Greetings and welcome to the Pegasystems First Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ken Stillwell, CFO, CAO and Senior Vice President. Thank you. You may begin.

Thank you. Good evening, ladies and gentlemen, and welcome to Pegasystems Q1 2017 earnings call. Before we begin, I would like to read our Safe Harbor statement. 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 expects, anticipates, intends, plans, believes, could, should, estimates, may, targets, strategies, intends to, projects, forecasts, guidance, likely, and usually, or variations of such words, and other similar expressions identify forward-looking statements, which speak only as of the date the statement was made and are based on current expectations and assumptions. Because such statements deal with future events, they are subject to various risks and uncertainties. Actual results for the fiscal year 2017 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 Q1 2017 earnings and in the Company's filings with the Securities and Exchange Commission, including its quarterly report on Form 10-Q for the quarter ended March 31, 2017, its annual report on Form 10-K for the year ended December 31, 2016, 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. And with that, I'll turn the call over to Alan Trefler, Founder and CEO of Pegasystems.

Thanks, Ken. We started this year with a pretty outstanding quarter. As I have said in the past, our business can be lumpy on a quarter to quarter basis, but it's always good to start with a good lump. We are happy with our performance around the globe and across our verticals and saw a good mix of business between our apps and platform. While we continue investing in strategic areas to grow the business, we are managing our costs well. Most importantly, we continue to see our clients achieving impressive business outcomes through using our software. Ken will provide additional financial details later. To recap overview of our strategy, we are very happy with how our strategy is playing out. We are now being recognized in the market as the CRM alternative to Salesforce.com, especially for the enterprise. Our heritage has always been about empowering organizations to get real work done, something that has been woefully absent in the CRM market. We believe CRM is more than activity records, opportunity tracking and reports. For us, CRM is about removing friction across the entire lifecycle to fuel exceptional customer and employee experiences, while helping our clients achieve optimal efficiency. Foundational to this is our ability to outpace the competition in three key areas. First, we are the leader in real-time artificial intelligence for customer engagement. Second, we offer the only software platform that automates work across all customer channels and through all corners of an enterprise's operation, including customer engagement, customer acquisition, sales, onboarding services fulfillment, and others. And third, we are the only CRM provider that offers true cloud choice. Let me provide some additional color on how our focus on these three key differentiators is driving our success in the marketplace. The first one, the leader in real-time…

Thanks Alan. Pega's start to 2017 really extends our momentum from last year. For Q1 of 2017, we experienced strong license and cloud commitments and revenue growth. Year-over-year top line revenue grew by 25% and license and cloud revenue grew by 34%. Both our top line and license and cloud revenue were positively impacted by approximately $7 million perpetual license arrangement that could easily have occurred in Q2 but we worked hard to sign it in late Q1. As most investors know, we look at our business over the long-term, so arrangements [indiscernible] moved between quarters frequently. We view this as a reality of being a leader in the enterprise software market. Naturally I'm happy to report about the deal coming in early versus trying to explain why a deal of this size was delayed. Our solid license and cloud commitments were achieved without a whale in Q1, consistent with the first quarter of 2016. To remind everyone, our definition of a whale is a customer software commitment of greater than $10 million. Whale size arrangements are still likely in our business going forward. For our Q1 year-over-year, services revenue growth of 25% exceeded our long-term growth expectation of more like 10% to 15%. This is an example where a small number of clients chose Pega to lead the implementation with our Pega partners playing a key role. We mentioned previously that we support key customer engagements directly with Pega resources to ensure success. However, we anticipate that this level of services revenue increase does not represent a change in our strategy and may not persist in the future. Our Q1 recurring commitments were approximately 50% of our total license and cloud commitments, similar o what we anticipated in our guidance. We continue to highlight the Pega philosophy of providing…

[Operator Instructions] Our first question is coming from the line of Greg McDowell with JMP Securities. Please proceed with your question.

Nice lump and certainly looking forward to PegaWorld in a few weeks. Alan, maybe I'll start with you. I was hoping you could maybe compare and contrast the beginning of this year to the beginning of last year, because certainly last year was somewhat of a slow start to the year but this year it feels like you guys came out with guns blazing and pulled the deal forward. So can you just maybe talk about maybe what's changed in terms of maybe sales, how you've set up the sales force this year, quotas, go-to-market strategy, the strategy that has enabled you to sort of come out with guns blazing?

I think a couple of things, and as you pointed out in your reference to my lumpy comment, I think in our business it's dangerous, good or bad, to get overly worked up about an individual quarter or even two. We look beautifully consistent as a firm when you look at years, trailing 12 months or end of years. Quarter to quarter, there are lots of things that can be different. I think if you go back to a year ago, we had really completely blown out the pipeline in the fourth quarter the previous year. And so we started with both a high level of exhaustion and I think a lot of work to do to rebuild, we can rebuild pipelines pretty quickly, but it does take work. So, I think we are a little bit better positioned by our more balanced results in 2016. But I also think that we've been introducing some meaningful changes to the selling methodology, adopting what sometime is referred to as a challenger method, which we've been putting a huge amount of work in to educate our sales force, to get them to really think about providing frankly a constructive but provocative way to envision this marriage of customer engagement and operational efficiency that we really uniquely can bring. Having both the parts of top leading customer engagement with the ability to do the heavy-lifting and go as far as people need to go, that's actually a pretty unique offering in the industry. And powered by cloud choice and other things, we're seeing that resonate with customers. And so, we have done a series of changes to the sales force, very much still works in progress, but I'm encouraged by what I'm seeing and we're going to continue to work that hard because you don't just announce sort of a new approach to market. It takes, as I'm sure you know, it takes many quarters to really get that inculcated into the marketing, which has gotten better, but we're expecting is going to get continuingly better in support of this methodology during the year. And all of this together leaves me encouraged about where we are, but still aware that we've got a lot to do this year.

That's helpful. Thank you. And then maybe one for you, Ken. I'm starting to get a lot of questions about one of your competitors, maybe more at the lower end than the Fortune 500 and one that recently made a public filing, but I was wondering if you could – I'm sure you're going to start getting lots of questions from investors about your competitive positioning against certain competitors, and I was wondering if you could just comment on how you compare and contrast your solution against others? And then – I'll leave it there, thanks.

Relative to that competitor, which I'm not afraid to say their names, company called Appian, we have moved to a point where they are certainly not on our list of companies that we think of as a core competitor, because we have moved so much to tie that sort of old school process automation directly into customer engagement and get the advantage of that. And you know what I love about them having had to file an S-1 is that their revenue was a lot less than has been alluded to in a whole variety of competitive situation. And I can remember what it was like to be $130 million a year public company, and that really wasn't a lot of fun. So, I'm looking forward to them learning those experiences firsthand.

Great. Thank you.

Greg, this is Ken. Just one quick follow-up on your first question to Alan, I'm trying not to confuse too much in the earnings script with all kinds of things that happen year-over-year, but remember that we didn't have OpenSpan in Q1 of last year. And so we would have had a little bit of an easier compare just related to the OpenSpan revenue that wasn't in Q1. Once again, I hate getting into like currency and all the things that move, but that is one thing that was different between Q1 and Q1 that we don't report that separately but just keep that in mind.

Yes, good to know. Thank you, Ken.

Our next question comes from the line of Steve Koenig with Wedbush Securities. Please proceed with your question.

Nice job on the quarter and so I'll just add best of lump and we'll take our lump. So you guys sound good. So really two questions, maybe first question is, so Salesforce.com, maybe some color on like what percent of deals you see them – has this changed from say a year or two ago? And then given the growing awareness of Pega as a CRM market leader and your evolution of your go-to-market focus, do you expect that to increase?

So I think we are fairly balanced in terms of being able to both go after deals where Salesforce.com is engaged and some of them more traditional deals where we really build on our historical strength of process automation and the realities in software people can choose to buy or people can try to sell things just based on power points and promises. So I won't say that we don't really compete with them in some of those, but in reality there is a set of deals where it would make no sense for customers seriously choose them as an alternative. But we are definitely going to see them more in the future because we are going after them, winning more deals with them, we're hunting that – two years ago, three years ago, we wouldn't have sold sales automation deals competing against Salesforce, now we are in there beating them, in the thing that was their historical strength. And the reason we can is that a lot of customers bridle being enslaved to the Salesforce cloud, and I think that that will only continue as sophistication about what cloud really means as we move from cloud being this elusory thing to cloud being something people really get. That level of flexibility, I believe that customers will come around to that in the coming years and we are thrilled to be adding the functionality, the features and still have the architecture that can go head to head with them and win. So yes, you're going to see us in more deals with them, but it's not because they are coming after us, it's we are coming after them.

Great. Okay, thanks. So then for the follow-up question, maybe we'll make it a two-parter but I'll keep three here, so you guys rightfully keep cautioning us don't over-generalize the one quarter, but you have put up many quarters of very good growth, and I'm wondering how should we think about trend growth here. Historically you have talked about 15% to 20% trend growth. Do you have enough data to think that it may be higher than that, has there been an inflection? And I guess if I may, kind of the second part of that question is, the way you reorganized your booking results in Q4, that was very helpful, and it allowed us to see – having historical data, that was great too. So your mix of recurring went from 60% as what we calculated in 2015 to 67% of bookings in 2016. Without pinning you down on numbers, where should that go, and how long should we think about it taking to stabilize? So any color on those two topics would be much appreciated.

I wish I could tell you that we have a statistical basis to claim a meaningful and go forward assured inflection point, but I do have a background in statistics and I would tell you that that would be a little more [indiscernible], than – which I know is possible on these [indiscernible] but it is a little more [indiscernible] than one can honestly walk in. Obviously we are pleased and obviously we feel good about how the business is doing. Relative to the shift between perpetual and recurring, the reality is it's very customer specific, and this whole mantra that we are pitching around cloud choice doesn't just apply to cloud choice. It also applies to how do you want to buy it. As long as you are willing to enter a rational business relationship with us, we are going to show the customer respect. And how you think it kind of ebbs and flows to tell you the truth. Customers, a lot of customers, are thinking that being able to do cloud and thinking of everything as an operating expense makes sense, but in some of the industries we are in where they spend a fortune on CapEx, they think it makes sense to buy, particularly if they're making a very large purchase, they would think it makes sense to buy using a perpetual license, which hits the CapEx line, which might be completely irrelevant if they are for example rebuilding telecommunications infrastructures and doing other things of that type. So I'd be [indiscernible] to say that we should move far off the kind of 50-50 expectation for recurring versus perpetual, but I'm very happy all day to sell the customer a perpetual license for fair price with a solid and continually renewing stream of maintenance. I think that's a respectable way to do things given that we're a company that customers expect and we live up to the promise that we'll continue to add new features to the software. So I'm not prepared to draw statistical shifts yet, maybe [indiscernible] depending on how it falls.

I would add one thing, Steve, that clearly over the last say four to five years, customers like buying recurring more than they did. That's just a market trend, right, and we are seeing that as well. And so we hope that continues but the reality is we want to be flexible. And getting a big perpetual deal with a cash payment upfront is not a bad scenario for us from an economic standpoint. So think about what I just said about that longer term view. I would put the same view on the growth curve, right. We have grown year in and year out for the last 15 years between 12% and 21%, some years it's 12%, some years it's 21%, but in general it's been in that 15% to 20% range. And the reality is that we are continuing to push to accelerate that growth higher, but to start and say once again, we see trends in a couple of quarters that tell us that that's going to be noticeably different, might be irresponsible to say in this kind of setting. We want it to be higher but…

Look, we have a buyer and we've told our company that we think high-growth – that really successful firms grow faster than we have historically, net of acquisitions. You got to kind of net the acquisitions out to understand the real growth rate. And we believe we can do that. When we're going to hit it? That's the question that we are working on. But I'll tell you, the products have never been better and the client engagement has never been higher.

Sounds good. I appreciate your answers and I've used up my questions, so look forward to talking with you shortly.

The next question is coming from the line of Mark Schappel with Benchmark. Please proceed with your question.

Great quarter and thanks for taking my question. Ken, starting with you, with respect to the operating margin leverage to reach your 2020 goal of, correct me, 20% EBITDA margins, what expense line items should we look from leverage on in the next year or so to reach that goal?

To be honest with you, Mark, I kind of flip it around internally to the Company and say, which one shouldn't we, right. I mean like we need to improve as a business across the board, and if we are going to expand margin, there is really not a silver bullet on one line like sales and marketing or gross margin. I think what you will see is as our mix of we leverage partners more externally, and remember to think about this over a longer-term period and not one quarter, as we leverage partners more as we try to accelerate our top line growth, naturally you're going to get gross margin expansion, so that you would see. And in addition, we are going to improve our services margin as we get larger, which you are also seeing in our results. We are going to improve our cloud margin as we get bigger as a cloud business. That will help us in gross margin. Sales and marketing naturally will. One of the big push around our challenger approach is because it helps to make sales, helps to improve sales effectiveness, it helps to improve velocity through the sales channel. So that would help. And I think R&D, we have always been a very product-centric company, product has always been really important to us and it always will be. So we will get some leverage there but we are not looking at reducing our R&D investment significantly. We are trying to continue to be a [Prada] [ph]. And G&A will naturally tag along and get some operating leverage as well. So, I would say it's all over the board.

Yes, we are doing a lot, and I think Ken deserves all the credit for having deeply insinuated a lot of thinking around financial awareness into the Company. What I like is that the firm as a whole is becoming smarter about spending money wisely, and that doesn't just mean we'll save money and get leverage in a number of these areas, I think it also means where we spend, we are going to get better and more fruitful outcomes. Is there a possibility in R&D on a percentage basis to have it go down a touch? Absolutely, if we increase our productivity, but we could in the short term make our margins pretty much any number we wanted to, the reality is we are positioning this Company for actually more rapid growth and we are very happy that we have got product differentiation that's going to be hard for competitors to catch and we want to make sure that that continues. And we are not spending on wild and crazy products, we're spending on things that we're actually able to bring to market, even though they are technically regressive.

And you know, Mark, just one last follow-up, you know as well as anyone that the more that we can accelerate growth, it makes the margin expansion that much easier, because you get the growth, you get the margin expansion as well. So, not considering keeping the foot on the pedal of growth is probably going to make things a lot harder if we're trying to expand margins.

Okay, great. And Alan, in your prepared remarks, you spent a lot of time discussing the Company's AI capabilities, and I was wondering if you could just give us a sense of where customers are with respect to AI. Are they still kicking the tires or are they starting to open up their wallets yet?

I come from a world where we used to teach computers to play chess before IBM threw brute force at it and made it so humanity learned nothing, with Kasparov losing to Deep Blue. So I come from a world where we used to teach computers by having your risk takes that would enable chess masters to try to instruct kind of how a computer envisioned a position. That was actually how I got involved in computers to begin with. And back then I think I had a very verified view of what constituted AI. What happened candidly over the years is that lots of things that are questionably whether they are really 'artificial intelligence', and now routinely put in the artificial intelligence bucket, and I think there is a lot of confusion in customers' minds as to what's really AI and what isn't. The way I recently described it in an interview is, we now consider AI as pretty much anything that makes a computer really appear smart. And by that definition, we've got slews of AIs, from very sophisticated machine learning and adaptive analytics technology to robotics that do things that people used to have to do by hand on screens and actually have a robot do it for them and observe the behavior to learn from it. So, the very fact that our software generates and regenerate software for the different platforms, so I think we have got a terrific AI message and one that's a lot more tangible and frankly customers are adopting much more than a lot of the other stuff out there I see which is frankly I think pretty questionable in a lot of cases.

Great. Thank you. That's all for me.

We do have an additional question coming from the line of Matthew Galinko with Sidoti. Please proceed with your question.

Congrats on the quarter. You called out the Gartner comment in the script and you have historically talked about your outbound marketing efforts. I'm just curious if there are any tangible metrics that you could share around improved brand awareness or any color on how those gains are supporting your selling efforts?

So we are seeing – basically there are some other things we look at, what is the activity on our Web-site, are people coming, are they staying, are we building a larger base of engaged contacts that we can deal with. And I'll tell you that the engagement numbers are meaningfully up, north of 40% from a year ago. So, we are seeing a whole lot of client engagement. We are going to be pretty dramatically enhancing the Web-site over the next couple of months based on work that our new CMO has done based on work with a variety of clients and other sorts of things, and I'm going to look for those numbers to continue to rise. So, a lot more client engagement and it really supports this idea that we talked about, about a year and a half ago, of supporting what we call digital buy, which historically we did frankly badly in terms of really letting customers learn from themselves what we did. And now I actually think we do pretty well and we are committed before the end of this year to do that excellently and we will report the improvements in customer engagement as that happens.

Excellent. Thank you.

We have reached the end of our question-and-answer session, so I would like to pass the floor back over to Mr. Trefler for any additional concluding comments.

Thank you, Ken, and thank you to all our staff, customers, partners and shareholders. We are working very hard, very, very hard on behalf of all of you and I think there's no better place for investors to see what we are up to and to hear from our clients themselves about what's happening than for our investors to reach out to Ken and arrange to join us at the investor session on the Monday at PegaWorld, that's June 5. So if you haven't, please reach out. I promise you it's going to be a great and informative day. Thank you everyone.

Ladies and gentlemen, this does conclude today's teleconference. Again, we thank you for your participation and you may disconnect your lines at this time.