Pegasystems Inc (PEGA) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Pegasystems Incorporated year-end and fourth-quarter earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions on how to participate will be given at that time. (Operator Instructions) As a reminder, today's conference call is being recorded. I would now like to turn the conference over to your host, Chief Financial Officer, Mr. Craig Dynes.

Good evening, and welcome to the Pegasystems 2010 annual earnings conference call. With me here in Cambridge is Alan Trefler, Pegasystems Chairman and CEO.

Before I introduce Alan, I will start with our Safe Harbor Statement and provide my financial commentary. Certain statements contained in this presentation maybe construed as forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. The words anticipates, project, expects, plans, intends, believes, estimates, targets, forecast and could, and other similar expressions identify forward-looking statements which speak only of the date the statement was made. Because such statements deal with future events they are subject to various risks and uncertainties. Actual results for fiscal year 2011 and beyond could differ materially from the Company's current expectations.

Factors that could cause the Company's results to differ materially from those expressed in forward-looking statements are contained in the Company's press release announcing its Q4 2010 earnings, and in the Company's filings with the Securities and Exchange Commission, including its report on Form 10-K for the year-ended December 31, 2010, 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.

Q4 was the strongest quarter for closing new business in our history. We set a record for new license signings. For the first time, the license component of new license signings exceeded $60 million for single quarter. Q4 bookings were double Q3 bookings, and on an annual basis we set a new annual record as 2010 license signings surpassed those of 2009. Healthcare, which had a very slow start to the year due to the healthcare reform, hit a new record in Q4 when they doubled the aggregate of all of Q1, 2, and 3 bookings.

We also continue to grow our customer base. In 2010, we did almost twice as much business with new customers as we did in 2009. Our bookings in Q4 were so strong that we ended the year with record backlog of $232 million, of which $147.1 million was licensed and $76.2 million is maintenance, which are both high margin revenue. This backlog does not include all the annual maintenance agreements and term license agreements that come up for renewal during 2011, of which historically, we have greater than a 95% renewal rate.

The mix between perpetual and term licenses is driven by customer circumstances, and is always unpredictable. In 2010, however, the mix moved back to more term licenses, and as a result we ended the year with a $90.9 million backlog of future revenue from term licenses, up from $76.3 million at the end of 2009. On page 31 of the 10-K, we detail how this term license backlog will be recognized as license revenue. This schedule shows that we already have 2011 term license revenue of $30.9 million before we close even a single new term license contract.

As a result of strong Q4 bookings, our revenue for the year was $336.6 million on a GAAP basis, or $348.2 million on a non-GAAP basis. This is about $11.8 million shy of our non-GAAP guidance of $360 million. As mentioned in the press release, we had one Q4 arrangement of approximately $20 million that we did not recognize as revenue due to the complexity of software revenue recognition rules. This one November deal, for which we've already been paid in full, is the primary reason why the total of short-term and long-term deferred revenue jumped up by $24.1 million from $50.6 million at September 30, to $74.7 million at December 31. This transaction was sufficiently complex that required extensive research and consultation, and the final revenue recognition accounting was not finalized until Monday.

Maintenance revenues $27.2 million on a non-GAAP basis in Q4, more than double what it was in Q4 last year. $6.7 million of the $13.7 million increase is due to the amortization of deferred maintenance agreements acquired from Chordiant, while the balance of the increase, almost $7 million, is due to the continued growth in our customer install base. Just about all of our customers subscribe to and renew annual maintenance agreements. Purchase accounting rules give a haircut to maintenance arrangements that are in deferred revenue at the time of the acquisition. This is why we have provided supplementary information on a non-GAAP basis in order to allow investors to more accurately model our maintenance revenue run rates.

Professional service revenue set a new record of $36.9 million on a non-GAAP basis, up by about $4.1 million from Q3. The increase is a reflection of the growth in new license signings that we saw in Q3 and Q4. Demand for services continues to be strong. So, in spite of the fact that a growing portion of implementation work is being done by partners, we expect that this trend will continue into Q1.

Partners also continue to be an important part of our bookings growth as they're associated with about 38% of all active opportunities in the pipeline. Demand from customers for training was also very strong. Training revenues in 2010 were up 61%, in comparison to 2009.

For the year, gross margins are about the same as they were last year, other than the much larger cost of license in our GAAP financial statements. This is due to the amortization of the software intangible asset created as part of purchase accounting. This charge is added back as part of the GAAP to non-GAAP reconciliation. Page 22 of our 10-K details the amortization of intangible assets.

On a non-GAAP basis total operating expenses for the quarter, other than the acquisition and restructuring charges, was $52.3 million, an increase of only $2.2 million from Q3. This increase is consistent with the $2 million increase in operating expenses that we saw from Q2 to Q3. As was the case in Q3, sales and marketing expenses made up most of the quarterly increase in operating expenses; however in Q3, sales and marketing expenses increases were driven by an increase in headcount. In Q4, sales and marketing headcount increased by only one employee. So, the $2 million increase in quarterly operating expenses were primarily due to commissions on our record bookings in Q4.

Since 2006, we've been investing heavily in R&D as well as sales and marketing. We plan to stay the course on this growth strategy. In 2010, we dramatically grew the sales and marketing organization early in the year, and by year-end, this organization had grown by 49% or 124 employees. We added many new sales staff earlier in the year as it takes about nine months to fully onboard and train our new sales staff. We believe that both the record Q4 bookings, and the strong pipeline with which we started Q1, are due to these new salespeople becoming productive.

During Q4, we added 29 people to our R&D organization. The majority of which were located in India. We will continue to invest in R&D to lengthen our lead over possible competitors, and make improvements in the product that will drive license revenue growth.

G&A expenses increased slightly from Q3 as headcount increased by four employees. Our FAS 123-R charge for stock based compensation for 2010 was about $6.7 million on a pre-tax basis. Note 13 of the financial statements details how this charge is allocated to cost of revenue and operating expenses. This charge is also shown as an adjustment on our GAAP to non-GAAP reconciliation that can be found in our earnings press release.

Foreign exchange rates reverse themselves yet again in Q4, and we recorded an FX loss of about $1.5 million, which effectively offsets the $1.5 million gain in Q3. We finished the year with a $5.6 million FX loss, exactly where we were at the end of Q2. Translation gains or losses do not reflect any change in our business conditions, and they are beyond our ability to control or forecast.

We are in the process of implementing legal tax and organizational changes where one of the effects would be to move FX gains and losses from the P&L to comprehensive income. Our GAAP income tax provision looks a little strange due to the new purchase accounting rules where certain items are now expensed for GAAP purposes, but are not deductible for tax purposes. On a GAAP basis, we show a loss of $6.2 million for the year with a tax recovery of only $306,000 or 5%. Our non-GAAP provision or approximately 33%, looks more normal and is a good rate to use for non-GAAP bottling.

Our accounts receivable balance increased by only $1.7 million from $75.9 million at the end of Q3 to $77.6 million at the end of the year. While we had record bookings in Q4, the small increase is the result of very strong collections in Q4. Our DSOs decreased from 59 days at the end of Q3 to 47 days at year-end. As a result, our cash position topped by $18.4 million in the quarter from $68.9 million at September 30 to $87.3 million at the end of the year.

During the year we repurchased 294,059 shares for $8.3 million at an average price of about $28.15. At our November Board meeting, the Board voted to increase the balance available to repurchase our common stock to $15 million, and extend the buyback period to December 31, 2011. Therefore, at year-end, we had a balance remaining of approximately $13.2 million available for future repurchases.

Deferred revenue shows up in two places on our balance sheet, short term and long term. The sum of these two, which is $74.7 million, is an increase of $24.1 million from Q3. This increase is primarily due to one arrangement of approximately $20 million which we did not recognize as revenue in the quarter, but received payment in full.

Our record bookings for Q4 and our record backlog and pipeline at year-end allows us to provide guidance for significant growth in 2011. We estimate 2011 revenue to be $431 million on a GAAP basis or $435 million on a non-GAAP basis. We expect 2011, like 2010, to be very back-end loaded year. This is annual guidance.

We prefer not to 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 the 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 its ruined many other software companies; however, we will give a more detailed outlook for the first half of 2011. So, with the caveat that we don't manage the quarterly numbers and revenue recognition can result in lumpy results, we estimate that due to the back-end nature of 2010, and our expectations that 2011 will be the same, we estimate revenue for the first half of the year to be approximately $192.5 million on a GAAP basis, and $195 million on a non-GAAP basis.

Our investment in sales headcount in early 2010 was one of the reasons for our record license signings in Q4. This has been a major driver of our growth, and so we will continue to invest in both sales, and research and development. Given this growth investment, we estimate that net income for 2011 will be $27 million or $0.69 per share on a GAAP basis, or $45 million or $1.16 per share on a non-GAAP basis. Like 2010, we will invest early in the year, and so our profitability will be back-end loaded as we will have high expenses and lower revenue in the first half of the year.

We held our annual sales kickoff in Q1, and we will hold PegaWORLD in Q2. Both of these events represent significant expenditures. As a result, we expect earnings per share of approximately $0.06 on a GAAP basis, or $0.30 on a non-GAAP basis for the first half of 2011. In estimating net income for 2011, we're forecasting a FAS 123R charge of $9.8 million on a pre-tax basis, or $6.5 million on an after-tax basis.

Lastly, I need to repeat that we do not manage quarterly numbers. We're managing the Company with a goal of growing rapidly, and extending our leadership position in our space. If this means making the right decisions to grow the business rather than make quarterly numbers, we will make those decisions.

In summary, Q4 was a quarter of amazing growth. While we recognized only $27.4 million of license revenue, we booked more than $60 million, built backlog and grew our pipeline to record levels. With more detail on Q4 achievements, I would like to now turn the call over to Pega's Chairman and CEO, Alan Trefler.

Thank you, Craig. I think you did a good job of highlighting the fundamental strength of our business as we enter 2011.

Today, I will recap some of the highlights of the last year, and identify some of our strategic themes for 2011. But before getting into those topics, let me say that it is frustrating to have had the business do so tremendously well in Q4, yet have a large disconnect between what was sold, and how the results are reflected in the revenue or net income lines. When we signed the big deal in November, having been chosen by an existing client to become the basis for a major transformation initiative, we were thrilled, but complicated big deals can create accounting challenges.

At the end of the day, we tell our sales team to worry about signing good business, to take good care of the client and to not obsess over revenue recognition. And that's how we operate, but that doesn't make the disconnect any less personally frustrating. To me, the record bookings and record cash receipts more realistically reflect the strong state of the business. Over time, I expect that revenue impact of big deals will continue to decrease. For one thing, we're seeing a lot more of our business go to a ratable model where there will be significant recurring software revenue, both in license and maintenance, to balance the lumps, and as we get bigger as we're focused on doing quickly, any one deal has a smaller effect.

Getting into 2010 for a moment, it was a great year for Pega. We launched PRPC, our Version 6, our flagship product, delivering a huge leap forward, and making it easier for customers to directly capture objectives, to situationally manage their business, and to automate work. We were recognized as the clear leader by both Gartner and Forrester in BPM, and recognized as a leader in CRM by Gartner. And earlier this year, the capabilities of our case management solution were recognized as the clear leader in capability in Forrester's Dynamic Case Management Wave. We grew our staff by about 50%, allowing us to substantially increase our coverage of the world's leading organizations, and we successfully closed and integrated our first significant acquisition, bringing new talent into Pega, new decisioning technology and additional strengthen in CRM.

Pega is strategically very well positioned. We are poised to enable organizations to achieve the business agility they demand. Taking the traditional definitions of BPM and customer relationship management, and moving them to a whole new level. We are the Company that fills the execution gaps in businesses, what they need when conventional ERP and CRM approaches or manual programming aren't enough to get the jobs done.

Because the Pega system runs off of business metaphors, like graphical process definitions or decision tables, the business agility we drive is unique and the results are staggering, faster revenue growth, intense driven guided customer service, and improvement in operational efficiency. Our clients can have it their way, as our trademark motto, Build for Change, says.

But while we are very happy with the position with the analysts, we believe that those BPM pictures don't reflect the full potential of our technology. We take it farther than the competition, becoming a true third alternative to settling for an unchangeable coded software package or building from scratch. There's tremendous pent-up demand to be able to apply technology better and Pega BPM delivers.

BPM is now about business agility, the being able to operationalize your business intent and Build for Change. We're augmenting this advantage in our core technology by delivering solutions in the form of industry specific frameworks, and horizontal offerings including CRM and case management, both areas where we have been named as leaders. Complimenting this with our predictive analytics and decisioning assets and enabling the core technology to run beautifully on the cloud, just make the BPM vision more powerful and accessible. Customers recognize the need to unlock business agility, and they see how our software is capable of true business transformation.

Let me illustrate with some recent customer highlights. Our large global insurer purchased our software as the strategic platform for their customer service transformation project, which will deploy PRPC in our insurance industry framework for customer service. This customer is expecting to achieve operational cost savings of approximately 25% by the end of this year, while improving both customer experience and employee satisfaction through the use of guided processes and realtime reporting. Actually, achieving this level of benefit is quite common. The President of Medco, a Fortune 35 company, and another transformational customer of ours, recently stated at a Forrester conference that they expected to save $900 million a year through their application of our technology.

Another large insurance company selected PRPC and our CPM framework to support a new national call center, making it much easier to sell to and service their base. Remember that CPM is what we call our version of CRM, which is also known as customer relationship management, except with CPM, the P stands for process. The customer has the ability to create multi-channel processes that work in the call center, the back office or over the web, and that reduce training and improved consistency by guiding the users.

ING Insurance in Central Europe, a leading insurance company has selected our Know Your Customer financial claims management frameworks, and agents across the organization will be using this as part of the ongoing process in eight countries. The biggest bank in Australia also chose our case management capabilities, and made us the standard for fraud case management beating out competition from both BPM alternatives and the stack vendors.

In financial services, we won a major new name client, a prominent US-based brokerage firm. We have the service backbone for 12,000 employees across four lines of business, servicing over 8 million accounts, and a trillion in assets. Citibank, a longstanding global banking client, has chosen to extend its implementation of PRPC to provide multi-channel work automation across the North American retail enterprise. Full deployment will touch over 17,000 bank users as a single backbone while facilitating client self-service.

Our emerging and very exciting telecommunications vertical had numerous wins both with our decisioning technology for cross sell up sell, and with the use of PRPC, to automate processes such as order management, provisioning, and fulfillment. Changing the very way that the users interact with their existing technology by wrapping and renewing it as we say, and some of the sound bites are precious. A major telecommunications provider in the US went live on a solution to guide their interactions with customers and maximize sales wins and help retention. A long time agent on the team remarked, quote, it's like having a psychic next to me, unquote.

Healthcare had a strong performance in 2010 with customers selecting Pega to drive automation in the call center, providing enrollments, appeals, medical review and other areas. In past quarters, we have previously noted that healthcare had been slower in the early part of 2010 due to confusion around Obama Care. Well in Q4, healthcare more than made up for the shortfall and blew past their strong 2009 performance.

We're also getting good synergy between our healthcare and pharma sales efforts. A large life sciences customer completed a multi-channel contact center for US operations, utilizing CPM for healthcare, helping to ensure regulatory compliance. It's expected to be rolled out to support other country implementations in the future. A top US automaker chose Pega for our new Warranty Claims Management framework to serve as a backbone for global warranty claims.

And our energy related businesses are showing great promise. In Australia, we won our first government deal, in which Pega technology will be used by the utilities regulator to drive processes, and in China, we closed our second deal on the mainland where Pega BPM will monitor processes for an energy provider. Great win driven by outstanding partner relationships, and part of, I think, the great promise that we have as we move into the energy sector.

2010 was also an outstanding year of engagement with our partners. We now have well over 4000 partner staff in the partner ecosystem, representing a net add of over 1700 for the year, and over 1500 partner resources achieved formal certification in 2010. In early January, we had over 100 key executives from our partner network join us at our annual sales kickoff to work with our sales teams on account strategies for 2011, and 20 partners have already signed up to sponsor PegaWORLD, scheduled for Orlando on June 6 and 7. We expect record attendance again this year in what is proven to be the largest premier event, bringing our customers together to discuss their achievements about enterprise agility, and showing how BPM works.

So, let's look ahead to 2011. We're excited by our potential in the market, and we plan to continue to support our growth in a number of ways. We will continue to buildout our sales coverage of target accounts, as there are many organizations that would benefit from additional coverage. We will continue our geographical expansion, especially in Europe and APAC.

We will continue to bring new capabilities to a product line. We have identified a number of changes that will significantly reduce training time while adding power to the software. We will continue to add vertical industry capabilities to speed adoption of our target clients. We will continue to marry the Pega and the ex-Chordiant assets, creating further opportunities for cross selling between the previous customer bases. And we will continue to use our cloud capabilities to make adoption easier and less expensive for clients.

In conclusion, 2010 was a great year for Pega. As we begin 2011, we continue to focus on customer-centric customer service, case management, and the true promise of business process management, helping organizations leverage our technology to unlock the agility they need in their businesses, driving revenue growth, improving customer service, and letting them have it their way, in control.

Matthew? We can now open the call for questions.

(Operator Instructions) Laura Lederman, William Blair. .

Thank you for taking the questions. I guess a few wrapped up all into one to understand the quarter a little bit better. If you take out that $20 million deal, can you give us a sense of how strong the quarter was? And also, on a related question with the $20 million deal, it's great to have such a big deal, but the problem is it made up it seems so much of the years bookings. And is there a way to go down market to not have a lumpy deal because even if you grow next year, a $20 million deal will still be a big piece of the bookings? And a third question, sorry I'm lumping them altogether, but I'm about to lose my voice, can you give me or us a sense of how much bookings increase for the full year? Sorry about that.

Yes, so a couple of different things. First, we don't count on necessarily, or at all pursue mega deals. The reality is there's actually a lot more business from this customer, and they were already a significant existing customer. So, I think that we are quite interested in going down market, but we can go down market even in very large clients by selling things in pieces. So, we don't drive for a big deal like that; however, having said that, obviously if it can be done on reasonable terms, we're glad to do it. And it does provide a good basis for laying a lot of backlog in this particular case.

This year, we've actually had fewer mega deals than in the past. I think it's just sort of a statistical anomaly. I would say that the bookings for the quarter were strong even without this deal. I mean, we had just an awesome bookings quarter and this deal, particularly the size that it was, was the icing on the cake. I would say that we had reported that for the first three quarters, bookings in aggregate were a little slow. They were slightly lower than 2009, which frankly was actually a very tough compare. This year, as a result of, I think, the excellent performance, we made up for that shortfall, and actually were able to come in with a somewhat higher bookings number than we had previously.

Final question, and then I'll obviously pass it on. Can you talk a little bit about the pipeline, and how it looks? You mentioned it looks strong, but let's say bookings were up only slightly for the full year. It's still a relatively low bookings growth number for '10, so how does it feel going into '11 in terms of returning to growth from a bookings standpoint?

The level of activity is numbingly high as we're going forward here. Basically what happened as you may recall, we did a lot of investing in at the very, very end of 2008 -- sorry end of 2009 and during the first couple quarters of 2010. And as we enter 2011, the pipeline is about order of magnitude 50% bigger than it was a year ago, which is good because that's consistent with our efforts to increase the staff. And so, we've meaningfully increased our sales and marketing staff, and we've seen a commensurate rise in pipeline. I will tell you that I consider the pipeline at extremely high quality, a lot of which has been done to scrub it. And we've also formalized a number of our procedures around how we propose to customers, also commensurate with the business continuing to grow, and needing to be more organized. So, I would say that the condition of the pipeline is better than I've ever seen it.

Thank you.

(Operator Instructions)Richard Davis from Canaccord.

Yes, with regard to the $20 million deal, if you're recognizing it at $1.5 million per quarter, does that imply then, it's a, because it obviously totals, over 3.33 years. Is that the duration of the contract, or is that just the number the accountants came up with? Or how does that fit together?

The arrangement was for a perpetual license. It's just the formula that was derived in order to recognize revenue.

Got it. And then with regard to Chordiant, do you have some examples of where you've done some cross selling, up sells into that base? And then the second question is, if you're willing to give it, is there any sense of the rough change in the headcount at Chordiant in aggregate, or would you be willing to talk about that number?

Yes, sure. We had actually a number of examples where we have had both cross sell campaigns and successful results. The Chordiant/Pega cross sell and up sell pipeline is very high, but I can think of several examples where we were able to actually take the combined Chordiant Pega assets and sell something that unified both of them that frankly is just terrific, and I think it's just the beginning. Your headcount question, I'm not sure that I understand it. We didn't, outside of the G&A areas, we didn't engage in any reduction. We really worked to incorporate the Chordiant technical staff, and the sales and marketing staff and whatever. There's always some disruption, but we did not buy Chordiant to let people go, if that was the question.

Yes, and then the last question, we get peppered with is Japan. Any impact there, because that's an inbound question we get on every single company we follow now.

Well, in one of those examples of interesting timing, we did open up Japan for us last year. We've got 10 people on the ground, and a great set of partner relationships that are obviously very, very critical. We hired a very experienced native Japanese gentleman to be our managing director, and to drive that office and he was able to bring along some excellent staff. So, we're pretty excited about Japan, but it's emerging. We really had very low expectations. It was zero revenue last year, and we are at low expectations for Japan this year. We think that's a multi-year sort of thing. We do have existing clients in Japan that we can actually apply some of those resources to doing service work for instance as well. So, I'm not at all worried that's going to impact our financial statements in any meaningful way.

Okay, thank you.

Raghavan Sarathy, Dougherty & Company.

Good afternoon. Thanks for taking my questions. I have two questions. First, on the license bookings. Craig, you mentioned a couple of times fourth quarter had record license bookings that exceeded $60 million. Can you give us some sense for what was the comparable number for the same quarter a year ago, and what was the growth in license bookings for the full year? And then I have a follow-up on sales force capacity and productivity. Thank you.

Raghavan, as you know we generally don't give bookings numbers because that number is not comparable across different software companies. The $60 million is the license component of bookings, so that's a very conservative measure. I know that several software companies include multiple years of maintenance, etc. Ours is just pure license numbers. So, we do always hesitate to give raw numbers. We tend to give direction, but in this case because it was such a phenomenal record for us doubling what it was in Q3, we decided that we would give the license just -- the bookings number for just this one-time.

And it was significantly higher than Q4 in the previous year.

Okay, and directionally any sense for the full year how license bookings was for the full year?

License bookings exceeded what they were last year. We were happy that bookings grew, which resulted in higher backlog and higher deferred revenue, obviously. In addition, the term license off balance sheet numbers, that are on page 31 of the K, rose significantly in the year as well. So, we were very pleased with the bookings, and as Alan said, especially when you look at the bookings in terms of a lot of bookings with new accounts, we see that as a pretty good indicator that the sales hires that we did earlier in the year are becoming productive by the end of the year.

Especially when so much of our business is focused on getting a good sail, closing something, and having a basis for follow-on business. We don't go in and do stupid deals that sell our customers out, which is sadly fairly typical of the software business. That's not our model. So, we've got a lot of customers who have actually now got the software in house who are in a position to radiate, and a lot of the business we sell is what we call radiation.

It's a good segway to my next question about sales force capacity. I think back when you reported second quarter, you said increased by roughly 55%, while only 15% of them are productive. Can you give us some sense how much it increased the capacity for the full year of 2010? How much of them are you expecting to be productive in the near term, and where would the headcount be by the end of the year?

I don't think we said that percentage was productive. I think we said that percentage had been onboard for more than a year. We're seeing that a lot of the new guys we brought in Q1 and Q2 are contributing, and that is reflected in both the record bookings we had in Q4. And as I said, in the record bookings that we did with new accounts because a lot of times, these guys go into new accounts. That's how we grow by covering additional named accounts, and for them to come onboard in Q1 or Q2, build up pipeline relationships in a new accounts and close business is a pretty good indication that they are being very productive in it seems like a long time, nine to 12 months. But I think really if you have to do all of that in 12 months, that's I think actually a pretty short time.

Let me give a little more color too because we've been thinking a lot about how we boost sales force productivity, and it's obviously very, very important. We need to do it directly and in concert with for example, our partners where we've also put a lot of complimentary work, but the way our sales force is organized is actually somewhat different from just about all of the other software sales forces that you may be aware of. We are not primarily a territory based organization. So, we actually have financial services salespeople in North America report to a manager for financial services, similar for insurance, the same sorts of things for communications and life sciences, and by doing that, what you really have is two things happening.

One, the manager is actually in a much better position to evaluate the effectiveness of the sales force by observing operationally what's going on because the manager knows the business, and can actually help out and I think be smarter about how they work with their staff to get them off the curb. And the second thing is we have been putting a lot of work into training and also trying to make sure that we identify frankly if there are problem performers, identify them faster and make sure we get to the right outcomes in those sorts of cases. So, a lot of investment has gone into making the sales force productive. I think the test for us, particularly as we continue to grow it in this year, is can we hit the sorts of increases in bookings and revenue that you would expect as you boost the sales force and you have more accounts. And that frankly, is the challenge for the business and it's one I actually feel quite good about.

Okay, thank you. I'll jump back into queue.

Steve Koenig, Longbow Research.

Hi, good afternoon. Just a few questions here. My first one is about the dynamics of your market and your competition. Are you all finding yourself competing more with the stack vendors, the BPM pure plays, the CRM vendors or the vertical apps and providers, and is there any change in this mix since last year?

Actually, the market has been undergoing quite a bit of change in the last 24 months. During the downturn a number of the smaller players in 2008 and 2009 lost momentum, and ended up getting sold. So, in fact, we actually saw for example, Lombardi, which was considered to be one of the premier vendors in the BPM space get acquired by IBM, which we were already competing with IBM because frankly IBM already had two other BPM products, something they had built themselves called WebSphere Process Server. And they bought years ago a company called FileNet, which was in the BPM space. So, it's kind of funny, you look at the Gartner quadrant and you see three IBM dots, which I think sort of sums it all up.

We find that for a long time, the stacked vendors say they have BPM, but we are having good success in getting customers to see the differentiation, and to understand that Pega really is quite different and a lot more. I'm personally really quite pleased by the consolidation. There's very little evidence that the clever attention to detail and customer attentiveness that you sometimes get out of boutique players -- there's very little evidence that continues for any extended period of time in large companies, and we think this is really going to help us continue to push our advantage forward. So, if the stack vendors are everywhere, SAP has said for years they have BPM. They have something called NetWeaver, which has been largely viewed as sort of a disaster, and competition is there. Having said that, as we continue to grow, we're clearly the scale now where the customers believe that we'll be around as opposed to a lot of the really smaller vendors. And we are, I think, served extremely well by the consolidation that's happened.

That's real helpful. Boiling that down, how would you describe your kind of normalized growth rate when you look past the variability that you get from the changes in the license mix? Your normalized growth compared to the market, how do you view that?

I think we're growing much faster than the market. One of the interesting things that happens when stack vendors buy somebody is their classifications. They do these enterprise deals, and they throw everything in. A lot of it is never implemented and they move the numbers around to suit whatever they want to report to IDC. So, I think that you have to always look at market share numbers with a little bit of suspicion from these stack vendors, not just in BPM. I just think, in general, we know that's done, but there's no question that our growth is way ahead of the market at this stage, and the adoption by our customers is very deep.

If you went to the examples that I'm talking about, we're becoming an integral part of the way these organizations do business as opposed to just some people do BPM where they route stuff around. They kind of use it to say -- I've got a document. I'm going to move the document around. That's not what we're doing for most of our clients. For most of our clients, we actually become a layer that the people use to get their work done. We sit on top of SAP in hundreds of organizations, and actually make that system useable. So, that's why I feel pretty good about where we are in the market, and how we're going to be able to continue to differentiate ourselves.

And if I may ask one last question. This one is for Craig. Craig? Cash flow came in positive for the year. It was down sharply from '09. With the hiring again early this year, should we expect cash flow to improve in Fiscal '11 and directionally, would that be modest improvement or would it be back to F '09 levels? Any thoughts you can give on that would be helpful.

Yes, we expect cash flow to improve in 2011. We had a lot of items associated with the acquisition, we acquired a lot of receivables that were a little slower to collect than our receivables. We had fantastic collections in Q4, our DSOs dropped and cash jumped up by about $18.4 million. So, we expect that to continue during 2011.

But it may take a little more than one year to get to the '09 levels.

Thank you.

Brian Murphy, Sidoti & Company.

Hi, thanks for taking my question. Alan, you're adding a lot of SI partners here. Can you give us a little bit of color on what is driving that just in terms of competitive dynamics in the marketplace? Why are these guys gravitating toward BPM tools, and is there any advantage for them in aligning with an agnostic sort of BPM platform rather than something that a stack vendor would offer?

So, to start with the last one, there's obviously major advantages for them to use us as opposed to Oracle or IBM because both of those organizations actively compete, and our whole strategy has been to have enough services that we can actually supplement our partners. But our whole strategy is to really put a lot of food in the water for our partners, and the reason that they're investing significantly and doing very dramatic things is that they see business out there, and they also have done a deep dive and they see this as transformational.

The thing I'm most excited about is we now both have some really good emerging relationships with the Indian partners, folks like Cognizant, Tata, Infosys that are very meaningful relationships that are bringing us work. But also, the sort of I think traditionally more aloof partners like Accenture, Capgemini, they are all over us right now. We are deeply involved doing strategic meetings at the highest levels with their management, Accenture actually went out and bought a company to deepen its bench in Pega BPM. This was a company dedicated to Pegasystems' BPM, and all of these organizations are working extremely hard to train their trainers. We've given them the right to train their own people, and to also buildout practices domestically as well as over in India. So, they see the business strategically. We're by far their best bet.

We can compliment pretty much anything. We don't have any conflicts of interest with a company like Capgemini, and for example, they've named BPM as one of their organization's three -- what they call three top line initiatives. And I'm actually going over next month to present to all of their senior executives at their retreat about what Pega BPM can do for them, and what BPM can do for the market. So, it's not to say they would not in some cases use somebody else's, but it's pretty clear we're getting the mind share of the right people.

Okay, and Alan, did you give us any color on nature of the $20 million deal? Was this a call center deal or was it more comprehensive than that?

It was what we sometimes refer to as a service backbone. So, it's part of how the organization would actually handle service potentially the multi-channel environment, so allowing you some service of the web, back office and in the call center, and also it was not a sell you out deal. This was a very rational piece of business that we would expect in several years the customer will be buying more, which is frankly the only way you build a sustainable company, which has customers interested in working with a sustainable Company. Interesting, they actually had an incumbent system from one of the stack vendors, and after having done some work with us in one of their groups, they made the decision that they wanted us to be the basis of their transformation. So, I'll let you figure out which of the two that could have been, but it was a very exciting win.

And what are you seeing out there in terms of call center replacement opportunities?

So, we're pretty excited. We've actually stood up a group, aiming to focus on this. It's really nice to have just crossed into the leader quadrant in the Gartner magic quadrant. The call center, I think, things fall into two categories. You have some customers who I think are going with guys like salesforce.com is right now. And frankly, we automated at a very, very different level than I think you can reasonably do in applications like that, and we're a model driven architecture. So, the way you define what you're doing is really completely different.

It's really designed to help people handle the processes, and then drive their processes to fulfillment. So, in the call center environment, we're finding that when the customer needs something that I would describe as even modestly sophisticated, the choice is either us or Siebel. And I don't see a lot of people really excited about doing their expensive, big Siebel upgrades. And we've got a strategy that lets us come in and compliment an existing Siebel system, and let the customer gradually step away from it. We can sort of burrow into Siebel and wrap and renew it. So, I think call center can be a tremendous business opportunity, and that's one of the places we have invested in 2010, and we're going to continue to in 2011.

And where is sort of the target rich environment there, which vertical?

Well, it's interesting. Communications was relatively new vertical for us. It's a tremendously target rich environment, particularly when we mix the ex-Chordiant decisioning capabilities. So, I've been stunned at how that's taking off. The banking industry is a good one. We've actually won a couple of -- I actually referred to one, a couple of call center and customer service, multi-channel customer service. Several big deals of that type have been won by us, but back to the insurance companies.

The sales cycle is long, and particularly when they've been distracted in a lot of cases with [their own mix]. As they come out of it, I'm expecting that we'll see quite a bit. And healthcare has traditionally been very, very good for the call center. We run the call center. We are the Aetna's strategic desktop on 18,000 desks at Aetna, for example, and they use us to win business. So, we are the system that call center uses, and all of the other systems are sort of buried behind it, so they can really manage it for example.

Okay, thanks a lot.

Edward Hemmelgarn, Shaker Investments.

Yes, a couple of questions. One, can you talk a little bit about your headcount increases for sales and marketing this year? When you added a lot of people last year at the beginning of the year -- what's the plans for this year, or what have you added already?

Well, we increased the order of magnitude 50% last year, and I don't think we'll do quite that much but I'd like to do close to that. I think that we're going to continue to monitor how we're doing, make sure we're not going beyond the capacity to onboard and to manage. But we think there's a lot -- we know there's a lot of accounts that either have too thin coverage, or who have in some cases no coverage, and we are talking about very, very significant companies. So, we're comfortable that as long as we continue to be disciplined about onboarding, and we can demonstrate we're getting productivity that we should just continue to grow that. And some of that is baked into the plan.

So, one of the things that's driving your plans for lower -- you had very good revenue growth outlook for 2011, but this is for you, Craig is that one of the things that's really driving the lower income in the first half is just going to be a continued, or significant increase in sales and marketing?

It's a combination of things. It's that, Edward, plus in Q1 we have our annual sales kickoff meeting where we bring all of the sales reps together, layout strategy, new products, et cetera. It's a major education session. That happens in Q1. That's very expensive to bring people in from all around the world. And then in Q2, as Alan said, we're holding PegaWORLD is the best and biggest event that we hold during the year, and that's in Q2. So, both of those things in addition to the sales force hiring will depress profitability in Q1 and Q2.

And for example, PegaWORLD, last year we had 1200 people show up. This year we're on track to have order of magnitude 1700 non-Pega people, and so we think it's a good investment. Folks leave that place jazzed because they get to see lots of other customers. It's a very customer-centric show. Last year we had 31 customer presentations, production of the website if you're interested. Some of those companies are doing just amazing things.

Got it online. Will look forward to it again. Second question then Alan, is you indicated you got a lot more new customers in 2010. Those new customers that you added, any that you think can grow into the type of major customers that you've traditionally have had. You have got a few customers that are very large.

Yes. I mentioned in my remarks about a sale, a brand new sale by the way to splicing a stack vendor into one of the largest financial services companies in the US and the world. And there is lots of these that have tremendous room to grow because you remember, we're tending to still sell to organizations that are massive, and we are very modest in our penetration of most of our large customers. There's a lot of upside opportunity.

Was that a customer that you hadn't been in before last year?

Yes, it was. It was just tremendous.

Okay, thanks.

And it wasn't the $20 million deal by the way.

No, you'd indicated that was a prior customer.

Raghavan Sarathy, Dougherty & Company.

Thank you. I apologize if you already answered the question. I just rejoined the call. With regard to the $20 million deal, I think Alan you said it's a service pack, multi-channel type of deal. Is that a BPM deal, or is it actually a Chordiant type of contact center deal. Can you clarify that?

So, Pega has brought BPM to the call center just before I answer just to clarify. So, we have that CPM framework which is built in the Pega technology. Now complemented by the Chordiant technology for decisioning, but the actual desktop and processes are the very, very strong Pega BPM technology because we think that process and smart systems make perfect sense in the call center just like they do in lots of other parts of the business. So, just in terms of how we think about it, but the primary purpose of the $20 million deal was in fact not being the CRM desktop. Should we do that for this customer, I think there's a lot more upside there. We will be embedded in an existing desktop, something we do quite a bit of, and sort of linking certain service propositions to the way that they carry out parts of their fundamental business.

And then just a quick follow-up. So, in terms -- I'm trying to get some sense for the productivity of the sales force, and I think you're trying to give us, you added more customers this year compared to last year. So, obviously the fourth quarter bookings is skewed a little bit by the big deal. Can you give us some sense for how many new customers you added this year versus last year, so that we can get comfort in the sales forces production?

In terms of numbers of new customers, we did almost three times the number of deals with new customers that we did last year.

Okay, great. Thank you.

Laura Lederman, William Blair.

Thank you so much for taking additional questions from me. Now that we're through 2010, if we could step back and look at why you think the bookings were only up a little bit, how much of it was healthcare and the delay there, but you said that was made up in Q4? So, how much of it was lack of whales except that $20 million deal? How much of it was the delay and hiring salespeople? What you did in '09, and did in the first half of '10. I'm just trying to step back now with the benefit of hindsight to understand more holistically.

I think, holistically, we do feel pretty darn good about the year. The reality is the Chordiant acquisition was very consuming of management time for pretty much the whole year. By the time we went into Q4, it's behind us, and we've really gotten the integration going, but we had never done an acquisition of that scale before, and it was a lot of work. I think that we may have slightly underestimated the amount of distraction that it had in the first couple of quarters of the year when we were doing the diligence, and then proceeding forward with the acquisition. I also think it's just a normal set of vagaries. We didn't have very many big whales this year. We had a bunch in 2009. I've got mixed feelings about that, but I think that the year ended very strongly. So, Q4 was just tremendous, and the energy and the momentum going into 2011, I would tell you is extremely strong. If it wasn't, we wouldn't be continuing to hire salespeople.

Sort of a strange question in terms of timing the whales, if you look at your '11 expectations, how much of that is regular way business versus whale business and I guess related to that --

Yes, we don't plan for whales. I mean, we just don't. In the back of our mind we figure we'll probably get one, but there's no way we're running this business as a whaling ship.

Okay. If '11 is not based on whales, why is this year expected to be so back-end loaded because I guess I thought there was more of a whale phenomenon. So, help me understand the back-end load a little better.

Yes, I think we've traditionally found in the software business, we've traditionally found that things tend to be back-end loaded.

I mean, most of corporate America are on calendar years, and they don't like to spend their budget early. They hang on to it. They have to run a sales process throughout the year as part of their Sarb-Ox requirement, and it takes them a little while, and they really don't start pulling the trigger on things until Q3 and Q4. I guess I was mislead a little bit by the ratability and the deal signings in '09. So, that was more unusual for you, and you're just really back-end loaded because of how technology is. So, '09 was more of a unusual circumstance than something you could expect going forward, then.

Well, I did say that I expected that we will get more ratable software related revenue. Some of that is maintenance. Some of it is we like term deals. It's really very good for running the business, and we actually do with the client once, but we encourage them. The reality is though, that provides a base. You can actually take a look in the K. It breaks out how much of our business comes from these different sorts of components, and we'll still be closing non-ratable business in 2011 and '12 on a go-forward basis.

Final question. Can you talk a little bit about Chordiant, and I don't know if you look at that pipe separately, but if you can give us a sense of the level of customer interest there. And how did that pipe go throughout the year, and how much of that closed in Q4? And how would the pipe look going forward? So, just give us sort of an '10 and '11 view of Chordiant?

Yes, so the pipe for the Chordiant, what I would describe as Chordiant product related stuff, which has now been in many cases merged with Pega. So, for example, we sold a use of Pegasystems in collections, which you can imagine is important to companies these days, which is the marriage of Pega and Chordiant in a single seamless package. That's exactly the types of things that we've been doing, but the Chordiant capabilities have proven very appealing to the customer base. And we're getting a lot of interest not just in the Chordiant bits, but in the aggregate package, which is enhanced by the ability, in particular, to do what's called predictive analytics. And we're right now actively in the process of dealing with a number of Chordiant customers, and working with them on their strategy for how they adopt PRPC-based technology. And there's an extremely high level of interest in that and there's been a lot of progress there. So, I look at the Chordiant acquisition as ultimately having been a very good thing for the Company. The reality is it was a tremendous amount of work, but I think we all believe it was worth it. Thank you, Laura.

Thank you for being gracious enough to take all my questions.

Thank you, and I'd like to turn the program back to our presenters now for any concluding remarks.

Thank you very much, everybody. We appreciate you taking time out in the evening, and we're working very hard to grow this business and do this right. And I look forward to being able to talk to you at the end of Q1.

Thank you, goodnight.

Ladies and Gentlemen, thank you for your participation on today's conference. This does conclude the program, and you may now disconnect.