Pegasystems Inc (PEGA) 2009 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Pegasystems 2009 annual earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions).

As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Craig Dynes, CFO.

Good morning, and welcome to Pegasystems 2009 annual earnings conference call. While I am here in Cambridge, Alan Trefler, Pega's Chairman and CEO, is in Washington, D.C.

Before I introduce Alan, I will start with our Safe Harbor statement and then provide my financial commentary. Certain statements contained in this presentation may be construed as forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. The words anticipates, projects, expects, plans, intends, believes, estimates, targets, forecasts and could and other similar expressions identify forward-looking statements which speak only as of the date the statement is made.

Because such statements deal with future events, they are subject to various risks and uncertainties. Actual results for fiscal year 2010 and beyond could differ materially from the Company's current expectations.

Factors that could cause the Company's results to differ materially from those expressed in the forward-looking statements include, without limitation, variation in demand and the difficulty in predicting the completion of product acceptance and other factors affecting the timing of our license revenue recognition; the mix of perpetual and term licenses and the level of term license renewals; our ability to develop or acquire new products and evolve the existing ones; the impact on the business of the recent financial crisis in the global capital markets; the negative global economic trends and the ongoing consolidation in the financial services and healthcare markets; our ability to attract and retain key personnel; reliance on key third-party relationships; the potential loss of vendor-specific objective evidence for our professional services; management of the Company's growth; and other risks and uncertainties.

Further information concerning factors that could cause actual results to differ materially from those projected is contained in the Company's filings with the Securities and Exchange Commission, including its report on Form 10-K for the year ended December 31, 2009 and other recent filings with the SEC.

The Company undertakes no obligation to revise or update forward-looking statements as a result of new information since these statements may no longer be accurate or timely.

Given the economic conditions, 2009 was a year of dramatic achievements for Pegasystems. Every quarter, we set records for revenue, we set a new record for license bookings, and as a result, we increased net income by 193%.

New license signings were approximately 30% higher in 2009 than in 2008. While the average size of the license signing did not change significantly, the growth in signings was driven by a larger number of deals we completed in 2009 as compared to 2008.

License signings are seasonal in this business, with the larger percentage coming in Q3 and Q4, so it was no surprise that in Q4 we set a new record for quarterly license bookings.

We ended the year with $192 million of backlog, of which we expect $128 million to be revenue in 2010. $133 million of our term and perpetual license backlog is highlighted on page 30 of our 10-K, where we detail by year how our off-balance-sheet license backlog will be realized.

The total of our outstanding term licenses increased by $6 million from Q3 to $76.3 million at the end of the year, while our non-term license balance increased by $11.4 million from Q3 to $57.4 million at December 31.

Our strong bookings had a dramatic impact on license revenue, which was up 51%, or $39.4 million, from $76.6 million in 2008 to $115.9 million in 2009.

Our government vertical was impacted by the bad economy, as license revenue in this sector was relatively flat. Both the healthcare and insurance verticals showed significant increases in license revenue. Our largest growth area was in financial services, which made this at the end of the year our largest vertical.

Our model of driving add-on sales based on the strength of project success is a significant driver of our business. During 2009, approximately 80% of license revenue came from follow-on sales to existing accounts.

Maintenance revenue was $50.1 million for 2009, an increase of $10 million or 25% from 2008. As noted in our 10-K, the increased maintenance revenue is a function of the continued growth in the installed base of our software. Our maintenance renewals exceeded 95%, as almost every customer renews each year.

Revenue from professional services, comprised of training and consulting, was $98 million for 2009, an increase of 3% from 2008. Throughout the year, professional service revenue growth has been held back by pricing pressures caused by the weak economy, lower demand in Europe and currency movements. However, on a quarterly basis, Q4 revenue of $25.6 million was a noticeable increase over Q3 revenue of $24 million. We expect ProServe revenues to continue on this growth trend in 2010 in spite of the significant amount of work being done by our partners, as well as customers, as they both become enabled to create their own applications. Enabling partners has proven to be successful, as partners are now involved in almost 25% of new license signings in 2009.

Lastly, we had no 10% revenue customers in the year or in the fourth quarter.

Our overall gross profit for the year was $173.1 million, up $43.2 million or 33% from 2008. The largest component of the increase is a $39.3 million or 51% increase in license revenue, coupled with a $9.2 million increase in maintenance gross profits.

Our professional services margin decreased to 14% in 2009 from 20% in 2008. The slowdown in the economy resulted in a rate pressure, which lowered margins [advance] throughout the year. This decrease hurts our gross profit and we expect an improvement in 2010 ProServe margins. However, the primary goal of our professional service organization is not to maximize margins, but rather to complete successful implementations that drive follow-on license sales and to enable our customers and our partners. The rate at which we are achieving follow-on sales and the growing involvement of partners is proving out this strategy.

Total operating expenses for the year were $131.3 million, an increase of about 14% or $15.8 million from 2008. The increase in OpEx reflects the strategy in investment that we've been following since 2006, with the goal of growing the Company to become a $1 billion a year player in our space.

$10.6 million, or about two thirds of the OpEx increase, was in sales and marketing. $4.4 million was due to higher sales commissions as a result of the increase in new license bookings in 2009 as compared to 2008. Higher sales commissions are always a good thing. The remainder of the increase is primarily related to headcount. During the year, we added 63 people to sales and marketing. While 21 were in marketing, we added 42 people to the sales organization.

To cover more accounts and more geographies, we need more people in sales. And while there is a significant on-boarding time with new sales hires, we expect that sales hires in 2009 will drive 2010 revenue growth.

In addition to the investment in sales and marketing, we added 60 people to our R&D organization in 2009. This investment was the primary reason that R&D spending increased by $7.4 million in 2009 from $31.5 million in 2008 to $38.9 million. While we are the leader in the BPM market, we strive to lengthen our lead. Improvements to our product lead to customer success, which drives follow-on sales.

Lastly, the financial statements show that G&A expenses decreased $2.1 million for the year. This is a result of having to include the startup costs of our Indian R&D center in G&A during 2008. So when you back out the impact of this accounting rule, G&A was really flat year-over-year. Even though we increased headcount, G&A costs stayed flat due to the settlement of outstanding sales taxes that were accrued through G&A. As we settle sales tax issues in states where we do not maintain a sales tax license, we reduce our accrual and this reduces G&A expenses.

Our FAS 123(R) charge for stock-based compensation was about $3 million on an after-tax basis, up from $2.4 million for 2008. Note 13 to the financial statements details how this charge is allocated to each department.

Interest income was down in the year, not only our rate floor, but in late 2008, we moved our cash investments into pre-refunded municipal bonds. These bonds, which are secured by escrowed investments in treasury bills, are very secure and liquid.

In addition, we have a smaller balance in installment receivables, and therefore, less interest income associated with this balance. This trend will continue in 2010 as installment receivables decline and eventually disappear.

Our overall effective tax rate through 2009 was 32%, up from 30% in 2008 but down from 34% in 2007. Our business was stronger in the US in 2009, and so our tax position and resulting tax rate was higher due to the relatively high rate of tax in the US compared to other countries.

Our net income of $32.2 million is an increase of $21.2 million, almost three times 2008's net income of $11 million. This is a phenomenal result in a tough economy.

Our record Q4 bookings increased our AR balance by $11.7 million, from $27.7 million at the end of Q3 to $39.4 million at the end of the year. Accounts receivable days billed outstanding, calculated on a quarterly basis, is an amazing 35 days, down from 56 days at December 31, 2008.

For the year, we generated $49.6 million in cash flow from operations. We ended the quarter with $202.7 million in cash and investments, up from $167.2 million at the end of 2008.

During 2009, we purchased 676,964 shares for $12.1 million at an average price of $17.85. Our Board replenished the buyback program, so we still have a balance remaining of approximately $15.8 million available for purchases in 2010.

Deferred revenue of $32.9 million was relatively unchanged from December 31, 2008, but increased by almost $5.1 million in the quarter from $27.8 million at September 30 as a result of our strong Q4 bookings.

Now with regard to 2010, I am pleased to be able to increase our revenue guidance from $300 million to $315 million. This is annual guidance. We don't give quarterly guidance for two reasons. Our customers, not us, determine whether they will buy a term or perpetual license, and a change in the mix can make our quarters extremely lumpy. In addition, we don't give crazy discounts at the end of a quarter to make guidance numbers, because our business is built on follow-on sales to our existing accounts. Big discounts would ruin our business, just as it has ruined many other software companies.

So while we don't give or manage the quarterly numbers, I would like to point out to those building models that historically, there have been quarters where revenues have not grown sequentially. In fact, in the high-growth years of both 2006 and 2007, we had down quarters during the year, but on an annual basis still put up growth numbers of approximately 30% in each year.

In addition, our profitability will be somewhat back-end loaded as we have high expenses in the first half of the year. For example, in Q1, we held our worldwide sales kickoff, and in Q2, we will bear the expense of PegaWORLD, which we did not hold in 2009, as many customers told us about their travel restrictions.

We do not manage the quarterly numbers. We are managing the Company with a goal of becoming a $1 billion a year software company and owning the BPM space. While this seems like a lofty goal, our progress to date towards this objective has been amazing. It was only 2008 that we surpassed $200 million of revenue, and now we are talking about breaking $300 million in 2010.

We believe that our growth is attributable to the significant investments we made in sales and marketing, as well as R&D. We start 2010 with 253 people in sales and marketing and 222 in R&D. In 2010, we expect to do more than three times the revenue we did in 2005, when we started this high-growth strategy. And so we will continue to invest in order to drive growth beyond 2010.

At this level of investment, we believe that in 2010, we will generate approximately $36.5 million of net income, which is approximately $1.00 per share. This guidance assumes a stable US dollar, and so significant changes in foreign exchange may impact our net income. In estimating net income for 2010, we are forecasting a FAS 123(R) charge of $4,750,000 on a pretax basis, $3 million on an after-tax basis.

In summary, 2009 was remarkably great year in a remarkably terrible economy. With more details on Q4 achievements, I would now like to turn the call over to Pega's Chairman and CEO, Alan Trefler, who is in Washington.

Thank you, Craig, and good morning, everyone. 2009 was an exceptional year for Pegasystems. Our total revenue reached $264 million, 25% growth over 2008. Our license revenue grew 51% on top of 50% growth achieved in 2008. And our fourth-quarter was our 10th consecutive quarter of record revenue. I would like to congratulate the team and thank our clients and investors for their confidence in us.

This continued growth has been driven by the pragmatic benefits and rapid return on investments that our unique Build for Change technology delivers to clients. Customers are seeking business applications that are fast to market and increasingly agile in today's rapidly changing and less predictable environments. And everyone has to do more with less these days. These are exactly the value propositions behind clients' choice of Pegasystems over the alternatives.

In Q4, we saw an increase in the selection of Pegasystems for revenue growth and market share initiatives. Several large financial services organizations chose Pega for loan origination and home lending servicing. In insurance, we saw wins for quote to order applications, and in healthcare, we saw wins for group enrollment.

We continue to see significant wins of our intent-driven, process-oriented approach to customer relationship management in contact centers and in multichannel settings. Our distinctive what we call CPM, or customer process management, technology had wins in many industries, including large wins in financial services, insurance, healthcare, life sciences, travel and transportation last year.

We are also seeing significant wins for back-office transformation, in particular, claims transformation in insurance companies, back-office transformation in credit cards and wholesale banking and care management in healthcare.

Though we see the economic recovery as still tentative, the economy has improved, and we are seeing leading organizations focus more on customer centricity, in parallel with the continued drive for operational improvement. This serves us well, as our capability to provide transparency and automation across process silos from new business to fulfillment enables powerful solutions to transform the customer experience. And our clients really like that they can start small with rapid ROI with self-funding projects and then extend and expand it across their total customer-facing processes. This is an innovative and very appealing approach in tough times.

In addition to our sales wins, we had approximately 70 systems go live across our customer base in 2009. In Q4, we had systems go live at a large domestic insurance company to manage institutional new business; endorsements and umbrella policies at another. A large healthcare payor organization went live with our customer process management solution and transformed their customer experience. And a large European telecommunications company went live on a system to manage account settlements and reduce costs. There were many others.

In 2009, we also made significant advances in our Alliance strategy. We signed Platinum agreements with Accenture, Capgemini, Cognizant, IBM and Infosys. We also signed Gold and Silver level agreements with a number of additional consulting and services firms.

These agreements all describe specific joint actions that we will be taking with these partners to foster effective practices in a broad ecosystem of staff, capable of installing and promoting Pega technology. Our partner pipeline has increased by over 50% from the first half to the second half of the year. Thousands of partner staff were trained in 2009 to our technology and over 500 new partner system architects became formally certified in 2009.

We continue our investment in technology and innovation is, we think, going to be very important to our future success. We also are building out our Solution Frameworks that add business function and make it easier, faster and more reliable for people to apply this technology in certain areas. To do this, we are adding engineering staff in both North America and our engineering center in India. And we will shortly be releasing SmartBPM 6, our newest market-leading BPM platform that represents extensive work, and we think will continue to carry the ball further and further.

We are excited about the new capabilities in this that will have customers further accelerate their time to market, reduce training that is required and improve the collaboration between business and IT. Pega already leads in this area with our unique, directly capture objectives capability, and we will be offering new abilities for clients to bring process and improvement to the way that they build for change. We think that this will build on what we have done historically and is a good indicator for where we will be going in the future.

Now, I've been asked about consolidation. There have been changes to the marketplace, and some of the recent acquisitions in the last I would say 60 to 90 days, in particular IBM's purchase of Lombardi and Progress Software's purchase of Savvion, have caused a number of people to wonder what is going on.

Underlying this question is the fact that people still have very different opinions of what constitutes BPM. Some even call it business performance management, think about it more as reporting or business intelligence. Others try to merge BPM with services-oriented architecture, thinking of it as really an integration-oriented or orchestration-oriented capability. And many others think of BPM as primarily business process modeling, where businesspeople can draw pretty pictures, but where the real automation, return on investment and business transformation are not there, and certainly not there in quantity.

We think these views are simply extensions of sort of historical thinking, rather than the game-changing view of what BPM can do for business and government organizations. And in our view, BPM is about fundamentally changing the way that business and IT work together, how they design and build business applications. It is kind of like one of our customers recently said to us, "I've been doing this for 30 years, and this is the way I always dreamed it would be."

We see clear, distinctive business-oriented capabilities as being required in BPM, driven by empowering the business and changing the way the technology is used. This requires a model-driven approach that integrates business processes with business policy and with the user experience, and where the power of software is used to add a smart brain, as it were, to the way business is done.

Presenting customers with acquired pieces of technology, all built on a paradigm of manual software programming, cannot possibly accomplish the vision of BPM as we see it.

I will tell you that there is nothing new to these consolidations either. The acquisition of substandard BPM-ish technologies doesn't have a history of paying off. For example, a decade ago, TIBCO bought a company called InConcert. It didn't work out well, so they bought Staffware in 2004. Replacing the broken InConcert products with the weak Staffware product did nothing for their positioning or results. Their BPM revenue has been flat or down in the last two years.

Metastorm bought CommerceQuest in 2005, then Proforma in 2007, then two other deals trying to buy critical mass. The recession killed their growth and they had to pull their IPO.

Software AG bought webMethods after its growth stalled in 2007, and more recently, IDS Scheer in 2009, which also had hit a rut. We haven't seen any improvement in their competitive positioning.

BEA bought Fuego in 2006 before being acquired by Oracle in 2008. RuleBurst acquired Haley in 2007, and Oracle then acquired the combination in 2008.

The stack acquisition model continues. We saw ILOG be acquired by IBM in 2008 FileNet, offering them the separate pieces and leading to some confusion between FileNet's BPM and IBM's existing process server products. They bought Telelogic in 2008 to supplement requirements capabilities that they previously bought from Holosofx. Then in late 2009, IBM acquired Lombardi after their growth had slowed. So now IBM's BPM portfolio consists of three competing solutions and a multitude of separate supporting tools and products.

And then Progress most recently acquired Savvion in 2010. Savvion's growth had also stalled, and Progress has been sucking up companies like this for a while, like IONA* a year ago and other SOA acquisitions. They had previously partnered with Lombardi, but after the IBM acquisition, that obviously had to be replaced.

This sort of melange of acronyms and acquisitions doesn't make customers feel warm. I've got three thoughts. First, most of these acquired firms never came close to the critical mass that we have, and all had hit real air pockets in their growth. Because their products weren't solid enough to generate the real value proposition that customers are seeking from BPM, they couldn't grow rapidly in tough times; very different from Pega's results over the last two years.

Two, we hear from clients that they are less than thrilled at losing choice in areas that could be competitively relevant. Some are concerned about being owned by these massive stack vendors, and many appreciate the choice to operate across staffs that Pega offers.

And three, a coherent strategy and technology design really matters here. We have built four generations of our product line from scratch over these years, and have been able to think about how we make the complexity simple and linked together at its heart. These acquisitions add complexity that contradicts the clients' needs for a clean approach, suitable for business users. And that is what Pega is all about and what Pega offers.

I will tell you the consolidation hasn't really created challenges for us in the past, and we don't see it hampering us in the future. If anything, it just makes our scale as the only meaningful, independent firm in this space that much more distinctive.

So let's talk a little bit about moving forward. 2009 was an exceptional year for Pega. We achieved the record revenue and profitability, and we've seen a major increase in adoption of our Build for Change technology. We remain completely dedicated to client success and making sure that businesses get return from this technology. And we are doing this as we expand our distribution capabilities and try to leverage new partner relationships and channels. It is a fun and exciting time.

But we have aggressive plans for growth and are working hard. Our prior investments have reaped rewards and we believe it makes sense to continue to invest in profitable market-share growth that has the potential to really help propel us in what we think can be a very significant market.

At some point, the BPM market will turn from its current push market to more of a pull market. We want to both take advantage of today's growing opportunities and be in a position to take advantage of what we expect will be a much larger market in the future.

So this means we'll invest, positioning for faster growth in 2011 and beyond, while maintaining discipline to invest wisely and achieve improved profit and cash flow.

Areas we have targeted in Q4 in 2009 and plan to push forward to in 2010 include sales staff; we are going to materially add to our direct sales force. Geographical expansion will increase; we are targeting more in Asia and other geographies, [where] BPM could be a very strong market. For example, we look to open China in the coming months.

We will double down in areas of Europe. We've seen success by putting language skills in country. Much, much better to be selling in Germany and Switzerland with German speakers, and we intend to increase this, both in current places and other areas in Europe.

We will continue to invest in the partner ecosystem with those high-quality firms who are prepared to invest with us to pursue new clients and ensure client success. This is consistent with our direction of having an enablement and expert services focus for our professional services business.

We are adding industry and marketing and solutions frameworks for new verticals to provide the return on investment for BPM in industries that we are going to be targeting. For example, we are doing work in areas involving healthcare providers, broadening on our historic strength in healthcare insurers, building on successes with such firms as Tenet Hospitals and Kaiser, or communications firms, building on successes with Deutsche Telekom, and targeting new markets like energy and life sciences.

By increasing our target verticals, we will be looking to bring our capability to the attention of many more Fortune 200 firms in 2010, and we will also be looking to deepen our engagement around customer process management, taking advantage of the power of BPM contact center.

In Q4, we brought on a new Chief Marketing Officer and will be looking to get an additional visibility through improved use of Internet-based marketing and capabilities, as well as greater participations in industry forums to support our vertical strategy in partners.

We will not take our technology positioning for granted. We will continue to drive our distinctive BPM vision into the product to improve ease of adoption and power. We see our upcoming Version 6 as an important step forward and see significant ways to further improve BPM adoption in the technology itself as the market matures in coming years.

And we will broaden our efforts in the platform-as-a-service business. In 2009, we introduced and sold initial solutions of our new BPM cloud offering, which we are providing in partnership with Amazon's EC2 elastic compute infrastructure. We are looking to establish meaningful growth of our BPM cloud business in the coming year.

The goal of these initiatives is to both have a strong year in 2010 and position us for even stronger results in the years to come. We have a great opportunity in front of us and we intend to marry its aggressive pursuit with prudent investment and the sort of judgment that comes from having had to grow this business from scratch.

In closing, I would like to mention that our upcoming PegaWORLD conference is scheduled for April 26 to 27 in Philadelphia. We are expecting a record turnout from the world's leading organizations, and we welcome you to come join the buzz, the fun and the excitement of being part of Pega.

With that, let me turn it back to the moderator and open it up for any questions.

(Operator Instructions) Nathan Schneiderman, Roth Capital.

Thanks in advance for taking my questions. My first question for you is if we look at software backlog, so the combination of the license and deferred revenue, the term backlog in the perpetual off-balance-sheet, the math I am doing on that is it was up about 5% year-over-year. And I was a little surprised it wasn't up more than that, given the strong growth profile that you've experienced. And I was hoping to hear your thoughts in general on the software backlog growth and the overall backlog growth, which seemed to slow a little bit from the pace of the prior year.

Actually, I get a different number, Nate. If you look on page -- I'm just trying to find it now in the K -- we give the total backlog number in the K for the year, and that is compared to the prior year. I think it is $133 million, and I think it is up more --. And so the analysis on page 30 is in that number. I don't know if that helps you out or not.

Well, maybe if we kind of drill down and just take a simpler look, and we can talk about the software-specific piece off-line.

But if you just look at, for example, the current backlog was up $18 million year-over-year; the prior year it was $28 million. So it looks like the growth in back -- and you can look at the same kind of dynamic on total backlog, just the dollar growth was a lot less in 2009 than it was in 2008. And maybe you could just comment on what looks like -- obviously, you are still growing nicely, but it just looks like a slowdown in growth relative to what you experienced in 2008 on the backlog side.

I think if you take a look at what we expect vis-a-vis the next year, I don't sense any real difference in the proportion of next year's revenue (technical difficulty) already incurred.

So some of the backlog numbers can have to do with actually when, for example, term agreements renew, et cetera. So you can read a little too much into it.

But I will tell you the momentum in Q4 was very, very strong. It was by far our greatest year of license sales --.

Okay. Maybe if I could ask a question on the term license results for the year. So in 2009, you were up $11 million year-over-year. The 10-K made a comment that it was primarily due to accelerated payments. And I remember this issue came up a little bit on the last call, but I was hoping you could share with us what was the magnitude of those accelerated payments? Is that -- and remind us what happened to drive that, and how would that have compared against the accelerated payments that you received in the prior year of 2008?

We had more accelerated payments in 2009. We actually don't drive it. That is a customer decision. Sometimes at the end of the year, believe it or not, some companies want to get cash off their balance sheets. I don't know why, but -- and they want to prepay term licenses.

Could you share with us the dollar value of those accelerated payments and what was the prior year?

I don't have both sets of numbers, but I seem to remember that in 2009, I think we had about $5 million or $6 million worth of prepayments on the -- that I can remember off the top of my head.

Okay. Final question area for you. I was just hoping, Alan, maybe you could speak to any interesting trends or success you've had thus far in January. Is January starting off a whole lot stronger than it did last year, and anything you can say about year-to date? Thanks so much.

I think it is always dangerous to give comments about anything when you are in the early parts of a quarter. But I will tell you the level of activity is extremely high, both in terms of the number of deals that we are bringing to our pricing committee, and frankly, the services engagements, which often are indicators -- or leading indicators of business. So we are extremely busy.

Laura Lederman, William Blair.

Thank you for taking my questions, as well. Following up on Nate's questions, one is you talked about license bookings being up 30% for the year. Were the Q4 license bookings roughly up that same number as well, or percentage?

Up over Q4 of last year? Yes, they were.

So license bookings, if you will, were up 30% or more year-over-year in Q4?

Yes. What we called bookings are what we call really license signings. We are very conservative in our measure. We don't include maintenance. We don't include professional services. Our metric is pure license signings. And we were up 30% in the year and set a new record in Q4.

And following up on Nate's question, how come that doesn't show up in the numbers on the backlog, if you will, and the exhibits on the Q? (multiple speakers) What are some of the differences for us to get from that 5% to the 30%?

One thing that has changed over the year is that professional services revenue is relatively flat. So there was always some professional services component in the backlog that we quote in the K, and that number is actually down from last year. The increase is primarily due to a dramatic increase in license in the backlog number in the K. So the license is actually up significantly.

Okay. Switching gears a little bit, can you talk about the pipeline, which I think [we saw from] -- Nate was asking as well, in terms of your strong bookings in Q4, license bookings up, as you said, 30% or more. How does the pipeline look? Was it drained at all from the strong Q4? Or another way to put it is how does the pipeline look versus last year at this time?

I guess what I would say is obviously, when you do sell a lot, the items obviously come out of pipeline. So the effect of that is the pipeline is impacted.

Our pipeline, however, is up. And I will tell you that the mood in the buying population --it is not just if you have a certain number of dollars in the pipeline, but it is, frankly, the quality of the deals in the pipeline. The economy as a whole, and I think Pega and BPM as a whole, are in a much, much better place than they were 12 months ago, in terms of sort of the visceral feel of the economy and buyers' interest in engaging.

As Alan said, every Monday morning, we have a pricing committee meeting, and I think yesterday's meeting was the longest one we've had all year.

Cool. If you look at Lombardi and Savvion being acquired, are you seeing them more or less since they were purchased by IBM and Progress?

Well, it is relatively new, but I will tell you most of the feedback we've gotten from the customer base has been negative in terms of their interest in continuing with in particular Lombardi since the acquisition. I think that, frankly, some customers have already got a couple of versions of BPM from IBM, and they are not necessarily thrilled about having another one on the plate to add confusion.

And we've actually had outreaches from the firms who indicated that they would like to talk to us in the wake of that. It is all new, so it is hard to know, but we certainly haven't seen anything that would suggest that the competitive position of either of those firms has improved at all.

All right. My final question, and then I will pass it on, is it's great that you receive 80% of revenues from existing customers. But kind of the flipside of that is the ability to get new customers. So can you talk a little bit about new customers and if you look at the pipeline, how much of it is new customers versus existing. Because it's always, obviously, important to get new customers.

Yes. The thing about that number, if you actually think about a strategy, our strategy is to basically sell to a customer and then do follow-on sales to the customer, as opposed to trying to go and sell them out with some sort of enterprise type structure.

That has a couple of follow-on effects. One, the second and third deal they do with us are not considered a new customer even if they happen in the same year, and there are quite a few pieces of business like that.

It also means that we need to have salespeople to increase our footprint because we are not done when we make a single sale to a firm and move on. So I think that when times are tough, especially it is good that existing customers will buy from you. We agree we need to sell to new customers, and we actually had pretty good results last year selling to new customers.

The expansion of the sales force, which we began in Q4 and we will be doing through the rest of this year is to allow us to touch many, many more customers. We actually call on well under 50% of the Fortune 100. So we see a very, very good opportunity in hiring people to go after those other organizations. And we would expect that we would be very successful with that as we have been in our traditional verticals.

So I think you are right. I think this will be a great year for us to open up as it would (inaudible) and go after new customers both this year and 2011.

Thank you.

Richard Davis, Needham.

Maybe a little change of the focus here a little bit from kind of what happened to maybe why it is happening. First -- and also, Alan, if you can solve the problems in D.C., that would be helpful as well.

But in any case, non-budgeted deals you sometimes are able to get. In other words, I'm a CIO and I'm like I'm not sure if I want a BPM product. But especially since you've kind of done your land and expand strategy, you've been able to kind of walk in and say look, you are going to get a quick ROI.

Can you talk about how that drives your business vis-a-vis kind of the opportunities? Because one of the things we hear sometimes is guys are like, well, you know, we are not hearing a big budget increase for these tools, but you guys have seemed to been able to buck the trend. So how did that play into the strategy in terms of sales? And then I had one follow-up.

Sure. I think the key is to have that conversation more with the line of business person and the CIO, as opposed to the CIO themselves. And if you can explain to a business person how they can in 90 days get a system up and how it can pay for itself, you can get the attention of that person, and if the CIO believes they can pull it off, then that puts you in very, very good shape.

For some of the largest banks in the world, for example, in the last six months, we've brought live systems to allow them to implement the loan modification programs that they need to implement to try to get out of the Wall Street Journal, for example. And being able to handle those and get those live saves them a tremendous amount of money because, frankly, they don't get into trouble and they also don't get their loans bounced when the loans are presented to Freddie, because there are documentation issues and other types of things.

So self-funded projects have been very important in the last year, and I think will continue to be important, frankly, on a go-forward basis; it is a wonderful way to do business.

And then the follow-up would be, I think it was in May -- I can't remember for sure -- but you introduced I guess smart platform as a service, which is kind of a cloud offering. And as I recall, it was a partnership to some degree with Amazon and Capgemini.

What has been uptake so far, and then what is your kind of long-term view of that trend as you get an increase in cloud computing as a general sense and how you guys play in that scenario?

We've actually used the cloud computing environment successfully with six or seven customers, primarily for development and testing purposes. And the transition we are going to go into this year as we go forward is actually we have some customers who are now thinking that they could be interested in doing this on a production basis as well.

So we are extremely well-situated for cloud computing, because our development environment, the way that people configure their systems, is actually implemented in a browser. Everybody -- pretty much everybody else in the BPM space, they have what is called a fat client development environment. And cloud computing really is about doing things with browsers. And our whole development environment is browser-based.

So I think this could be really, really interesting, and we are going to push forward. The reality is I think it will -- the platform as a service to really take off, I think is probably a multiyear activity, but it's one where we've put a team in place and we are going to be pushing very hard starting and be doing.

Great. Thanks very much.

Raghavan Sarathy, Dougherty & Company.

Good morning. Thanks for taking my questions. I have two questions. First, let me start off with Craig.

So I understand for some time you talked about investing for growth and your GAAP net income guidance is consistent with what you have been saying all along. That said, the net income guidance could also imply that margin expansion could be de minimis this year. So given this backdrop, how should we think about reconciling your efforts to work with indirect channels, such as SI, versus your own organic efforts to support growth?

Well, as Alan pointed out, we will continue to invest in the sales and marketing organization. It is very important that we expand our account coverage from, say, the Fortune 100 to the Fortune 500. He also mentioned that we have geographic expansion going on. That is not incompatible with doing more work with partners. Oftentimes, partners put even a greater strain on the sales organization by introducing them into new opportunities that they ordinarily wouldn't hear about.

So that is an important investment, and we will continue to make that investment, just as we have in the last few years.

In addition, we will continue to invest in R&D. As Alan said, when you can -- if you can get an application up and live in three to six months, the payback is tremendous, and that really helps us close deals. A lot of deals that were marginal terms of the customer didn't have the appropriate IRR, all of a sudden are very important and are very doable. So that is another significant investment for us that helps drive revenue.

And if I could follow up on that, but this year it seems like you are making investments much larger than the past years. So should we look at this year as the year of investment to support future growth, and as we should expect more normalized rate of margin expansion as you look past this year?

(multiple speakers) Software companies, as they hit certain numbers, have just incredible margins and returns. But one way to think about it is for the last two years, we have increased our license revenues by over 50% each of the last two years, but we haven't increased our sales force at that rate.

Given that we still think a direct sales force is important and given that the direct sales force has obviously been able to get results, even as we do things that might have more leverage, like partners, we think that it makes sense to do that. And there is a meaningful cost to bringing on new salespeople and new (technical difficulty) people. We do invest a lot as a firm in training, and we are comfortable that is a smart and important thing to do and critical for our clients.

But that is a lot of what makes the cost profile be front-end loaded when we do some of those things. But there is no question that over some extended period, the software margins are beautiful, when in fact the Company hits a certain stride and a certain scale.

Great. Thanks. And then one for Alan. Historically, you have generated the majority of your license revenues from existing customers, as they expand the use of your product. And I'm wondering if you could give us some color on how much runway you have in terms of opportunities for continued penetration among your existing customers.

I think that's a great question. When I take a look at, for example, our top 10 customers, I would say that on average, we are under 20% penetrated. One of the reasons that we are working with the existing customers is both because they are, frankly, just terrific customers to do business with, and there is a lot of opportunity there.

So I think it would be a mistake to assume that like a lot of companies we run around selling out these firms. We try to really establish long-term relationships that will work on a mutually beneficial basis, and there is a lot of upside to the existing customer base. Which, frankly, is one of the reasons we want to add sales capacity rather than just taking our existing sales capacity and moving it on to new organizations. We think we should do both.

Okay. Thank you.

Brian Murphy, Sidoti & Company.

Thanks for taking my questions. I just have a couple here. Alan, obviously, more companies are out there talking about the BPM space in different ways. And I think you touched on maybe the potential here for some increased fear, uncertainty and doubt around the space.

If you could talk a little bit more about why you think your narrative for sort of what BPM is and how it is evolving will prevail, how you think the systems integrators will influence that, and you also touched on how eventually this will change from a push to more of a pull type phenomenon, and maybe talk about the traction you have there with systems integrators versus the competition.

Sure. I actually think that it is not a situation of fear, uncertainty and doubt. We are actually seeing an increased certainty in clients that this makes sense. There is nothing that we are seeing that makes clients feel less confident that this thing called BPM has legs. It is one of those sort of times when there are different views of what the market is, which, by the way, we think is great, because our view seems to be prevailing. And that, I think, is part of why we have both a technical advantage and a sort of strategic advantage in terms of how we are doing it.

So the integrators, frankly, are much more interested in general dealing with us post acquisition. Obviously, you have a company and one of our partners, like Capgemini, you can imagine how when a company like Lombardi, which was also a partner of theirs, gets acquired by IBM, that certainly doesn't make them look more fondly on that technology.

I think that the integrator pipeline, as I mentioned, is up very significantly, and we are expecting to continue to see that grow strongly this year. We are now in the point where partners are actually bringing deals to us, which is something we really didn't see very much a year ago.

Great. Craig, I think you mentioned in 2009 the government business was flat. Can you maybe give us a little bit of color there, and maybe go into what you think the outlook is for the government business going forward?

I think it looks better for 2010. I had a look at the pipeline and what is going on, and we have a pipeline of government business in the US, as well as some sort of pseudo-government business in Canada as well. And that is a first for us. It looks to be better for 2010.

Yes, I'm down here in Washington. I actually mentioned pretty explicitly on quarterly calls about six months ago that we were pretty dissatisfied with our government business. And we actually subsequently have made some management changes. We've brought in new leadership. We've brought in several new salespeople on the ground. I will tell you that we are having a wonderful time hiring people. Being the growth company in the space, and with BPM being a hot space, we are inundated with real talent that is interested in joining the firm. So it is a terrific place to be.

And I am feeling much better about the government business this year than I've ever felt before, and I think we've got the right team to make some real headway this year.

Great. And just one quick similar question, on a geographic basis, not too many soft spots here in the business. But it looks like Continental Europe in the back half of the year was down pretty significantly.

What is the outlook there in 2010?

I think last year was a very, very tough year for Europe. We commented about that before, and we saw weakness in Europe throughout the year.

In the first quarter, we have seen very significant upticks in activity, and we've actually closed business in Europe that makes me encouraged to think that this could be a stronger year for us, both with some new customers and some existing ones. So we are feeling better, and, frankly, that is part of what our motivation is to build out the sales force in a couple of countries where -- frankly, it is reasonably safe to build out the sales force when you've got extremely large customers in country that you are not fully covering. And we are using that as kind of a base for us to build up in a number of places, such as the German-speaking countries and France. And we are even looking to move into Italy.

Great. Thank you.

Edward Hemmelgarn, Shaker Investments.

One comment -- I thought the year was very good. Anyways, congratulations.

One, in terms of your training of service staff, that has an ongoing issue in '09. Are you about done with the upgraded training of the service staff?

I don't think we are ever going to finish, but we've made, I think, the massive bulk of the investment. We have pulled people out of the field for very long periods of time to try to increase the number of what we call certified lead system architects, who could be people who could leverage entire programs. And the bulk of that work was completed. Frankly, that reduced our capacity to train outside people, which didn't help the training revenue last year. And that also, obviously, reduced the services revenue as a result of us having more people out of the field.

But we have seen an improvement in terms of the results on projects, and we're actually quite happy we made that investment. But it will not be as proportionately significant this year, and we've already seen a pickup in what we expect training revenue to be as we enter this year.

Okay, great. In terms of -- I think, Alan, you said that partners were involved in 25% of sales, I believe, in '09. If that is the case, what percentage of installs did they do, and then what percentage are customer installs? And I think in the past you've said you do about 10% of the installs. Is that correct?

Well, we strongly encourage customers, and we've been increasingly pushing this encouragement, that customers should basically be materially involved in nearly every install. The vision we have of BPM is this is not something that is done to customers, but this is something that lets customers Build for Change and take over their technology.

Not everyone agrees with that, frankly. Some people want it done to them. But increasingly, what is going to drive the adoption of BPM is organizations saying, hey, this is a different way for implementation of change in my operation. So customers are very heavily involved. I would say customers do material work in over 80% of the implementations.

And we've got a number of customers -- I would say well over a dozen -- that have put up material centers of excellence, where they have actually got their own central experts and are just driving this technology very aggressively internally.

I would say that partners touch a good three quarters of the implementations that are out there. And there is probably more than half the implementations that partners are driving at this stage, often with a couple of Pega people involved, but sometimes independently, where there are partners who have that level of depth and expertise.

Okay. A couple of questions, Craig. What do you think the tax rate is going to be in '10? It was up in the fourth quarter.

Right now, I am planning on the same tax rate for 2010. We will adjust it throughout the year depending on the geographic mix.

So 32% roughly?

Yes.

Okay. And in the past when the -- or at least in '08, when the dollar was increasing relative to other -- relative to the euro, primarily -- you had some translation losses. Should we factor that in for 2010, given that the dollar has been increasing lately?

Yes, the dollar has been increasing lately. It moves around so much that it is really hard to manage a position. We do try and get out of foreign currencies as much as we can. It would not be a surprise to see a loss -- foreign exchange loss in Q1. And then what usually happens is the dollar moves the other way and we have a corresponding increase in Q2. That has been the trend over the last few years; it sort of moves up and down quarter to quarter and we go from loss to gain.

And then Alan, what would you say were the two most significant new apps that you had in '09?

Could you repeat the question? I am sorry.

What were the two most significant new applications that you guys moved into or that your software was being used for in '09?

I would say that one is this whole area of care management in healthcare, which is the application of some case management technology to being able to deal with patients and people with a sort of critical care situations off multiple illnesses. We have been working with some Fortune 50 firms to really very dramatically change the whole way they go to market in this area.

And the President of one of them, the President of Medco, Kenny Klepper, has agreed to become our keynote speaker about how they are using this technology to really transform the way they go to business -- they go to market at PegaWORLD. So I think that was quite significant.

I can actually probably name more than that. We have really had a breakout in insurance claims, in the automation of insurance claims, becoming a backbone for a number of firms in that space.

And I'd also say the emerging platform as a service business. We were very satisfied with the work we did with those six or seven customers who used platform as a service to accelerate their implementation.

And we are very happy about our partnership with Amazon. They are going to be a major partner of ours at the upcoming PegaWORLD. And we think that is also going to be a very interesting development that we are glad we brought to market last year.

Okay, thanks.

Raghavan Sarathy.

I have two follow-ups. First for Alan. Alan, you talked about signing a number of large SIs as Platinum partners. I was wondering if you could give us some color on what does this entail from a partner perspective in the sense license (inaudible) commitment and (inaudible) commitment, etc.?

To become a Platinum partner, the company has to commit to literally giving exposure to hundreds of their staff, actually certifying very significant numbers of staff. These are negotiated with the individual organizations. And we also jointly pick a meaningful number of license sales that we expect them to drive.

We've introduced for every one of the Platinum partners a full-time partner-manager, who generally comes from either that firm or from having worked with that firm, who understands how to navigate the organization, and whose mission in life is to make sure we get the visibility and that there is an effective joint partner pipeline built.

So I would tell you the partner program has moved to a level of rigor that is very meaningfully different than it was in the past, and we're starting to see results from that.

All right. And then one for Craig. If I look at your EPS guidance, it implies that you are expecting share count decline from the fourth quarter level. Am I looking at this right?

The share count is based on the share count at the end of the year of share count, where you have about $15 million available for buyback in the year. We've kept our share count relatively flat for about the last four years, and we are hoping that with our buyback program, we can keep the share count about the same.

Okay, thank you.

And sir, I am showing no further questions in the queue.

With that, let me thank everybody for listening. Let me thank people for having given us the opportunity to deliver a terrific 2009. As I think about the margin questions and other questions, I hearken back to 2006 and 2007, when folks were wondering why we were investing in growth as opposed to focusing on, frankly, driving more near-term EPS.

There, it was because we thought there was an opportunity, and we see an even bigger opportunity now. So that is going to drive our prudent strategy. We are going to continue to work hard on behalf of all of our constituencies, and I look forward to talking to all of you in the future. Thank you very much.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.