Welcome to the Pegasystems first quarter 2008 earnings call. (Operator Instructions) At this time, for opening remarks, I would like to turn the call over to Craig Dynes.

Welcome to the Pegasystems 2008 Q1 earnings conference call. With me here in Cambridge is Alan Trefler, Pegasystems’s Chairman and CEO. Before I introduce Alan, I will start with our Safe Harbor statement and provide my financial commentary. Certain statements contained in this presentation may be construed as forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. The words anticipates, projects, expects, plans, intend, belief, estimates, targets, forecasting, could and other similar expressions identify forward-looking statements, which speak only of the date that statement is made. Because such statements deal with future events, they are subject to various risks and uncertainties. Actual results for the year 2008 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 include, without limitation, variation in demand and the difficulty in predicting the completion of product acceptance and other factors affecting the timing of our license revenue recognition, the level of term license renewals, our ability to release new products and evolve existing ones, the impact on our business of the recent credit market turmoil, and the ongoing consolidation in the financial services and healthcare markets, our ability to attract and retain key personnel, reliance on key and third-party relationships, management of the company’s growth, and other risks and uncertainties. Further information concerning factors that could cause actual results to differ materially from those projected is contained in the company’s filings with the Securities and Exchange Commission, including its report on Form 10-K for the year ended December 31, 2007, and recent filings with the SEC. The company undertakes no obligation to revise or update forward-looking statements as a result of new information since these statements may no longer be accurate or timely. Given…

It was obviously a strong quarter financially, and I’m also pleased to say that we’ve moved forward in a number of different areas that we think will bode well for us as we go into future quarters. Talk about a couple of things here. First, we introduced a major new release of our Business Process Management platform, what we call PRPC, PegaRULES Process Commander Version 5.4, and we introduced it to analyst and customer accolades. Some new capabilities are in this release that were especially exciting include the ability to directly capture business objectives into the technology. One of the messages and one of the missions of Business Process Management is to really make it so that organizations can be far more agile, far more effective. The traditional model by which business users go off and write 600-page requirement documents and hand them over a wall to be designed in IT and specified and signed off in blood and then converted into a program code, that’s a very 1970s way of doing things. And BPM lets you completely change that process. With this technology we’re able to foster an entirely new mode of collaboration where business and technologists can work together and very quickly see, understand and capture right into the technology how they want it to work. It’s really very exciting, and the new advances in our release 5.4 have really captured the imagination of both clients and analysts. Automated globalization, one of the things we’re finding increasingly is that organizations want to be able to define a set of processes, a set of rules, deploy them in an initial language and then be able to move across Europe, into Asia, and only have to define as little as they can to cause the systems to be translated into…

(Operator Instructions) Your first question comes from Geoff Hulme - Porter Orlin.

How do you think about, now that you’re getting to some critical mass and traction in this hot, as Forrester defines it, sector that a lot of people are making claim to making progress in, from consulting firms to systems integration, to big application software companies? We’ve grown nicely here. We’re still a $200 million software company that some people probably haven’t heard of yet. But how do you think about having this position that you have in this functional area with all of these other companies surrounding you, and getting from this point to the next point?

Well, I think a couple of thoughts. First, we understand that for us to take true leadership in this area as this market becomes less fragmented we need to grow very, very rapidly. And as we think about how to do that, we understand that that’s probably going to be through a mix of things. That very much we believe is going to involve a different relationship with strategic consultancies so that we can leverage that we are less responsible for delivering all the services. And we’ve made that a key corporate objective, and we’re working very diligently to pursue that. We also believe that the market is still in many ways nascent and frankly in some ways competition is getting easier, not harder. The acquisition of other companies that were in the magic quadrant a year, 18 months ago by the acquisition, for example, of FileNet or the just-announced acquisition of BEA, I think actually serves to weaken innovation in this sector. And our clients have told us and we have seen that we’re not just in a leadership position, but we’re actually able to increase that leadership. I believe that as our product improves and as our network increases, that we have a tremendous opportunity here. Particularly if at some point in time this market turns from being a push market where we’re selling directly, to a pull market where in fact there is clients who really understand what BPM can do and can apply it. Right now that’s still very early, I think, as you point out, and there’s still confusion. Our job is to over the next year get our brand out there, get the true message of BPM out there, and then see if we can have the channels and other support to support rapid growth.

Your next question comes from Edward Hemmelgarn - Shaker Investments.

You commented that in the 10-Q and on the call, I think, is that you said that orders were down from the fourth quarter. How did orders during the quarter compare to the prior year’s first quarter?

You make a very good point that orders are always down in Q1 compared to Q4. We were right around where we expected to be in our budget. The geographic mix was a little bit different. I think we were just a little bit up from where we were in last Q1, but we definitely came off a very strong Q3 and Q4. And so Q1 concentration was in building pipeline and building deals that we can close throughout the rest of the year.

So you are now getting a more of a what one would describe as a pattern that you would expect.

It’s a pretty consistent pattern in the industry. Whenever you’re selling a product to someone on the customer side as a capital expenditure, they get their CapEx budgets in Q1 and they have to decide what made it and what didn’t, and then they start evaluating what they are going to do. And they spend very frugally for the first two quarters, and by mid-Q3 they wake up and they go, wow, we’ve got this budget; we better choose it or lose it. And you see a much higher level of activity in those quarters.

Are you seeing any overall warming at corporations in terms of their interest? A number of people have commented that at the beginning of the year there was the shock and there was a bit of a reluctance on the part of corporations to engage. Are you finding that changing now that we’re in the fifth month of the year?

Well, I think we’ve not really seen a problem getting our clients to engage, particularly since a lot of our strategy is to radiate or to continue to evolve in existing customers where they understand what we can do. What I will say is that there is an increasing, throughout the year and actually in the fourth quarter clients are less likely to believe the hype. There tends to be just a really pragmatic interest. I think there tends to be an interest to do things in phases or waves as opposed to go out and buy what might end up being lots of shelfware. So the conservatism from the newspapers we’re seeing is manifested in the buying behavior. But it’s not a lack of interest, and we’re wildly busy. So we’re not at all in a situation where our sales force and our services teams are being shut out of clients; it’s very much to the contrary. I just want to make sure that as they do something they’ll get a financial benefit in three to six months.

Subscription revenue, there was a new curve that you threw at us. Was that something that was also present but not material in ‘06 and ‘07, or this was something new in the first quarter?

It’s something new in the first quarter. It’s a way to solve certain problems that customers have where they need certain features. Perhaps they plan to start with a domestic rollout of an application but then want to move to a worldwide application and they need new features in the future. And so it becomes more of a subscription when the arrangement includes unspecified future features.

You expect, though, this is a feature of your offerings that will likely continue in the future.

I think the offering makes sense in a lot of cases, especially in some of our accounts. We have some of the largest corporations in the world, and most of them operate very internationally, and this makes sense for them.

And my view has always been that what was classified here as a subscription is in many ways really quite analogous to what you would have thought of as term licenses. Clients paying a more modest amount sometimes over periods of time, or regardless of when they pay, the revenue gets spread out over a period of time as opposed to the alternative, which is the big upfront perpetual model.

Well, but the difference is with your term license, they have to in the future, the client has to continue to renew, and so as long as they are using it, it’s in effect a perpetual payment at some. Obviously if you have to renew the term at whatever the term terms are at that point in time. But with a subscription, I am assuming that it’s just a longer period to pay for a perpetual license.

No; actually it’s not. It is a set period of time of which they can get these new benefits, and after that point in time, if they end the subscription, they no longer get the benefits of these new features.

As Alan said, it’s more analogous to a term.

And it obviously varies. It can vary by deal. But in principle, I think you can think of it as being in many ways a similar to term and the maintenance that goes along with terms.

The key difference is that you’re already delivering some products in there, but you don’t know preciously the exact terms, final terms of what you’re going to be delivering to them.

Yes, unspecified new features over the term.

What, in terms of service cost to sales, do you have a target that when you look at service and training what you would like to be able to get that to on a normal run rate that you’re modeling to at some point in the future.

Well, to be quite honest we’re not too concerned about the margin on the enablement. Our objective is to enable customers. By enabling customers they can do more of the work when it comes to implementing applications. They can do that work faster. They can do a better job of it, which means that they will enjoy the benefits of that application faster, and they’ll be ready to buy the next license in a shorter period of time. So that’s the objective of the enablement. As far as the service margin goes, as I said the service margin is down this quarter. You’ll see a more normalized version of that margin next quarter and through the year. Now that we peeled off maintenance, you’ll see that normalize.

Your next question comes from Gregg Speicher - Moss Creek.

How does the service department feel right now? Is it really bulging up against capacity? All the other fast-growing companies I follow, that’s one of the harder things to manage. Is it just tough to manage that right now due to demand?

It’s very busy, and different geographies have different rates. But we are seeing an extremely high demand for services. Our strategy, though, is very explicit. Our strategy is we are really trying to bring up three classes of additional resource into the mix. The first class is the client themselves, where we have a very specific client enablement strategy and have been successful with many of our clients, that tend to be very effective at implementing Pegasystems and both helping on implementations and even doing new implementations themselves. The second is our, what I would describe as our muscle partners, organizations that can bring Indian or onshore resources to try to bulk up teams if they want to make a big push to get something done quickly. And the third is these emerging strategic partners where we see them as not just building teams that can do work but also being able to engage with a strategic agenda around customers transforming their business, etc. So our strategy very much is to not grow the services organization at the rates we expect the overall service ecosystem to grow and to very, very radically focus on enablement, focus on frankly working with some of these, both clients and partners to do a little handholding as they come up the curve; and all of that frankly reduces services margins. I have told the services organization point blank that this year and, frankly, as long as we think that the growth possibilities are there, enablement and spreading the word is more important than what happens in any given quarter or what happens to the services business as a standalone business. Its not, it’s really there as part of this vision of how to get BPM understood in the industry.

We are ultimately a software company, not a service company. I just had one more thing to your comment, Gregg, is that we provide professional services with two sets of resources, our own employees and subcontractors. And when you add your own employees, your capacity goes up in a step function. And to smooth that out, and if we have a sudden surge or a sudden decrease, in a month or a quarter or whatever, we ramp up and down the contractors. They are the buffer.

Would you want to have any further comments on either the revenue or the cash flow guidance for ‘08 with the strong results from Q1?

Well, we only give annual guidance.

Could you give us an update on the named account/affinity model you’ve been building out? Are you happy with each salesman’s progress? Do you need keep hiring rapidly to keep that working? Any thoughts there?

Well, we are hiring and we are evaluating. We did a number of re-evaluations and some actions as we ended the year. We’re very much trying to look at the effectiveness of the overall sale force, to try to make sure that it’s not just making numbers in aggregate, but that every sales person has the right support and that we have the right expectations of the sales people, so that we can in effect get, I would describe as more reliable results in the future. We have made a number of changes in that regard, and I will tell you it is a wonderful time to be the hot company in a hot sector. When so many enterprise software companies, the mid-tiers, business objects, from BEA to FileNet, when all of those have been acquired, we’re finding that we’ve really got a good chance to hire top-notch sales people. We’re continuing to hire with an 80% focus on the affinity model or 80% of our sales force is in fact dedicated to specific named accounts and really get a chance to build these relationships.

Can you talk about the company you acquired, revenues, numbers of customers, etc?

Yes, the company that we acquired had some really great technology and some staff and modest revenues, but what we really liked was their staff and their technology, and they tended to operate in the middle tier of banks. And what we’re doing right now is we’re bringing their intellectual property into our high-end engine, so that we can deploy it at the world’s biggest banks and other financial institutions. They also have experience in insurance and some other key areas. So we’re basically taking something we like and are bringing it up market. So there is no really revenue that we acquired at all from them. We really just acquired the IP assets and the staff, and we allowed them to continue with their existing revenue base and existing customers because frankly that was not our target market, the tier banks are not.

Nevertheless the addition of these people, their level of expertise, their contacts in the industry, are helping us right now to build pipeline.

Your next question comes from [Hal Barry – Graham Partners]. [Hal Barry – Graham Partners]: Craig, as you hit this $200 million run rate, you think you’re near a point where you can provide investors some target-operating model in terms of gross margin and operating margin level that you think the business should obtain, or not necessarily near term but at least mid-range to longer-term target?

Well, I think as we go through the year and we see that back and forth, we build these term license inventories. We draw them down a little bit. I think through the year we’ll see that level of inventory perhaps reach a more normalized level. And at that point in time we won’t be deferring revenue onto off-balance sheet inventory, and we can really look at our P&L and give a more normalized level. We did give guidance of increased profitability for the year. [Hal Barry – Graham Partners]: But no comments on when you think you should achieve best-in-class software [inaudible] margin operating margin levels?

I think it’s hard. My personal opinion is that in situations where you are pursuing unusually rapid growth, and we are targeting to be a growth firm here, that that coupled with the inherent lumpiness of our business can make giving the more stable margin analysis that frankly larger firms or firms that are not growing as fast can give, I think that makes it difficult. Yes, my belief is as we grow and as the business becomes more mature, obviously that’s going to be much, much easier.

It’s a trade-off for us every quarter when we make decisions on hiring new sales people, investing more in R&D, or cutting back on those things and increasing our bottom line. And as Alan said, by investing in growth we are leaning towards that decision. [Hal Barry – Graham Partners]: Alan, when you look at the PRPC implementations today versus one or two years ago, how big is the change in terms of having the business user educated today to the extent that they are the ones editing and adjusting these business objectives versus waiting for IT to do it and then just having it implemented on that end? How engaged in the process do you see the business user at this point?

Getting the business to be more hands-on in terms of their implementations as opposed to thinking that the responsibility ends with writing Word documents is something that requires not just technical change but in organizations there needs to be a cultural change. So what we’ve seen in the last couple of years that’s extremely gratifying. Because we have a lot of customers now, not all of them but a lot of customers, where the people we call business architects, people from the business who’ve generally been through a week of training, are actually making pretty amazing ongoing changes either individually or as part of project teams during implementation. And that has become I would say in the last two years very much a reality at maybe about half of the accounts that we do business with. I think that’s going to increase as the other organizations see what’s possible, and frankly as our software gets better. We still think we have work to do to continue to drive this vision, but pretty happy with where it is.

Your next question comes from Unidentified Analyst – [Inaudible] River Partners. Unidentified Analyst – [Inaudible] River Partners: How much of the business right now is being driven by the system integrators, not a sales guy at Pega passing it along to them, but them driving it with their customers direct?

So I would say it’s much, much larger than it’s ever been before, and I think that’s partially because we have conscious strategy. And I will give you the answer, but in truth it’s not like the systems integrators will actually close the business for you. We need to continue to sell with them and work with them and sometimes convince them that we are the best solution for their customer. But I would just say off the top of my head that a quarter or more of our selling is intimately tied to systems integrators, and I would say it may even be as high as a third, as I think about the last quarter or two. Unidentified Analyst – [Inaudible] River Partners: I assume that’s up substantially year-over-year?

Yes, it is. Two years ago, it was entirely episodic. We would occasionally get something that was done in conjunction with the systems integrator, but we did not have that maturity of relationship. I will tell you that a much larger percentage of deals that are not necessarily driven in by or in conjunction with systems integrators, there were systems integrators actually have a very material part of working with the clients during implementation. The significant majority of our deals have system integrator involvement in the implementations with the client. Unidentified Analyst – [Inaudible] River Partners: Can you talk a little bit about the average deal size and where that’s been trending?

Yes, it’s actually been pretty stable between I’d say it very much goes between $400,000 and $650,000. Now we have numerous outlined events, million-dollar-plus deals. We have several of those this quarter here. I am not a great fan, frankly, of massive, massive deals because usually when a client overbuys, somewhere down the road either the client or the software vendor ends up regretting that. And so we don’t actually push the team to go and try to do the bubblicious massive deals or, I know there are other companies that depend on those; those not our style. But we have several over a $1 million deals this quarter. Unidentified Analyst – [Inaudible] River Partners: Can you just touch a little bit on how you price. How do you price the deal and what separates a big deal from a smaller deal, and you’re not pricing per seat necessarily.

Our model is a model where we think the client should pay a fair price relative to the usage of the technology. And the usage of the technology is often measured in terms of seats. For example, we in Q1 won a very nice highly competitive call center piece of business where you would license it by the number of call center seats. Because the technology’s so broadly used in situations where it’s not used by people who can be seen in seats or even in some cases is not used by people at all, we have a metering module built into the system, where it actually can measure the number of times it’s invoked in a year, the number of times the system actually does a piece of work, meaningful work in a year. And we will sell clients those, think of them as services-oriented architecture clients. We’ll sell them in effect an engine license that’s metered based on this indication usage there. It can in fact be very cost effective for clients, and if they use it more over the future years we’ll get paid more. Unidentified Analyst – [Inaudible] River Partners: On the mix of customers in terms of, by vertical, what are you seeing there?

I think we’re seeing that our healthcare business is doing actually extremely well. That continues to be a real star. I think we have seen some conservatism in the financial services businesses, around the insurance business and the financial services banking businesses, where there is a lot of activity. But as I said, people are just being just very, very sure that they’re going to get a cost-effective return in a short three, six, nine-month timeframe as opposed to doing larger projects.

That being said, though, we did close business with the financial services sector in both the U.S. and international. It’s not like the business has been shut down. We’re still doing business with them.

Your last question is a follow-up from Gregg Speicher - Moss Creek.

You talked about the new major release. Is there anything particular to the functionality that you were talking about that’ll help you get over some of the conservative spending or hesitation by customers? Is there anything that really increases ROI or shortens the implementation cycle? Anything like that you can point to?

Yes, we’ve actually been now using this for a couple of months. We began using it actually before it was officially released and have been using the technology now for the last couple of months post-release. And the estimates of our services teams is that the use of this functionality can reduce the implementation duration and cost 20% to 30%, which is very material, obviously. So we’re seeing clients intrigued about this, and I think that’s part of what, frankly, just makes it easier to generate interest. If you can take a project and take a six-month project down to four and a half months, suddenly the return on investment is much more tangible.

And that’s important right now, you hear a software company saying about it’s getting more difficult and there is more reviews. By lowering that cost, by decreasing the time that it takes to do an implementation, we dramatically improve the IRR, and that helps get things approved and through their purchasing system.

And I would like to thank everybody for joining us on this call. We are glad to have made it through 25 years. We are hoping that our next 25 years shows an accelerated growth rate. And we are working extremely hard for you to see if we can make that true. So once again, thank you.