Pegasystems Inc (PEGA) 2011 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Pegasystems' fourth quarter 2011 earnings conference call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to hand the conference over to Mr. Craig Dynes, Chief Financial Officer. Sir, you may begin.

Good evening and welcome to the Pegasystems' 2011 Q4 earnings conference call. With me here at the Morgan Stanley investor conference in San Francisco is Alan Trefler, Pegasystems Founder and CEO. 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 anticipate, projects, expects, plans, intends, believes, estimates, targets, forecasting, could and other similar expressions identify forward-looking statements which speak only as of the date the statement was made.

Because such statements deal with future events, they're subject to various risks and uncertainties. Actual results for the fiscal year 2012 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 2011 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, 2011, 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.

On our Q3 call we reminded everyone that our individual quarters can be lumpy and down quarters are often followed by significant annual growth. Our Q4 results show this pattern to be true with record Q4 bookings and revenue, as well as record annual bookings and revenue.

Q4 license signings were the largest in our history. For the year the aggregate value of license signings was up more than 75% as compared to 2010. In addition to driving license revenue to $45.4 million for the quarter, our term and perpetual license backlog, as detailed on page 32 of our 10-K, jumped to almost $210 million, an increase of 70% or $86.2 million from last year. By covering more accounts and more verticals we continue to dramatically grow our customer base. The aggregate value of licenses signed with new customers grew 145% from 2010.

At the end of 2011 we are holding total backlog of $359.8 million, an increase of 55% over the backlog at the end of 2010. This backlog does not include any portion of annual maintenance agreements and term license agreements that we expect to renew during 2012.

On every call we also note that our financial revenue can be impacted by the mix between term and perpetual licenses. Last quarter we noted that we saw a short-term pipeline that was leaning slightly towards term licenses which, as compared to perpetual licenses, results in lower financial statement revenues in the immediate period.

Term license signings in Q4 were off the chart. Our backlog of non-cancelable term licenses of $161.4 million is up $70.5 million or 77% from 12/31 of last year. Term license revenue is $8.6 million for the fourth quarter and is $34.4 million for the year. The record value of term licenses that we signed in Q4 had little impact on the fourth quarter, but will have an impact in upcoming quarters as we recognize the revenue over the term of the license.

Page 32 of our 10-K details by year the revenue we expect from our term license backlog. Already, before we sign any new term licenses for 2012, we expect that 2012 term license revenues should approximate $37.7 million. Perpetual license revenue for the quarter was $34.3 million, an increase of $13.8 million or 67% from Q4 of last year.

Annual perpetual license revenue was $94.1 million, an increase of $50 million or 19% from last year. The growth was driven by an increase in both the number of perpetual license arrangements and average deal size. At the end of 2011 our backlog of perpetual license arrangements was $48.4 million, a $15.7 million or 48% increase from the balance of $32.7 million at 12/31 last year.

Maintenance revenue was $31.7 million on a non-GAAP basis in Q4, an increase of $4.4 million or 16% over Q4 of 2010. On an annual basis, maintenance revenue grew by 40% to $117.1 million. Professional services set a new record of $160.7 million in annual revenue, up 21% from 2010.

The increase is due to new projects started as a result of strong new license signings in the first half of 2011. Now, with the record Q4 bookings, demand for services will continue to be strong even though we are constraining the growth of our professional services since our partners are leading in a growing majority of new implementations. Partners also continue to be important part of our bookings growth as they are associated with the majority of all active opportunities in the pipeline.

Training revenues were relatively flat in 2011 even though the volume of training days increased. In order to rapidly increase the population of trained Pega professionals we will move to a more widely available online training methodology in 2012 called Pega Academy. We are making this investment to drive faster training and successful implementations. While this drives growth in license revenue, it may hold or even reduce training revenues in 2012.

For the year, gross margin percentages are down slightly from last year, partly because 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.

Professional services gross profit margin is also down from last year. In spite of the fact that our partners have a lead in most customer implementations, we've been hiring and training staff in order to fill demand created by the record Q4 license signings. Investing in the growth and support of our partners means hiring and training a large number of new employees which reduces utilization and gross margin.

Operating expenses increased by $13.3 million from Q3 to $69 million. $2 million of the increase was in R&D while the balance of $11.3 million was in sales and marketing. While part of the increase in sales and marketing was headcount, the largest driver of the increase was commissions on our record Q4 license signings.

In 2011 we increased sales and marketing headcount by 87 new employees of which 72 were in sales. We were able to accelerate sales hiring in the second half of the year, where we hired 45 of the 72 new sales employees.

I'm often asked if this is it. Have we hired all the sales people we need? We've been steadily growing sales capacity since 2006 and we see more growth ahead of us. We believe that our increase in license signings and revenues during this period is directly attributable to this investment and we will continue to grow our sales capacity in order to cover new accounts, new geographies and new vertical markets.

Similar to the sales organization growth, during the second half of 2011 we added 100 new employees 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 products which drive license revenue growth. G&A expenses increased by about 13% in the year. As we increase our international footprint, we incur increased tax and professional fees along with need for additional headcount.

Our FAS 123(R) charge for stock-based compensation for 2011 was about $9 million on a pretax basis. Note 15 to the financial statement details how those charges are allocated to the 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 on our earnings press release.

In spite of the wild ride on the currency markets, we recorded an FX loss of just less than $10 million. In fact, the actual net loss is less since we recovered most of it through offsetting gains on our hedging contracts which are recorded as part of other income net. Our low GAAP income tax rate is due to two factors. During the year we recognized the benefit on certain tax positions for which the statute of limitations expired in Q3. Previously, these benefits were considered uncertain tax positions and, therefore, unrecognized.

In addition, our US taxable income is much higher than our book income. This generates a significant domestic production activities deduction which is a permanent difference and, therefore, serves to lower our book tax rate. In addition to the rate, the individual quarterly provisions for both Q3 and Q4 were very volatile. This is due to tax provisions for each quarter being calculated based on the estimated annual tax provision.

Our estimate at the end of Q3 was based on a lower income estimate for the year. The lumpiness in our quarters dramatically impacts our estimates of tax positions as demonstrated in Q4, where our record bookings and revenue increased net income from our Q3 estimate and caused us to go from recording a tax benefit in Q3 to an overall provision in Q4 based on our actual results.

On a GAAP basis we earned $10.1 million of net income or 26% -- $0.26 per share on a diluted basis. On a non-GAAP or pro forma basis we generated $28.4 million or $0.72 per share of net income on a fully diluted basis. We provided a non-GAAP reconciliation as supplemental information in order to compare our results to analyst models. On this reconciliation we've added back certain non-cash charges such as our stock compensation, or FAS 123(R) charge, as well as the amortization of intangible assets that are created by purchase accounting.

In addition, to present a more normalized or run rate view of earnings we've added back any extraordinary or one-time charges such as the cost of moving to our new offices in Cambridge. The lease term and lease payments on our existing offices end in 2013. We have a free rent period on the new offices, so the lease payments begin as the old lease ends.

This means that on a cash basis we have no overlapping rent payments. Payments on the new lease start when payments on the old lease end. However, GAAP accounting makes us straight line the new lease cost and results in double or overlapping non-cash rent expense for both offices in spite of our free rent turn.

We've added back this overlapping non-cash lease expense as well as the one-time costs of moving the offices. We're moving the offices in two stages, therefore, our GAAP to non-GAAP guidance reconciliation we have forecasted the second stage of these nonrecurring moving expenses.

We had fantastic billings and collections quarter. Our cash flow from operations jumped from $19.6 million at the end of Q3 to $39.8 million at the end of the year. As a result our cash position increased by $13.1 million in the quarter from $98.3 million at September 30, to $111.4 million at the end of the year.

Due to our record license signings our trade accounts receivable balance increased by $16.8 million from $16.3 million at the end of Q3 to $77.1 million at the end of the year. In spite of the strong collections that fueled our cash flow, the record bookings caused our days billed outstanding, or DBO, to increase slightly from 58.5 at the end of Q3 to 65.3 at year end.

During the year we purchased 139,000 shares for $4.1 million at an average price of about $35. Late in the year our Board voted to increase the balance available to repurchase our common stock to $15 million and extended the buyback period to December 31, 2012. Therefore, at year end we had remaining balance of approximately $13.9 million available for future repurchases.

Our bookings record for Q4, our record backlog and strong pipeline at year end allows us to provide guidance for a seventh consecutive year of growth. 2012 will mean a new milestone as we estimate that revenues should exceed $500 million. There is no significant difference between GAAP and non-GAAP revenue for 2012.

We expect 2012, like 2011, to be a back end-loaded year. This is annual guidance. We prefer not to give quarterly guidance for several 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, our quarters have annual, not quarterly, budgets to buy software and we don't give crazy discounts at the end of a quarter to make guidance numbers, because our business is still on follow-on sales to existing accounts. However, we'll give a slightly more detailed outlook for the first half of 2012.

So, with the caveat that we don't manage to quarterly numbers and revenue recognition can result in lumpy results, we estimate revenue for the first half of the year to be approximately $225 million. As I said, this is due to both our strong pipeline of term licenses and our expectation that 2012, like 2011, will be back-end loaded.

We believe that a significant driver of our growth has been our investment in sales headcount. We increase our sales potential by not only covering more accounts in established verticals and geographies, but by covering new verticals. As an example, for 2011 we saw strong traction in the communications and media vertical.

Continued growth in this industry, as well as establishing our oil and gas vertical, will help us achieve new bookings records in 2012. These are major drivers of our growth, so we will continue to invest both in sales and research and development throughout 2012.

Given this investment, we estimate that net income for 2012 will be $15 million, or $0.37 per share on a GAAP basis, or $36.5 million, $0.91 per share on a non-GAAP basis. Like 2011, we will invest early in the year and so our profitability will be back-end loaded as we will have higher 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 these events represent significant expenditures which, when combined with a back-end loaded revenue year leads us to estimate that we will be breakeven on a GAAP basis, but we'll have earnings per share of approximately $0.25 on a non-GAAP basis for the first half of 2012.

In estimating net income for 2012, we are forecasting a FAS 123(R) charge of $12 million on a pretax basis, $7.9 million on an after tax basis and expect the amortization of intangible assets created from our acquisition to be $7.5 million on an after tax basis. In addition we're forecasting nonrecurring charges for accelerated depreciation, moving costs and abandoning our lease as part of our office move to approximately $6.1 million on an after tax basis.

Lastly, I need to repeat that we do not manage quarterly numbers. We are 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 and new records for bookings and revenue in very difficult financial conditions. With more detail on Q4 achievements I would now like to turn the call over to Pega's Founder and CEO, Alan Trefler.

Thank you, Craig, and good evening to those of you on the phone. Pega knocked the ball out of the park in Q4, yielding exceptionally results for 2011 while setting the stage for continued growth. We set all-time Company records for license bookings, revenue and license backlog. We closed more deals and more verticals in more countries than ever before. It's exciting to see how the world's best brands and most respected companies are buying Pegasystems technology to do things they never thought software could do for their businesses.

Our wins ranged from seamless, multi-channel customer experience initiatives to major next step action decisioning and personalized retention and cross sale programs. In light of the difficult economy, we adjusted our focus to highlight areas of traditional strength, helping our clients achieve significant operational productivity improvements and cost reductions. It is incredibly exciting to see and hear clients talk about the uses of our technology and the staggering returns they are obtaining, and I will touch further on some specific examples in a few minutes.

In 2011 our continued R&D investment has yielded a focused portfolio of industry-leading products. These include major new product releases, PegaRULES Process Commander, our unified rules and business process management platform. Additionally, new versions of Customer Process Manager, our leading multi-channel customer service solution, the industry's first fully unified decisioning and process management capability, what we call Decision Strategy Manager, combining predictive and adaptive analytics in a unified platform with rules and processes, and the market's most sophisticated and agile next best action marketing solution for retention, cross-sell and up-sell.

These offerings work from a common architecture to enable our client's agility and the unprecedented ability to improve customer centricity while saving money. We also delivered numerous industry frameworks. These help organizations more rapidly an inexpensively achieve the benefits of business process management solutions.

Examples include order management for telecommunications providers to more effectively and efficiently handle complex business-to-business orders and fulfillment; mortgage processing for banks, to help them deal with our country's mortgage crisis; eligibility and enrollment for federal and state governments, enabling more accurate benefits processing for citizens and a lower cost of operations; our care management framework for healthcare payers and providers to improve results for those with chronic diseases; adverse event case management for improved speed and compliance at a lower cost for pharmaceutical corporations; collections for financial services, delivering unified decisioning to improve the customer experience for customers with better outcomes for the institution; incident management for energy companies, enabling powerful case management of incidents across distributed organizations to provide control, tracking and response automation; as well as many other enhancement releases across all our industries.

Partners also continue to be a core element of our strategy. And in 2011, partner communities increased dramatically and really improved the level of capability and made great Pega investments. The number of Pega-certified staff in our partners increased by over 80% more than 2010, and partners are now leading over 55% of Pega implementation. Our license pipeline, generated in conjunction with partners, is now over $1 billion.

One of the significant investments we began in 2011, which we will fully roll out in 2012, is the creation of a broad self-study enablement curriculum, an initiative we call Pega Academy. Self-study enables students to become knowledgeable on Pega implementations and solutions at their own pace and at the locations of their choosing. Early results indicate we can reduce the time to train by up to 40% with equal or better certification results. Our partners are very excited about this program, and we believe it will have a significant impact on increasing the size and capability of our ecosystem.

As Craig mentioned, our movement to self study and our increased investment enabling partners may have some short-term impact on our services margins, but our strategic vision is that broadening and strengthening the ecosystem will be the most effective and ultimately profitable way to grow the Business, and we are seeing enthusiastic endorsement and investment from our partners regarding our approach and their ability and willingness to grow their practices.

We well understand what we bring our clients and our vision is not just to continue to grow, but position ourselves to broadly help the world's best companies use agility as a weapon to prove their customer experiences and save money through operational efficiencies. Pegasystems growth is driven from the staggering results our clients achieve from the use of our bill for change software with numerous examples of 30% growth in revenue, 40% improvements in productivity, and 5% point increases in customer retention.

For years we've had a vision that computing capabilities had advanced to allow software to become significantly smarter, and to enable businesses to use software to automate manual work across operational silos, to offer seamless customer service across channels, channels by contact centers, branch, web, mobile, IVR and social, and to understand and personalize their interactions with their customers based on context, and to do most of the programming that in the past had to do manually by automating the very programming process itself.

We designed and built this technology, refined it during four complete rewrites over nearly three decades, and have a very differentiated approach and architecture. We call this offering our Build For Change software because it's about giving our clients results now while positioning them for success in the volatile future.

As you can see, customers are proving that it is faster and better to do business applications this way than traditional programming alternatives. This past quarter we had wins across verticals that demonstrate the value of this approach versus both large software vendors and niche application providers. Several of the world's largest global banks in North America, Europe and Asia chose Pega to create a servicing backbone, the end-to-end process from initial customer interaction through customer service fulfillment.

These banks, in a time of increased regulation and increasing customer expectations, needed a capability to be seamless across all the channels that use their customer service, and that interact with them across all the different vehicles and in all the different ways that they need to operate. They're using us to manage the work associated with servicing these customers across operational units and to automate much of this work.

In each case, Pega technology won competitive battles versus major vendors and incumbents because our Build For Change technology was viewed as the only one that could meet their needs at scale and in an environment of continuous change. This quarter a large and growing insurance business process outsourcer chose Pega to rebuild their insurance platform. Only Pega could enable them to easily specialize by client and in significantly less time and with less cost.

A top European life insurance company chose Pega as the basis for their customer experience transformation. Again, Pega's unique ability to provide the seamless multi-channel experience, to automate complex cases, and handle interactions across silos is what made this highly cost effective program able to go forward.

One of the world's largest and most respected telecommunications companies purchased Pega's software for next best action marketing, enabling powerful predictive and adaptive analytics capabilities for their agents and for their web channel to create better tuned, more personalized customer offers.

Several state government organizations purchased Pega to improve citizen service while reducing costs. One state is replacing their legacy case management system to improve social services, and another state is improving their retirement and pension benefit services, both at a lower cost to taxpayers. We are proud to help states meet their dual challenges of improved citizen service and reduced expense budget in these demanding economic times.

We're also very pleased with the uptake of our cloud offerings. The fact that both our end user and our development environments running a browser makes our architecture unusually well-suited for the cloud, as has been recognized by new and existing customers. One of the world's top consumer products companies bought Pega customer service on the cloud to modernize and automate the international customer service call center.

A large healthcare company purchased and implemented Pega cloud for new business management, and a large manufacturing firm bought Pega case management on the cloud for a major productivity improvement program. Our Cloud business exceeded our plan in 2011 and we look to significantly grow this Business in 2012.

It is our ability to change the game at both ends of the spectrum simultaneously, both improving the customer experience while driving the cost reductions that rapidly pay for the implementation that continues to be central to our growth in these tough times. Despite these and many other great wins, we believe we are still early in the stages of this market, and that adoption of our technology will continue and that we will continue to invest in increased sales coverage to achieve the potential of our vision.

We see tremendous opportunity both with our established clients and in areas we are yet to cover. Our sales and partner coverage investments going forward are to double down on our traditional markets while also expanding in the newer verticals where pipeline and early wins are showing great promise.

We will also continue to invest in R&D at a higher rate than most software companies in order to extend our leadership in the market and to continue to drive the vision of what Build For Change can deliver for our clients. We're in a great position of having both a terrific, distinctive unified architecture and yet still seeing many important ways in which we can improve it.

This improves advancing not only our Core business process platform, but also our winning business solution frameworks like multi-channel customer service and next best action marketing, all complemented with our industry framework solutions that add industry best practices and processes on top of our Build For Change platform.

We see having the best technical capability as one of the most leveraged things we can do to improve, grow, and take advantage of the business opportunity in front of us. At the same time, we are prudent and practical business people and are committed to being diligent about managing discretionary spending. Our business perspective is to spend wisely, investing to ultimately obtain a return commensurate with the huge opportunity we see in front of us.

2011 was a great step forward in this journey and we are even more excited about 2012. With that, let's open the line for questions.

Thank you. (Operator Instructions) Our first question comes from Richard Davis from Canaccord.

Thanks very much. Alan, one thing -- two parts. One, you touched on a little bit. You mentioned you're dealing with some of the social media guys. Is it more about customer experience and things like that if you could elaborate a little on that. Then, second, I've been out talking to companies, some of these new tools companies in San Diego and several in San Francisco. So, their models tend to be very low entry prices, a lot of digital fulfillment which then translates into high gross margins. Sales and marketing, in many cases at these firms, are 15% of revenues and R&D is 35% of revenues, so they do spend a lot but they get roughly 30% operating margins. So, nobody complains about your growth because it's very good but they do whine about the margins. Can or do you see your margins higher either through business model or scale at some point, maybe it's not 2012 but is this a business that should be -- can generate 25% margins? You're at $0.5 billion in revenues, so a lot of companies that size do those things. Philosophical on the second one, tactical on the first one.

Sure. Tactically, we're doing a number of very interesting things around social media. It's been an important initiative set for us. We've got these brilliant integrations, for example, that allow somebody to just pop Pega right into their Facebook environment if they're a corporation and really engage with their customers at a multi-channel where the customer can start on Facebook, call the call center and then pop into the web to finish something.

We've also done some very interesting work in conjunction with a variety of partners around mining the social media streams from, for example, Twitter to be able to make customers better served and part of a true multi-channel experience. We put quite a bit of work into that. I'm actually very happy with the way that's working.

Regardless of the theoretical margins, look, we've made a decision that we're going to invest both in R&D, and in selling and the sales force. I think there's no question that this can be a 25%-plus point profit business at a scale. It's just that where we are now, we really think that there's so much uncovered territory both in terms of frankly, organizations that we're in but aren't fully covering. Organizations that we have yet to touch but are still on the Fortune 200, but it makes sense to accelerate the growth. Frankly, one of the considerations we have for 2012 is we are going to accelerate that growth which is why I think the margins will be lower. If we had chosen to, we could have definitely had higher margins numbers. The issue would have been how rapidly can we grow in 2013 and '14. I think this business at some point is going to explode. We need to be in a position to take advantage of it.

Got it. That's helpful. Thanks.

Thank you. Our next question comes from Nathan Schneiderman from Roth Capital.

Hi, Alan and Craig. Thanks for taking my questions and congrats on a nice bounce back this quarter. I was just curious, Alan, when you're looking at the business and thinking about the success this quarter and then in comparison to what happened last quarter, can you give us your perspective on this? Were there -- was this just you feel the idiosyncrasy of a lumpy -- inherently lumpy business or are there certain problems that you identified that you put corrective actions in place and that had a positive impact?

I think the main driver is the lumpiness of the business. We talk about it, I think it's nice to see that lumps can be extremely, extremely positive as well as obviously we took a hit in Q3. I think as I said on the Q3 call that we were a little surprised by the mood having flipped as rapidly as it did from customer acquisition to -- oh, my God, let's save money. We normally play with a foot in both camps. We did some re-weighting in Q4 as we were doing going into Q1 to really emphasize projects and uses of our technology that drive more immediate returns and I think that was important in Q4. As the economy is tough, I think that will continue to be important, but we're also continuing to push with the other foot as it were. So, it's not like we did a major shift. We just did some recalibrating to emphasize cost benefit.

Alan, you possibly said this during your presentation. I was -- for some reason I didn't hear you very clearly on my line though. I thought I heard you, reference pipeline growth, but I didn't actually hear the number, but how much was pipeline up year-over-year?

The pipeline was up year-over-year I'd say, from memory, over 20%.

Okay. Great. And then --

Maybe more than 20%.

35%.

35%.

35%. Okay. Great. Final question. I was just curious on the big deal front, if you could share with us, the number of deals exceeding $5 million and the number of deals exceeding $10 million?

Yes, sure. Not being a fisherman it's kind of odd that we've chosen to use aquatic life to categorize our deals. In the quarter, we got two what I would call whalish deals, those are things we would normally think of as being $15 million or more. We got a couple of -- a number of tunas, that I would think of as being in the $8 million to $15 million range. Just a good collection of business along the entire rest of the spectrum. Some smaller deals with introductory customers, some nice follow-up pieces of business in the $2 million to $4 million range. Those are some of our favorite deals because they're part of what builds reliability when you've got more of those than some of the huge ones that swing in and out.

Great. Thanks very much.

Thank you. Our next question comes from Justin Furby from William Blair & Company.

Hi, guys. This is Justin in for Laura. Thanks for taking my questions and congrats on strong results here. I guess maybe to start, just following up on the pipeline commentary. Alan, you mentioned it's up I think 35%. Can you talk a little about I guess maturity and then maybe pipeline coverage today versus where it was a year ago?

One of the things we're very happy about that I mentioned was that I think we're doing a much better job this year and over the last 18 months around engaging with partners, which is a key element of our strategy as we think about how we want to grow this business. We think that's going to be key. So we have a very, very material increase in the work with partners that was around either cultivating the pipeline or driving it -- or driving it forward and I think that's very healthy and it represents a maturation of the business.

I'll also tell you that the pipeline grew nicely pretty much across the board where we saw good solid growth in both new and traditional sectors. Which is important because part of what's led to the expense investments, we placed meaningful bets in some verticals beyond our traditional ones, verticals like, for example, the government, verticals like life sciences, oil and gas, energy. These verticals, I think, have been showing excellent, excellent opportunity and we saw, for example, marked improvement in our federal vertical.

Most exciting, though, is our telecommunications vertical has just really broken out to be, from my perspective now, a fully mainstream vertical with the scale and the opportunity to build momentum as a result of wins all around the globe. So, I'd say the pipeline was healthy and not concentrated which is very much what we're trying to do with the business.

Okay. Then in terms of the competitive environment, any -- who are you seeing the most in competitive situations? Any material change over the last quarter? Just a general update there would be helpful.

We see the seller stack guys, the guys like IBM and Oracle. Most of my -- most of the people we sell to already have two or three things they call BPM sitting on the shelf. The thing that I've seen that's been really helpful is we've had a number of clients who have tried something else and are now returning to us, many of whom are referencable about that change of experience. I view that as very positive. I think the unified architecture we have continues to get a highly differentiated assessment with our customers which is key. So, it continues to be competitive but we obviously are able to differ differentiate ourselves, as you can see from the results.

Okay. One last one, if I may. Craig, on the $500 million guide for '12, if you think about it in terms of license versus maintenance versus pro services, obviously the last couple of years services and maintenance have been above the license side of things. Do you expect that dynamic to play out in 2012 particularly given the fact that you've seen material increases in your term piece of the business? (technical difficulties)

No. The trend is going to be a little different going forward. We're really making a conscious effort to sort of more slow growth our professional services organization just because we have so much more partner involvement now. Partners actually lead in the vast majority of all implementations. So, that doesn't mean we're going to be out of the services business. We're going to be in it, but we really encourage them to take the lead in these projects. We're still going to hire up and we're still going to grow services because partners often need help and we want to fill in where they need that help.

So the composition of our services staff I expect will become more senior and more, the way we're referring to it internally, now as we're calling it Pega Consulting. So we'll still have the capacity to do the occasional project if the customer demands it, but our real goal is to empower our customers and our partners to really be able to drive this engine. So, over time, you should expect our mixes to change to reflect that.

Okay. So is it reasonable to think of license growth in the 20% range for 2012?

Well, we didn't get specific guidance other than total revenue, but the license has to grow around 20% at least to get to the number, possibly more than that. Our maintenance business is pretty steady but that grows a little lagging but in lock step with the license revenue growth.

Okay. Great. Thanks very much.

Thank you. Our next question comes from Steve Koenig from Longbow Research.

Hi, gentlemen. Can you hear me okay?

Yes.

Great. Okay. Thanks. I want to ask you about annual and quarterly achievement. Let me start with the annual side. I don't want to sound snide in this question, but I do want to ask it. I'll just put it out there and the question really is, on your guidance now you've missed your initial guidance on both the top line and the bottom line for two consecutive years. So, I'm wondering what makes you feel better about this year's guidance? Is there anything different systematically or were those things just -- were those one-time anomalies? What can give us some comfort with the guidance you put out for the year?

So, I think you can get some comfort from looking at the specific license backlog that we disclosed, looking at the momentum of the business and the fact that we disclose an awful lot of information about what is in deferred and what is in our term and perpetual license backlog. I think those can provide a level of comfort.

The reality is that Q4 was just an enormous, enormous quarter, but a lot of it went into backlog which we're really not at all unhappy about. If some more of it had gone into the current period, it would have changed the numbers. Part of that's the lumpiness and I do believe this is going to be an extremely powerful growth business. I think we've demonstrated things that should create a level of confidence. But the reason we talk about lumpiness is we don't want investors who are going to over react to the fact it is lumpy to at all be surprised.

The key metric for us is the bookings growth and, as I said in the script, that was up 75% and in this economy that's a fantastic achievement. We're pretty pleased with the performance.

Okay. Great. So, I think that's a good lead in for my next question. I realize -- I think it's prudent for you to condition investors to expect lumpiness given the back-end loading and given the fact that you don't encourage end-of-quarter discounting, which I think that's a good thing in terms of your MPV. I'm wondering, though, is there anything that you can do or are doing to reduce just the extreme roller coaster ride that investors have to take quarter-to-quarter to invest in Pega, in terms of either --? (multiple speakers)

A lot of changes with our ability to achieve greater scale. So, frankly, we are much less lumpy with a $500 million target than we were when we were back -- wasn't that long ago that we did $162 million and I guarantee you we were lumpier then than we are now. Some of it is as we get past $750 million, which we're going to try to get past as fast as possible, you're going to see an early decline.

The second thing is as we improve our coverage so that we've got deeper coverage in multiple industries, some of the secular trends that affect one industry more than another will also, frankly, be much better. As we increase our client base, so that we're doing more radiation, where inside a customer we're selling out into other areas as opposed to penetrating. We find that radiation is far more reliable as you would expect as it relates to lumpiness than when you're just trying to get that first time buyer and a client to trust you for the first time to step up.

So, we do have very specific things that we're working on to attempt to reduce the lumpiness and to improve the channel through the partners and the other sorts of things we're looking to do to reduce our cost of delivery and our cost of going in. I think we need to be candid and we're not going to let the fact that we're lumpy allow us to miss what we think is a spectacular opportunity here which I guarantee you we're all very focused on.

Great. Great. Well, thanks and congratulations on your Q4, guys.

Thank you. (Operator Instructions) Our next question comes from Brian Murphy from Sidoti & Company.

Thanks for taking my question. I just wanted to follow up on the guidance and the margin questions. Alan, is it fair to assume that -- I guess I should say does the guidance assumed that license revenue will start to outpace service revenue in 2012?

From a growth rate point of view we absolutely expect it will, but from an absolute number point of view I think it's going to take more than one year to close that gap up. Craig, what do you think?

Yes. Regardless of when you look at the profitability, the guidance we're giving on non-GAAP EPS is up 26% from this year. We also are focused, as I said, on backlog. We're also focused on cash flow and we did almost $50 million operating cash flow in the year. So, there's a bunch of other metrics as well. Margin is important, we realize it, and I think it's a scale thing for us.

Can you just talk about expectations for sales force productivity in 2012?

Just want me to talk in general or do you have a specific question?

No. Just general commentary would be helpful but -- and if you could tie it in with sales and marketing as a percentage of sales, should we continue to expect that to go up in 2012?

I think we're really trying to hold that fairly constant, I would say. Because the challenge you have, and we're going to do quite a bit of hiring in this plan, around sales force expansion in anticipation of 2013. The reality is it does take really six months for somebody to begin to really start to engage with the clients the way we need around the opportunity, the nature of the business.

So, one of the challenges we've had is, over the last three years we've increased the sales force quite a bit and, of course, that really takes the average tenure of the sales force down. So, we're looking to perhaps slightly increase sales force productivity this year, in light of the fact that the sales force is still going to be growing quite a bit -- but not massively.

That's very helpful. Thanks. One last question. Did you close any large deals in the oil and gas vertical this quarter?

No, there weren't any -- nothing large in that vertical.

The pipeline's great, though.

There was one what I would describe as mahi mahi as opposed to perhaps tuna or whale. (laughter)

Okay. Thanks very much.

Thank you. Our next question comes from Raghavan Sarathy from Dougherty & Company.

Thanks for taking my questions. A couple of questions for Alan and then a few for Craig. Just in terms of the backlog composition, I'm surprised that you're signing more term licenses now than when you did during the recession. In the recession you were signing a lot of perpetual licenses when we thought you would be signing term licenses. I was wondering, could you give us color on what's driving customers to choose more term licenses now, when supposedly the economy has improved? Some of the factor business decisions driving them to choose term licenses, maybe even technology reasons?

I would tell you that I'm a little surprised as well. So, I'm not going to say that -- I'm unprepared to draw any major conclusions other than to say that the decision about how a client buys, be it term or perpetual, is one that appears to be very, very situational. Sometimes we go in thinking the best arrangement with the customer will be a term and they suddenly decide that they have some latitude in their capital budget.

I think one of the things that has been happening is that a lot of the financial services organizations, which is a meaningful part of our business still, a lot of them are sensitive to capital these days and the term license allows them to run as an operating expense. That's fine. But we're happy either way. We think that frankly, there's a certain volatility-reducing impact term licenses have that actually make me rather happy.

Then Craig, -- I'm sorry, Alan, if I heard you right you said the license pipeline generated with partners is over $1 billion. That seems like a huge number. Can you clarify what that -- is that well qualified or help us understand that figure?

So that would be a number, it wouldn't be generated by partners. That would either be generated by partners or deals in which we are working in conjunction with a partner.

Associated with partners.

Associated with partners. So, where the partner is playing an active role. We're trying to get our partners to generate pipeline, and some of them actually are doing a pretty good job of it now. But that's not anywhere close to $1 billion at this stage. For it to be considered pipeline as we discuss it, it's got to be pretty well qualified. It's got to be an opportunity that's specific that we can put a dollar amount on where we're identifying a locust of buying activity and they have a bona fide need. We don't consider the front-end garbage of the pipeline to be part of it. We have categories for that, that we leave out of our pipeline discussion.

Did you mention a figure, maybe I misheard?

I mentioned I believe $1 billion.

That would be a total pipeline.

Of total.

Okay. That's pretty big. Then a question for Craig. I think there was some question around license revenue growth but one thing I noticed that you were -- you had a pretty strong license revenue growth, but if I look at the perpetual license growth, the backlog for the 2012, that's only $22 million, $23 million. Obviously that's a big driver in terms of your EPS and I was wondering how should we think about your perpetual license revenue in the overall mix?

Well, as you said earlier, Raghavan, the customer's decision to buy term or perpetual, it's up to them. It's pretty unpredictable. Perpetual license revenue definitely hits the P&L faster than term license. It can swing at any point in time in the year, as we mended our guidance at the end of last year because of the term license pipeline. Just like you said earlier, in 2009 we were expecting people to go to term licenses and they didn't, they went to perpetual. So, it's highly unpredictable and I also, like Alan said, we don't like to make predictions because as soon as we do we're proven wrong.

But your non-GAAP EPS of $0.91, that assumes obviously some significant pick-up in perpetual license, the back half of the year?

Oh, yes.

But Craig bases those estimates on what we see happening in the market in the last couple quarters. We bake in current --

We have a historical model and then we look at the pipeline and in the short term -- the shorter term, we can see which way the licenses are going to go. The longer term it's often difficult to look at a license out in Q3 and Q4 and figure out whether it's going to be term or perpetual.

Two quick questions. Maybe I missed. Did you mention what is the tax rate assumption in your non-GAAP EPS guidance?

Yes, it's about 32%, 33% going forward. It should be much more normalized than the 2011 rate was.

Then in terms of the difference between GAAP and non-GAAP here -- non-GAAP EPS, is it only amortization of intangibles or are there going to be other one-time items like we saw in the last quarter?

There's basically three items. The amortization of intangibles, the FAS 123(R) charge, and the last one is the non-cash duplicate rent that the accounting generates and one-time moving charges. So, that we can get to a more run rate or more normalized financial statement.

Okay. Great. That was $6.1 million, is that right?

Yes. There's a reconciliation on the press release.

Okay. Thank you.

Thank you. Our next question comes from Mark Schappel from the Benchmark Company.

Hi. Good evening. Most of my questions have been answered, but just one question, Alan. Based on the quarter's good results, is it fair to assume that you captured all the large deals that failed to close in the September quarter?

No.

Okay.

I'm sorry, did you ask did we capture all the large deals from the September quarter?

That failed to close in September.

Failed to close in September. I thought you asked if we closed all the deals that we had hoped in Q4 and actually there were some more that we could have gotten in Q4, I think that we're still working on. The Q3 ones I don't think we were really depending on. There was a sluggishness across the board. We actually did an excellent job of closing the Q3 ones, but we weren't counting on any major deal in Q3. We just saw a slowness, I think, across the board in a couple of geographies in Q3, largely especially driven by Europe, frankly, where folks came back at the end of August into September and there was just a malaise. Thankfully, in Q4 we were able to break through that and actually get some of that business to close. Some of it's still being pursued into this year.

Thank you.

All right, well we're in an interesting situation here where we need to bring this to a close because we're actually at the Morgan Stanley Technology Conference and Craig. I are about to go downstairs and do our fireside chat interview in front of the audience. So, we wanted to make sure we did that in light of actually having our financial results announced or we couldn't probably have said anything at that point in time.

I will tell you that we're working hard. We're thinking that there is tremendous opportunity in this business which is why we're continuing to invest. If you want to see an interesting example of how clients are getting real tangible benefit from this, there's a four-minute video on our website or that you can YouTube that is Pegasystems at BAA, the British Airport Authority, the guys who run Heathrow. Basically this includes the CEO of BAA and their customers talking about how our technology has completely changed the way that they run ground operations. We're not doing air traffic control but a lot of the work on the ground making sure the planes are effective and gates are done properly, et cetera is now being driven by Pega Software. They do a nice job, I think, of describing a really interesting and unusual use of our software and they attribute a double-digit gain in on-time departures which is huge in terms of both fuel and customer satisfaction, directly to what our software has done in their environment.

So, if you want to get a sense of that, that might be of interest. Of course, if you want a deeper sense, we're having our PegaWORLD conference which we think is going to be a blowout this year, the end of the first week of June in Dallas. Once again, we'll be talking to you before then. Thank you very much for your support. Look forward to talking again soon.

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program. You may all disconnect and have a wonderful day.