what the mix of our deals are going to look like in Q4. What we do know is that our Q3 had a larger mix of term deals, which is really fantastic for the long term of the business. And we were still able to achieve a pretty respectable revenue number.

Naturally, if a lot of our deals in Q4 go the way of term, I think that you all understand what that does to short-term results, and the way to look at that is to look at a combination of revenue and our backlog, of course. And that is the way to think about our business. I would just point back to that. I am sure most of you get that, but just to highlight that point.

Yes, that is very helpful. Okay, thanks, guys. I will leave it at that.

Thanks, Steve.

Mark Schappel, Benchmark.

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

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

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

Sure, it is interesting because robotics have become pretty hot. Though, if you actually think about it, a lot of folks are positioning things in a pretty weird way. Our positioning here is unique, if you go take a look at the other market, it -- guys in the market. If you want a couple of stand-alone robots that go throw in some part of your operation, we can do that.

However, now that OpenSpan is beautifully integrated and connected to our BPM and case management, those robots can actually now have an audit trail that describes what they do. If they need to talk to some things through robotics, and just so folks know, robotics, in a lot of ways, is simulating keystrokes, kind of like a -- think of it as a fast non-human typist going into through the front door of a system.

Anything that is pretty sophisticated is typically going to merge some of those robotic capabilities with things that you would think of as more conventional system-to-system interfaces, and through a multiplicity of systems. You really want to make sure things are in sync. Typically, you are not just going from an Excel spreadsheet into one system. Typically, you are going between systems and doing that sort of stuff. And that is a scenario in which our BPM heritage and roots, and the OpenSpan technology just is beautifully complementary.

So we are seeing customers, who are just looking for robots to try to make things go faster, now understanding they will get a lot more leverage if they think of the robots as being part of a process, as opposed to stand-alone entities. I think it has turned out nicely strategically, I think the teams get along together really well, and we are really happy with it as a nice complement to what we have done historically.

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

Sure, so I think that Tom is putting together the plan for next year. He has got a very good team, and they are bringing their thoughts together for what we want to do. But there is no question in my mind that Pega, historically, was just meaningfully under-marketed. If you think about it, we were a company that really originally only sold to a couple dozen of the world's largest firms, growing that to maybe 500 to 600.

Now that we are talking to more firms and getting more visibility, we are seeing companies that we never would have talked to. Think of firms like Nielsen, and firms that absolutely have these needs, but they were not in one of our highly specific target markets. So we are going to continue to invest, and really work to get both more visibility but also make it easier for customers to digitally buy.

What that means is that they need to be able to find the right stuff on the website, and we need to have the materials out there, both directly and through our partners, to make it so that the engagement that is now expected makes sense. I think we are very rational folks in looking at how we do this, but I am pleased that the commitment we made to marketing was a wise one, and one that we want to continue.

Great, thank you.

Greg McDowell, JMP Securities.

Great, thank you, and it is wonderful to see the backlog grow in that manner. A couple questions. The first one, with respect to Steve's earlier question, I will push it a little bit harder on the whales. If you could just -- I know you do not want to get into too much detail on industry and such, but if you could just talk about whether these were new logo wins or existing clients? Were they competitive wins? Was it more BPM or CRM, or case management focused? Any additional details you can provide would be helpful, I think.

Well, I think both of these would be characterized as being a combination of something new and something old. It is not uncommon for us to -- having had a success with a client, to do a significant amount of follow-on business with them.

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

That is a good question. The simplest way that I can explain it, Greg, is that if you think about a company that is going through a rapid shift from a perpetual to a term model is going to have margin compression in an extreme way. A company that is doing it in a slower manner, naturally, you probably may not see much margin compression or notice it. I think the thing that we have highlighted for the recent past is to really pay close attention to our backlog because it is difficult to connect the meaning of our non-GAAP operating margin without thinking about the amount of term license, and when that is coming in.

I think what we have seen over the last few years is that our recurring revenue has grown from in the 40%s, up now to 54%. With that, our non-GAAP operating margin has been at that 15% range. I think it is easy to speculate that, that is a performance issue, but the reality is some of that is related to revenue, not matching expense. That naturally is probably something that you are commonly hearing.

I think the important thing to think about is that, that as the term revenue continues to grow, you get through that trough. We have not seen a real trough in margin; we have not experienced that. What we have seen is margin that has not grown to the extent that the Street expects it to grow. But I think what is important is the amount of recurring revenue that we have is growing, and I think that is a really important thing for us to make sure that you understand because that is part of the reason that our margin has not expanded over the last few years. And I just do not think we have done a tremendously good job of maybe being transparent or clarifying that to you.

Got it, thank you. That is helpful.

Matthew Galinko, Sidoti.

Good afternoon, guys. Thanks for taking my question. First of all, on the Rabobank deal, Alan, you called out your strength in decisioning and being quite a bit more effective than who you were going up against there. Can you maybe talk a little bit more about that win? Why you ended up so far ahead of your decisioning competitors, and maybe just talk about more broadly, I think you touched on this earlier, but just a little more broadly on decisioning, why you are coming out ahead?

Yes, so one of the things we do, which is interesting -- and by the way, one of this relates to one of the whales, where we got a major follow-on a piece of business -- that sometimes we end up being in a head-to-head match with decisioning, and I think that is good. I think the fact that our real-time decisioning is rated by Forrester as absolutely best in class, in terms of capability. The fact that if we get a client who just wants to figure out what the right product is, to be most suitable or most appropriate for a customer, that we are absolutely best in class on that. I think that is fabulous.

But the stuff really comes together when you do not just want to make a good decision, you actually want to operationalize it. You actually want to fulfill it, you actually want to be able to take the loan application, make an initial decision in the system, but then run that through some loan committee and actually take some stats, and then on-board a customer. That is where the decisioning really marries up with case and process because the decisioning wants to lead to an outcome -- a case, as it were, in our parlance.

The process is, how do you execute this, how do you do it in conjunction with the customer system? So, we are, I think, differentiated purely in decisioning because the engine is so powerful. But if you actually want to move beyond intellect, to actually put some muscle into it, that is where you have got to go put some Frankenstack together with the other guys. Or you have got to do it only in their environment, as opposed to being able to make it work both in a cloud environment and with your systems, up close and personal. That is where we really shine, and I think that is a pretty significant and sustained differentiator for us.

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

I think the sales cycles in Q3s are hard to gauge, because Q3s are just weird. It is like until September, nothing much is happening in many ways. I do not think that the sales cycles have really particularly worsened, though I do not have a statistical basis. That is just being out there in the field. I will tell you there is a lot of activity going on for Q4; it is going to be frantically busy, which is -- I think we think that is a good thing, right, Ken? (laughter)

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

Historical -- I would think so.

Fair enough. Maybe one last one for you, because you did call out government as a nice sector for you, with some wins this quarter. Do you see any incremental investments you will need to make in the coming quarters, or a year or so to get deeper into government? Do feel comfortable with where you are? And do you see any need for investment -- on the engineering side, and product side, or on the sales effort on either side, I guess?

There's some things that are incremental investment. For example, in the federal government space, there is something called FedRAMP, and there is something called GovCloud. There is some additional investment that we have been making to be able to support government-specific environments and practices. There are also some either government-specific or government-mandated audits that can cost hundreds of thousands of dollars to get done to demonstrate things. Frankly, it is not enough, I think, to really significantly move the cost needle unreasonably.

The core product itself turns out to be extremely well suited to the government space, and I think years ago, people would ask me what I was unhappy about. One thing I said is I really do not think we are doing a very good job getting into government; I was very candid about that. I am obviously feeling a lot better now, both at the national/federal, and the state and local levels, so we are pretty pleased.

We just -- I will just share, the State of California is a government client of ours. One of the things that they did fairly recently is the California Franchise Tax Board, which is what does all of the corporate taxes, put in a Pega system with one of our partners to really help run a lot of the guts of the tax calculations. And were so thrilled with the result that they hosted an event on their premises for 250 other workers from other government agencies to show off what they did. We had some of the other government agencies talking about what they accomplished.

What I like about this is, unlike some of the other vendors, where if you actually listen to the presentations, it is not actually clear what they did. Our customers, when they talk about it, tend to be really very specific and very tangible. I think we are starting to see a really happy critical mass gathering in terms of these governmental organizations.

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

Got it. All right, thanks guys.

Thanks, Matt.

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

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

Thanks, guys.

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