Pegasystems Inc (PEGA) 2013 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Pegasystems Fourth Quarter Earnings 2013 Call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. I'd like to turn the call over to your host, Rafe Brown, Chief Financial Officer. Please, go ahead.

Good evening, ladies and gentlemen. Certain statements contained in this presentation, including but not limited to statements related to future earnings, bookings, revenue, and mix of license revenue may be construed as forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. The words anticipates, projects, expects, plans, intends, believes, estimates, targets, forecasts, and could and other similar expressions identify forward-looking statements which speak only as of the date the statement was made. Because such statements deal with future events they are subject to various risks and uncertainties.

Actual results for the fiscal year 2014 and beyond could differ materially from the Company's current expectations. Factors that could cause the Company's results to differ materially from those expressed in the forward-looking statements are contained in the Company's press release announcing its Q4 2013 and fiscal year 2013 earnings and in the Company's filings with the Securities and Exchange Commission, including its annual report on Form 10K for the year ended December 31, 2013, and other recent filings with the SEC. Although subsequent events may cause the Company's view to change, the Company undertakes no obligation to revise or update forward-looking statements whether as a result of new information, future events, or otherwise since these statements may no longer be accurate or timely.

With that, I will turn the floor over to Alan Trefler, Founder and CEO of Pegasystems.

Thank you, Rafe. And welcome, listeners. This call is quite special for me. In 2013 Pega passed many important and exciting record milestones, a testament to the tremendous success our clients are having in their use of Pega software. But even more significantly for the call, I want to talk to you about Pega's go-forward strategy that we believe can take advantage of a tremendous opportunity.

First, let me briefly reflect on 2013. Pega has now surpassed the $0.5 billion mark. This record revenue is achieved despite an environment of great economic challenge in every part of the world and business shake ups in almost every industry we serve. In becoming a $0.5 billion business, we achieved record profits, earning $1.50 a share on a non-GAAP basis which was a 38% increase over 2012. We surpassed the 2,500 headcount milestone and we achieved a record level of license backlog by adding $58 million of license backlog in Q4.

You may remember that on our Q3 call we pointed out that while the revenue was strong to that point in the year we'd consumed $27 million of license backlog. Not only did we make up that deficit in Q4, we increased total backlog by $31 million on a year over year basis. As Rafe will discuss, we saw a lot of ratable business in Q4 which we actually prefer as it contributes to the increasingly impressive committed license backlog numbers over time and should improve our quarterly revenue consistency.

But please recall that offering both perpetual and ratable models to our clients does increase the lumpiness of profitability as well as revenue as the selling effort and expense stay in the period even though the revenue moves out. The effect can be significant. For illustration, if the full increase of $31 million committed backlog had instead come in as upfront perpetual licenses, it would have kicked our 2013 17.5% license revenue growth to over 36% though obviously that revenue wouldn't then be available to fuel growth in future years. Given this interplay between revenue and backlog I think it's helpful to consider both the revenue and the committed license backlog changes in tandem to understand the fundamental sales and margin results of the business.

Now, some of the improvements to sales management practices appear to be starting to help mitigate our lumpiness. For example, in 2012, the standard deviation of license revenue across our four quarters was approximately $19 million. This dropped to $11 million in 2013. We're going to continue to work to bring more balance to our quarterly results though I expect significant lumpiness will continue until the increasing size of the business and the increasing base of recurring revenue more significantly mitigates the volatility.

Looking at the mix of business, the results of 2013 were nicely balance across our verticals, geographies, and deal size. Our 2013 business growth was accomplished with much less dependence on whales than in past years. Again, an indication of increased balance. Our geographic mix also strengthened this year with growth in all geographies. The particularly strong performance in Japan and APAC are from investments in sales and marketing we have made there in recent years. Japan is particularly satisfying as we saw what has been a meaningful three year investment trend, very positive, and we grew significant business at a time when we know other software firms have been reporting softness there.

While achieving record financial results, we also dramatically strengthened other elements of the business in 2013. We released our seventh major version of Pega's industry-leading unified platform with terrific advancements in user interface, navigation, easy of use, data management, and case automation. And our Q4 acquisition of leading mobile application platform provider Antenna Software obviously strengthens our capabilities and expertise in the highly strategic mobile technology area. We are already seeing a terrific capability in technology and increased mobile-related deals in the pipeline. As we did with our 2010 acquisition of Chordiant's analytics technology, we expect to tightly integrate the technology and the teams during the year with the technology benefits emerging strongly in the second half.

Consistent with our strategy of creating capacity and options for delivery, we have been working even more extensively with partners. Our deliver ecosystem is now exceeding 15,000 certified architects and growing. In 2013 alone we had over 12,000 new and returning students take training through our online Pega Academy, completing over 0.5 million classes. I might add that Pega Academy is built on Pega's unified platform and is running on Pega's multitenant Pega 7 software in the cloud. Our position was in key system integration partners also strengthened significantly in 2013 with Pega being recognized as having strategic importance to several key partners. We have increased meaningfully the senior relationships with some of the world's leading management consulting firms who see the unique power of Pega software as able to help their clients achieve the vision of enterprise digitization.

For example in 2013 we had Accenture's CTO speak at PegaWORLD about Accenture's vision to quote, every business must become a digital business. And they highlighted how Pega technology aligns with their digital strategy and the needs of their clients. And to preview a bit of our upcoming PegaWORLD, we'll be featuring a Mackenzie partners on the emerging needs of digital enterprises and how they have seen their clients use Pega to transform and simplify.

These messages dovetail with topics I've been mentioning over recent earnings calls. We've talked about the evolution from clients buying specific technology solutions that they have to piece together to engagement around a broader business agenda. In Q4 we saw an acceleration in both interest and sales of attention to the broader agenda. And organizations showed interest in the digital concept across our verticals and our geographies.

For example, a large healthcare plan, a Blues plan, made their first purchase of Pega software in Q4 to be their sales and underwriting platform for the future. Now, perhaps a few years ago they would've bought a Salesforce automation application and a rating and underwriting application and stitched them together with a stack vendor middleware piece or maybe they would have customized some cloud offering that did some portion of this end to end function. But now they're saying that in the current world of healthcare they need to become a digital business and leverage software that handles all of the aspects of member acquisition and servicing in an agile digital way. They need a platform that gives them differentiation and a runway for growth. They chose Pega because it was a better way to use software to become a digital healthcare insurance Company.

A large global bank bought Pega's software in Q4 because their customers and their internal business operations were demanding a digital way to engage. They viewed the experience as personalized to the expectations of large and high net worth clients. They'd already played with and even purchased a raft of alternative technologies and decided that Pega was the only viable alternative. And to boot, their COO and global head of business transformation has signed on to keynote at this year's PegaWORLD conference.

And in Q4 a leading technology manufacturer increased the use of Pega software in the transformation to become an agile digital enterprise. They realized that the traditional way of coding software programs for each customer engagement channel and the traditional model of buying applications for each unit of the supply chain was outdated and ineffective. They chose Pega and are continuing to extend the Pega footprint throughout the organization using it to digitize and complement their systems of record and their point cloud solutions.

All these examples and many more I could cite reinforce the potential that Pega offers to our clients and shows that it is much bigger than simply the extensions of the past. Over the last six months, we stepped back and thought about what we were seeing and where we should go. Per the previous examples, we're hearing from across our clients that they are frustrated by the inefficiency of product approaches and see the benefits of harnessing advances in computer power and connectivity in a firm way. Market realities dictate that they become digital enterprises to retain empowered and connected customers, to simplify and streamline operations, and to embrace the accelerating pace of change.

Now, our clients acknowledge huge returns and great success because from the historical use of Pega's industry-leading software in individual software markets. It gets described as business process management or BPM or business rules management systems, BRMSs, or CM for case management, KM for knowledge management, CRM for omnichannel contact centers, DM for decision management or PAAS, for platform as a service applications or MAM for mobile application management. And more. But this alphabet soup of technology oriented silos of capability misses the heart of what customers need to become successful digital enterprises.

Increasingly our clients see us as much more than these piece parts. They see Pega software as the platform on which they can accomplish their transformational journey to become a digital business, to become a better business. They realize that today software is central to business execution. This is not a world of no software. But as Mark Andreessen said, software is eating the world. Yet most software use is mired 60 year old practices going from manual specs to manual coding. That is why the unique unified Pega Build For Change platform delivers the principle of model based execution to transform businesses.

This enables our clients to implement a vision of change that is shared by all stakeholders. Business people and IT staff collaborate using a visual language that models the requirements and design in a way that everyone can see and understand. And once defined this way, the finished application and its documentation are generated and immediately ready for use. The Pega approach bypasses the error prone and time consuming process of manually translating requirements into code. The software's automatically created directly from the model, closing the costly gap between vision and execution.

We see that it is this convergence, the digital business imperative that businesses must run better and the emergence of our Build For Change platform that can deliver a new approach to software that together delivers the vision of what we call better business software. This brings clients three huge advantages. First, the power to engage, to engage customers, prospects, partners, and staff so that every interaction is valuable for everyone involved. The power to simplify, make operations and technology easy to access, easy to use, and to have an end to end philosophy on how you're going to run your business and the power to change, making agility a strategic advantage to help firms take and defend positions of strength in the marketplace.

This is the new way to think about software and now there's a way to describe it so it makes sense to business people -- better business software. We see the emergence of the new business focused and model based approach to software that can provide a platform for digital enterprises and we see that happening rapidly. It's an enormous opportunity for Pega because they're all the individual markets we have historically served combined. We have unique and differentiated technology to meet this need which is why so many consultants and integrators are rapidly building out Pega practices.

The alternatives to using Pega's unified model of architecture for becoming a digital enterprise are trying to do it through hand-coded custom software, trying to buy function specific apps and stitching them together. We see these are falling far short and see ourselves in a unique and exciting position. We know we're on to something that could be big, transformational for our customers and a huge opportunity for us.

Taking full advantage of this vision will require great execution. In October we brought on Rafe Brown as our CFO and, Rafe, you've been a terrific addition to the management team. And yesterday we announced that a new Chief Marketing Officer, Robert Tas, will be joining us to drive our new vision. Robert has an outstanding background for the role and he started in enterprise software sales and sales management through a variety of high-tech marketing firms, and then most recently as the worldwide head of digital marketing for JPMorgan-Chase. What's great about both Rafe and Robert is they bring key skills, highly relevant experience, and a passion for helping our clients transform their businesses.

We plan to be the leader in this large formative market. Towards that end you'll see a continued investment in R&D and investment in sales and marketing. While we'll be thoughtful about spending as we demonstrated in 2013, we'll also be smart about being aggressive and winning and refuse potential and plan to turn that into very exciting growth for Pega.

To conclude, let me invite each of you to PegaWORLD 2014 held June 8 to 10 at the Gaylord National in Washington DC. You can come see for yourself how the world's leading organizations are achieving digital transformation with Pega's better business software.

With that, Rafe, back to you.

Thank you, Alan.

Let me take you through our fourth quarter and year end results, starting with revenue. We're reporting both GAAP and non-GAAP income which captures among other things the impact of the Antenna acquisition accounting. A full reconciliation of all GAAP to non-GAAP measures was provided in the financial tables with the press release issued earlier today and is available online, on our website.

As we've discussed in the past, quarter to quarter comparisons do not generally reflect the underlying momentum of our business due to the timing of when our large transactions close. What is most important from our view is how our business performs on more of a trend on a full year basis and our future outlook which I will discuss in detail in a moment.

For the full year 2013, non-GAAP revenue was $511 million, up 11% year over year. This included the contribution of approximately $6 million from Antenna which we acquired on October 9 of this last year. Most importantly, full year non-GAAP license revenue was $192 million, up 17% over the prior year even as we meaningfully increased backlog. Over the course of 2013, we generated a higher mix of license and maintenance revenue relative to services revenue. As a percentage of 2013 full year non-GAAP revenue, license and maintenance revenue stood at 69%, up from 64% in 2012.

In dollar terms, non-GAAP services revenue were $161 million in 2013, down slightly from the prior year. As we've previously discussed, this change in mix of revenue is consistent with the Company's stated strategy to focus on growing the number of implementations performed by our partners and clients.

Looking forward, our strategy of building a vibrant partner ecosystem will lead us to grow services at a slower rate than license revenue which allows us to focus our resources on market share gains and scaling the most profitable aspects of our business.

Looking at our results on a geographic basis, non-GAAP revenue in North America grew 7% to $300 million for the full year 2013 and stands at 59% of total revenue. Revenue from EMEA was up 5% to $166 million with particular improvement in our Continental European business where we've been focused on investing in distribution capacity and technical expertise. Key wins in the communication and insurance sectors helped grow the business despite and overall economic climate that remains challenging.

Our fastest growing region was Asia-Pacific which grew 72% during the year to $45 million of non-GAAP revenue. Continued sales and marketing investment within the region produced strong traction in the insurance and banking sectors and we noted particular attraction in both Australia and Japan.

We noted last quarter that we're working on the number of large transactions, or whales as we've referred to them in the past. During the quarter we closed two such transactions, generally defined as those that are greater than $10 million. In addition to these large transactions, we were pleased with the growth in the overall number of license transactions. While large transactions are important to our business, we're also focused on building a flow of smaller and more easily repeatable business.

In terms of the dollar mix of license deals during 2013, the proportion of ratable recognized deals jumped in the fourth quarter compared to the fourth quarter of 2012 as we've discussed the mix between perpetual and term or ratable licenses is to a great extent dictated by the needs of our customers though the Company does somewhat prefer term license deals.

Turning to the rest of the income statement, for the full year we posted the non-GAAP gross margin of 71.3% for 2013, up from 68.6% in 2012. This improvement in gross margin was attributable to the improved mix of license and maintenance revenue relative to services revenue in 2013. Annual non-GAAP operating expenses were $276 million, up 9% from 2012 with most of the growth in operating expenses coming from the sales and marketing line.

Our full year 2013 non-GAAP operating margin was 17.3%, up from the 13.6% posted for the full year of 2012, a function of our being particularly vigilant with respect to expense management in the early part of the year given macro economic uncertainties and remaining somewhat behind on our hiring goals as of the end of the year.

We have previously stated our intent to continue to balance investment and growth initiatives with the delivery of attractive profits. Consistent with this strategy, we believe continued investment in our sales organization and product development efforts are warranted given the significant market opportunity before us. This includes further investment related to our Antenna acquisition. As you know, this was a business in transition. In order to fully capitalize on the opportunity for Pegasystems to become the clear leader in mobile we'll be investing in development and operations related to Antenna during the coming year.

We will continue to invest in our products by expanding our development team with overall R&D increasing slightly as a percentage of revenue in the coming year. We will also be moving and expanding our real estate facilities in India where we've had success attracting high quality talent that's been key to our ability to rapidly innovate.

Finally, in 2014, we plan to expand our sales and marketing efforts. It is essential to our strategy that we have adequate coverage in our target accounts to ensure the transformational power of Pega's better business software is fully understood. Overall, we expect sales and marketing to increase slightly as a percentage of marketing in the coming year.

Turning to earnings, we posted non-GAAP earnings totaling $1.50 per diluted share in 2013, up 38% from the $1.09 posted a year ago. For the fourth quarter, our non-GAAP earnings were $0.61 per diluted share compared to $0.65 posted in Q4 of last year. Operations from the newly acquired Antenna business were roughly break even on a non-GAAP basis during the quarter.

Now to license backlog, we compute license backlog by adding billed deferred license revenue as detailed on page 59 of our Form 10K filed earlier today and off balance sheet license commitments as detailed on page 31 which are signed license arrangements that are unbilled and not recorded on our balance sheet. We finished the year with $326 million of total license backlog, up 11% over the prior year.

To add some color to the growth in our backlog it's important to understand that renewals are an important and growing piece of our business. However, year to year the amount of business available to renew fluctuates. Our renewals also tend to be multiyear commitments, so the multiplier impact on license backlog can be significant and create very challenging compares to future years with less business to renew or licenses with substantially shorter renewal periods.

The fact that we had significant renewals in 2012 created a challenging compare for our total backlog metric for 2013. To provide an order of magnitude, our renewals in 2012 were more than twice the amount available to renew in 2013. With this in mind we're pleased that we were still able to grow our total backlog by double digits for the full year 2013.

As such, it is also helpful to look at the current portion of backlog which is to say backlog which we expect to recognize as revenue in the coming year. At year end, the current portion of backlog stood at $121 million, an increase of 24% over the prior year. By effectively excluding the impact of multiyear ratable license arrangements including renewals, it's a helpful data point in assessing the underlying momentum of our business.

For the year, the Company produced $81 million of operating cash flow, an increase of 85% over the prior year. Free cash flow which we define as operating and cash flow less CapEx was $75 million. We finished the year with total cash to marketable securities of $157 million, down from Q3 primarily as a result of the $26 million net cash outflow related to the Antenna acquisition earlier in the quarter. However, we do expect we will quickly be replenishing our total cash position as we have a number of large receivables due in the first quarter.

In 2013 the Company repurchased 390,000 shares for $12.5 million and at the end of the year we had a balance $14 million available for repurchases in the coming year. We finished the quarter with total headcount of approximately 2,600 employees, up 22% from the same point last year. Of course, this figure jumped significantly in the quarter with the acquisition of Antenna adding approximately 250 employees to our headcount figures.

Turning to guidance, as disclosed in the press release issued earlier today, we are initiating revenue and EPS guidance for the fiscal year 2014. We expect non-GAAP revenue for the full year 2014 to be approximately $580 million. Without getting into the specifics of our revenue details, we do expect license revenue to continue growing faster than total revenue during 2014. We also expect services revenue will grow in 2014 but at a slower rate than license and maintenance revenue.

From a GAAP perspective, we expect revenue to be approximately $576 million in 2014. Keep in mind that while we're continuing our efforts to smooth bookings throughout the year this will be a process. It takes time. As such, we expect bookings and revenue to be largely backend loaded in 2014.

Moving to profitability, in 2014 we expect to earn approximately $1.56 per diluted share on a non-GAAP basis. This estimate reflects slight headwinds from two areas. The Federal R&D credit has again expired and thus our estimates exclude any potential benefit. Recall that in 2013 the Company was able to benefit not only from the 2013 R&D credit but the 2012 credit due to a late reinstatement. On a year over year basis, this equates to approximately of $0.04 of headwind. If the Federal government does reinstate the R&D tax credit we would expect our EPS to benefit as a direct result and we'll take that into consideration at the appropriate time.

Additionally, we're working to rapidly integrate the Antenna operations. We anticipate Antenna will be approximately $0.06 dilutive on a non-GAAP basis in 2014 with a goal to be accretive in 2015.

It is also important to understand that we will have built our 2014 -- excuse me, it's almost important to understand that we have built our 2014 plan with the intention of increasing the proportion of ratable of term license arrangements when compared to that ratio for the whole of 2013. An increase in ratable bookings provides greater future stability in terms of revenue but the shift has a dampening effort on revenue and EPS in the current period. GAAP earnings per diluted share for the full year 2014 are expected to be approximately $1.

In summary, we continue to scale our business and advance our market leadership position during 2013 and we are beginning 2014 with solid momentum. We plan to continue investing in growth initiatives, particularly in the areas of product innovation, sales, and marketing, and believe we are in the early stages of a very large and expanding market opportunity.

Before I conclude, I would like to remind our analysts and our investors to save the dates for PegaWORLD, June 8 through 10 in Washington DC. This is a great opportunity for you to hear from our clients themselves how Pega's better business software is enabling the digital enterprise. If you'd like to find out more, please contact us through our Investor Relations website.

With that, Operator, we will open the call to questions.

(Operator Instructions) You have a question from Steve Koenig with Wedbush Securities. Your line is open.

I wanted to ask you, Rafe, to answer a question and one quick follow up for Alan. In terms of the term contracts, can you remind us of what the -- what's the average length of the term contract? And how much of that contract is usually billed up front?

That's a great question, Steve. Our term contracts do cover a number of different ranges in life -- I would say roughly speaking the average term is approximately three years. Now we have traditionally billed not that much up front. They would often be billed annually or quarterly. You would find that cash flow coming in over the life of the term contract.

And, Rafe, when you say traditionally does that imply that there is any shift? Or is there up front you allow to shift how you're billing that term contract at all? Lengthen it perhaps or anything different?

Well, certainly in terms of the contract life, there's nothing like a long contract to really help alleviate the renewal anxiety one has. We're always anxious to do longer contract life as it makes sense economically. And in terms of billing terms, we're looking at watching cash flow closely. So, we'll take advantage of opportunities to bill up front when that makes sense for both parties.

Thanks. Then one last follow up for Alan, if I may. Alan, I liked your description of the alphabet soup of acronyms, you used to describe some of the technologies you're focused on modeling and development. What do you think is necessary in terms of getting that message across to the business buyer and how is Pega progressing on getting that message out? And what are you seeing in terms of your kind of sales cycle as well? Are you still seeing as much missionary selling as you have in the past? How do you expect that to go?

So, you know, relative to the last question, I'm expecting at some point -- it's hard to predict what the point is -- that there's a chasm here to be crossed where the market will increasingly turn from the push market, the missionary selling, to more of a pull market. We see that in some of our customers and we actually had a recent set of articles about the state of Maine which is not one of our largest customers though it's a customer that actually initiated a whoosh of five different projects last year and self-published this incredible story about how they were getting all this benefit that some folks may have picked up in the press, from the technology they tried to be customer-centric.

Sometimes organizations that are a little more what I would describe as forward-thinking can adopt this more quickly. With organizations that have large sort of traditional IT shops, we often find that there's going to be missionary work and I think it's going to be a lot of education there.

Now we're getting the word out, the strategy that we've had is one that we're following. We started a couple of years ago deciding we wanted to engage a lot more partners and develop channels for delivery. That's both to get the word out and also to make sure that we don't become an impediment to our own success. We've done a lot of work around education. I'm very optimistic that having Robert Tas on is going to really help us dial up our marketing which is something I figure is going to be key and the successful partnerships with Accenture and Mackenzie, Cap Gemini, some of the folks who are seen by their clients as more leaders than just delivery shops I think is also a terrific vehicle to get the word out.

The best thing we can do and we're going to see us doing a lot more of this, is to get great customer stories into the mainstream so that people can see what other folks are doing and you're going to see us continuing to leverage -- we have tremendous customer case studies. I think we can do a lot better at being able to get those flowing through the earned media and the rest of the sort of marketing ecosystem. I'm thinking that's going to be one of our big missions for this year.

Thanks a lot, gentlemen.

Your next question comes from Raghavan Sarathy with Dougherty & Company. Your line is open.

Hi. Thanks for taking my questions. A couple of questions. First one is for Alan. Alan, you mentioned that last quarter you had a number of whales in the pipeline and then Rafe said you closed two whales in the quarter. I'm wondering if you closed as many whales as you anticipated as was shared in the quarter and how does the pipeline look?

We got about the level of whales that I was sort of expecting. And we've got a couple that are still swimming out there and we've got a few that as often is the case, sometimes will turn into a non-whale. So, they buy in chunks which I actually think is just fine as we think about growing our business. That in some ways is a lot healthier than being dependent on whales. I was actually very pleased for the course of the year that we did so well and we were so balanced throughout the year without the traditional whale alliance.

Those in the pipeline, what I'll tell you is that we're going through the ordinary build reviews. There's calls that are placed periodically where the sales force goes through the North American and European active pipeline and they have despite the fact that they run very efficiently, they've become numbingly long and all the stuff is real. We're seeing that some of the increases to the sales force that we've made is starting to create good results. We're obviously going to have to change some of our internal practices as we grow the business bigger because we cannot have the calls continue to grow linearly based on the numbers of deals. I think the pipeline both quantitatively and often is very important qualitatively is quite healthy for the year.

Then a second question for Rafe, you mentioned that Antenna Software contributed $6 million in revenue. So, can you give us some sense of the revenue mix? I presume it's more weighted towards services. And what is the expectation for Antenna Software's contribution this year?

I appreciate that. We filed an 8K in December where we provided Antenna's financial statements for the pre-acquisition period and if you look at that, they're heavily skewed towards services. We do expect them to wind up with a healthy blend between license and services in the coming year and obviously the business is in a transformational period of time where we're making some changes to it. And also investing in that technology. So, I think in the coming year they will still have certainly more services than the rest of Pega but that will change over time.

Just so that I understand I'm looking at that filing. You had through September of 2013 $20 million in service. Does it also include maintenance or is it purely service?

Their services both include professional services as well as their hosting services. So, some of that's lumped together there if you will. I think one way to think about it is their business will be roughly split between license and maintenance at 50% and services, hosting services as well as professional services for 50%.

Okay. Thank you.

(Operator Instructions) Your next question comes from Mark Schappel with Benchmark. Your line is open.

Good evening. Thanks for taking my call, my question, excuse me. You may have mentioned this in your prepared remarks, but maintenance revenue was particularly strong in the quarter. I was wondering if there was any particular reason why that was?

We did have a very good maintenance quarter and that's reflected in the business as a whole growing. I think we did receive one prepayment that allowed us to take as revenue when it's paid, so it picked up slightly but on the whole it is just the run rate of the business that is showing up there. So, we felt good about that.

I think one of the things that's different this year from previous year is we just delivered better results outside of the fourth quarter. And a bunch of that ends up reflecting itself in stronger Q4 maintenance.

Okay. Great. And then, Alan, I think a couple of quarters ago you felt that the Company needed to ramp up its marketing and its messaging around the Pega -- granted you just hired someone in that area. I was wondering if you could give us a few hints or a few ideas of what we can expect here on the messaging front for the coming -- ?

I think you've heard pieces of it this evening. If you take a look at where we've been going, it actually started a little over a year ago We went out and hired a board member named Larry Weber who is a very well regarded marketing professional. He was the CEO of Weber Shandwick which was the largest PR firm in the world and Larry's been really instrumental in helping us rethink what we need to do from both a messaging point of view and a composition of the marketing team perspective.

From that, we've obviously been engaged in a search for a CMO. We really haven't really wanted to ramp up too fast until we have the right person on board and have done some of the other legwork but I feel we're really now at the point where between now and PegaWORLD you're going to see us become very aggressive about positioning this idea of the build for change platform, positioning the idea of the digital enterprise as being the thing that we empower which everybody we've tested it on has really liked it, existing customers, et cetera. So, I think you should see us once again entering June go from the soft launch which we've just done of these concepts as I spoke about the alphabet soup and seeking to elevate the conversation to what we're doing with a combination of partners, some things in the media, but also a lot the messaging that you'll see coming out of the Company and I think you're going to see the real heavy launch will be the second week of June at PegaWORLD.

Great. Thank you very much.

Our next question comes from Raghavan Sarathy with Dougherty and Company. Your line is open.

Yes. Thanks for taking my question again. So, one thing I noticed is the deferred revenue software jumped up 55% year over year, almost sequentially nearly doubled. So, the question is the deferred revenue software you disclosed, is that term or perpetual? I think historically I'd assumed it was perpetual. Then what led to the sequential increase in deferred revenue software as compared to historical what we've seen for the fourth quarter?

That revenue is principally term revenue that is already essentially been billed but has not yet come through the income statement as revenue. So, billed count go out for a term arrangement and it creates deferred revenue but that revenue would be recognized over the coming months or whatever period of time of the contract. Also, you know, keep in mind there are perpetual deals where with the complexity of the calendar you don't take all that revenue up front. We generally call those ratable deals. They're perpetual in nature but that revenue gets spread out.

With that almost too detailed accounting answer, we saw some big transactions where we were able to get invoices out early in the contract life which obviously is a good thing from a cash flow perspective and helps jump that number up. The way, as I mentioned in my prepared remarks, I think one of the good ways to look at the business is to look at both deferred revenue which is on balance sheet deferred revenue and then those committed license arrangements we disclosed in our 10K where you can really see the details and get a good feel for total backlog change. We even break that out by year so you have a good indication of when that income is going to turn into revenue.

Okay. Thank you.

(Operator Instructions) Our next question comes from Jim Gentrup. (Operator Instructions) You have a question from Jim Gentrup with Discovery Investment Research. Your line is open.

Good afternoon. Rafe, can you talk a little bit about the cash flow and pre-cash flow projections or expectations for 2014?

So, we don't give cash flow guidance. We haven't in the past and we're not giving it out this year. We were certainly pleased with our cash flow for 2013 and felt it was a good year for us.

Perhaps you could give us some general color then on how that might improve in 2014? What needs to happen there?

Obviously our hope is that the business continues to grow. The very nice thing with our business is we -- it does produce a nice cash flow as the Company grows. I think if we keep executing on our fundamentals, selling and watching our expenses as we have in the past, we would expect cash flow to follow in too.

I think if you take a look at that page -- what is it? I think 59 is the magic page this year? We show the expectations for cash flow and it's pretty clearly up year over year, perspective year.

Alan, page 59 on what document? I'm sorry.

On the 10K.

10K. Okay. Alright.

If you haven't seen it, Rafe put in a very detailed year by year liquidity expectation of commitment.

Okay. Thank you for that. Rafe, did you have a CapEx number expectation for this year?

Yes. We don't break out -- for 2014 we do not break that out.

Okay. And then, Alan, I'm just wondering if you could comment on the different verticals and, you know, weakness or strength in some of the verticals during the quarter and the year for that matter?

Yes. You know, government was terrific for the year as a whole and as I talked in early conversations, for several years I've been saddened by the difficulty breaking into government. We seem to have cracked the code and are now finding at both the state and Federal level and even internationally we're having really quite good success there. I think that another one I was really pretty happy about was healthcare. We've gone through some periods of slowness with healthcare I think around the ambiguity around Obamacare. We've now had a number of healthcare providers understand that they've got to change what they're doing and that's led to some pretty meaningful upticks in relationships. That's an area you're going to see us both investing a lot and I think getting a lot of good returns in the healthcare space.

I think across the board the verticals were generally pretty strong. We've got good potential going into this year. Finally I want to talk about an emerging vertical for us is manufacturing where we really are not as established as a vertical previously. Second half of 2013 we actually hired a strong leader for that vertical, we broke it out and started creating some marketing materials and I'm really please that we're seeing ongoing use of our technology in manufacturing. We're seeing customers starting to use us not just in some of the traditional service settings but in even some of the internet of things, machine to machine type of stuff. We've actually had some interesting developments there. I think that's going to end up being a very good vertical for us. In some ways they're a lot more digitally astute than some of the other businesses you'd expect to be further along.

The other question -- I appreciate that by the way -- the ratable deals. I think you mentioned, Rafe, I believe, that you were 2014 expecting those types of deals to tick up and I just wondered what gave you that confidence to make that statement and what some of the things if you can talk about that you're doing to move people more to ratable?

Sure. And it's our intention to have them tick up. There's always two parties to every contract and if it makes sense for our customers we're going to make sure we do what's right for that arrangement. But we do have some ability to influence it. We have that preference out there with the way we compensate our sales team. It's slightly more favorable on a ratable arrangement. So, there's ways we can influence the process that we think should help us gradually shift that mix more towards ratable.

Finally, if I may ask one more, you know when you talk about these different verticals, Alan, probably if I can go back to that for a minute, are you seeing the purse strings being loosened up a little bit more? Or with kind of all these areas, maybe willing to spend more? Or is it still you're taking market share from the incumbents?

We've always been in a position where in addition to taking market share from the incumbents we can get things live fast enough that sometimes they'll pay for themselves within the same fiscal year. Since 2008 that's been a big, big part of our ability to grow, that we can actually save them enough money they can start in chunks and then build up to some of these more enterprise digital platforms and that can be a pretty important model. I think that frankly the recovery is choppy. We see some evidence of improvement in some areas but it's not something we have a lot of confidence in. Having said that we haven't been growing our sales force faster than our license revenue really if you look at it and I think it's time for us to start doing that because there's a lot of accounts still even in the Fortune 300 that we don't think we're covering fully.

I've talked about in the past it's our intention over the next two years to start to open the architecture and begin to create a much greater level of coverage. We've got the partner ecosystem who can help us deliver. We've got the real-time online training that can help us educate the customers themselves. You're going to see us -- I believe Roderick put out a real push around digital marketing. All of these things ultimately should make it possible for us to leverage ourselves so we're not as constrained as we were, say, two, three years ago. That's when -- we talked about transformative investment, I think that's going to be something we can be very successful at by opening that architecture.

Thanks. I'll get back in queue.

Thank you.

This ends the Q&A portion of the day. I'll turn it back to management for closing remarks.

Well, I'll just end by saying we were pleased with the way 2013 ended. We're incredibly excited about this new positioning, about the ability to go after the opportunities in the digital enterprise. We've got a team that's working very hard and is very engaged and I'd like to thank you all for investing and listening. Have a good night.

Thank you.

Ladies and gentlemen, thanks for participating in today's program. This concludes the program. You may all disconnect.