Good day and welcome to the Pegasystems Fourth Quarter and Full Year 2018 Earnings Results Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ken Stillwell, Chief Financial Officer, Chief Administrative Officer and Senior Vice President. Please go ahead, sir.

Thank you. Good evening, ladies and gentlemen, and welcome to Pegasystems Q4 2018 earnings call. Before we begin, I'd like to read our Safe Harbor statement. Certain statements contained in this presentation may be construed as forward-looking statements as defined in 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 of 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 fiscal year 2019 and beyond could differ materially from the company's current expectations. Factors that could cause the company's results to differ materially from those expressed in forward-looking statements are contained in the company's press release announcing its Q4 2018 earnings and in the company's filings with the Securities and Exchange Commission including its annual report on Form 10-K for the year ended December 31, 2018 and other recent filings with the SEC. Investors are cautioned not to place undue reliance on such forward-looking statements and there are no assurances that the matters contained in such statements will be achieved. Although, subsequent events may cause our view to change, except as required by applicable law, we do not undertake and specifically disclaim any obligation to publicly update or revise these forward-looking statements whether as a result of new information, future events or otherwise. And with that, I'll turn the call over to Alan Trefler, Founder and CEO of Pegasystems.

Thank you, Ken. Q4 was strong capping off a terrific year and I'm pleased with how our strategy is playing out. And we're more convinced than ever that we have the right solutions and vision for what the market needs. As we discussed, our goals are to accelerate growth, while we move to a more recurring model and our year-end results demonstrate the progress we're making. A lot of this is continuation of the trends we've discussed over the year. We're seeing an acceleration in our move to the cloud and other recurring arrangements and our trademarked Cloud Choice message is resonating. And really all of our client deals are being deployed with Cloud Choice as an important factor. And in 2018 amazingly Pega Cloud, where we are actually the full-service cloud provider, represented half of all new deals compared to that being in the low 20%s in 2017. This is a very positive development in terms of driving recurring revenue and cash flow over the longer term. Now we started talking very much about ACV, well over a year ago, and our strong underlying business trends are reflected in license and cloud annual contract value, that's ACV, growing 40% year-over-year. And total ACV, which includes maintenance, grew at a very healthy 23% from a year ago to $570 million. As we've discussed over the past several quarters, ACV is the measure we are most focused on because we think it most closely reflects our underlying business trends, while we work through our transition to being a cloud and as-a-service company. But as we've also said, it's important to look at current performance, as well as future obligation and our commitments from clients, to really understand the health of the business and Ken will go into more detail of that…

Great stuff Alan, thanks. Before going into some of the details, I'd like to reinforce a few things. We're in the midst of a pretty significant shift of our client contractual commitments from perpetual to cloud, which is just a terrific outcome of our strategy. This shift to cloud creates a negative short-term impact on reported revenue and margins. As Alan mentioned in 2018, Pega Cloud commitments represented half of all new business. If we maintain our new business commitments of Pega Cloud at approximately 50%, 2018 and 2019 represent the years most impacted by the cloud shift. During this transition and even after the transition, Annual Contract Value, ACV and Remaining Performance Obligation, RPO or backlog are two key metrics we use to measure the growth of our business. Annual Contract Value is the most important measure because it reflects the growth and recurring cash flow commitments from our clients. Remaining Performance Obligation, which many people refer to as backlog, represents the total client commitments that have not been taken to revenue. When assessing the performance of the business, we believe the combination of ACV, RPO backlog and revenue can provide valuable information to help interpret the results. For example, if revenue grew but ACV and RPO backlog declined that would likely not be judged as favorably as if revenue was flat, but ACV and RPO backlog grew significantly. The key is the CR business growing and producing predictable future cash flows, which is why we are laser-focused on ACV. Now let me remind everyone of several key goals we set out to achieve in 2018 and beyond; first, we set a goal to accelerate growth. This is because our market opportunity is huge and we've been strengthening our position in the CRM market which Gartner said was the…

[Operator Instructions] We'll go first to Rishi Jaluria with D.A. Davidson.

Hey Alan and Ken. Thanks for taking my questions. Good to see the underlying business continue to accelerate. Ken let me start with your comment that your guidance for next year is assuming that cloud is still going to be kind of relatively flat at about 50% of new sales for 2019. Why is that number not increasing? And I understand Cloud Choice, but I would -- I guess expect given the cloud transition you're going through for that number to at least tick-up. Is that kind of specific to 2019 relative to the fact that 2018 was well ahead of your expectations? And then -- and maybe how should we be thinking about that number beyond 2019?

So, good question Rishi. So, we've had four quarters now where that percentage has consistently stayed around the 50% number. And when we thought about our guidance for next year, we felt that 50% was a reasonable target given that customers do have choice. And there are situations where customers want to use the Pega solutions inside their own cloud environment for instance Google Cloud, Azure etcetera. Could that percentage be larger than 50%? Of course, it could. And I think that we've given some kind of -- some framework on how to think about the impact to revenue in the past when the percentage varies off to 50%. I think we felt that it would be a little bit aggressive to pick a number much higher than 50%, given that we haven't seen that trend be higher than 50%. And so that's the reason why we built the model under that framework. A – Alan Trefler: And you need to remember that a Cloud Choice client may still choose to have Pega run it for them on our cloud. That can be one of their choices. That's what's happened actually with some of our perpetual license. We don't really get much Pega Cloud revenue when they do that, it ends up hitting another one of the revenue line. So there's no question that the practical and visceral shift to cloud is happening in a very, very profound way. I think that we don't have a better estimate to give you than what we've seen in the last couple of quarters going into this year. Q – Rishi Jaluria: Got it. That's helpful guys. And then if I look at perpetual license this quarter, where are those -- where is that perpetual license coming from? I mean it's not all…

Got it. That’s helpful. All right. Thank you so much, Alan and Ken.

Thanks, Rishi

Thanks.

We'll now take a question from Peter Lowry with JMP Securities.

Great. Thank you. First, how much of your business is U.S. federal and does the U.S. government shutdown have any impact on your business?

So it obviously is discouraging when government shuts down, but I would say that we won't see any material impact from our business as a result of the shutdown.

And we don't -- just, Peter, though the one thing that maybe worthwhile is, we actually disclose any customer that's greater than 10% in our financials for the year and you'll notice that we didn't have one this year. And so that -- and we would view the federal government as one customer. So that gives you an idea that even all federal government clients don't add up to 10% of our business. So that's helpful, just to give you like a sensitivity.

Okay, great. Thanks. And then, it sounds pretty good, but can you elaborate on how you feel about your current sales force productivity and where you're focused on with your sales and marketing investments?

Yes. I think, we've done a very good job, particularly, over the last six months at establishing really good patterns to help us manage the existing sales force and set a standard for being able to onboard additional people. So that's really the key, is to try to have what we call good effectiveness and good productivity, as we onboard large groups. What I'm excited about is that the overall productivity levels of the company actually increased in 2018 despite what we would consider to be quite material increases in the selling force. So I'm actually very -- you won't find I'm satisfied by much and I'm certainly not yet satisfied with selling productivity, but in terms of the progress, very impressive.

Okay. Thank you.

Thanks, Pete.

We'll now take a question from Steven Koenig with Wedbush Securities.

Hey, guys. This is Ahmad Khalil on for Steve. Thanks for taking my question and congrats on the quarter. First off, what would you say Pega's view on the demand -- in demand environment of today compared to say maybe six to nine months ago?

I would say that it's unchanged. I think, the demand environment was strong six to nine months ago and the demand environment today is also, I would say, extremely strong. There are a couple of geographies that are a little shakier. I think the whole Brexit and France confusion makes some of those countries a little more different and difficult to project. But we now have a substantial footprint that -- I think, which is benefiting with the fact everybody really is worried about how they improve their operational productivity, whether it's the large banks that are announcing -- Corbat and Citi announced how they are expecting to literally reduce thousands to tens of thousands of the staff in the coming decade. So to improve your efficiencies and make them more competitive digitally. We are perfect acknowledging to be able to bring customers more closely engaged with the institution and help them gain efficiency by eliminating loss of sort of extraneous work. So I see a lot of demand driven by efficiency gains and a lot of demand driven by companies, just wanting to try to secure a better relationship with their customer. So I view both of those as an important levers. And relative what happened in the various economies, we've always been pretty good at responding to macroeconomic shifts, if you look at our history, and being able to have both the revenue potential and customer engagement and the savings potential of the operational efficiency makes us feel comfortable continuing to do the investment and believing we'll get that return

One additional point to kind of add some color to that. We've had -- we had -- 2018 was an incredibly strong year for us and that was not on the backs of a small number of deals from just one vertical. So I think just thinking about cross vertical, you see a lot of strength in a lot of places, which we've -- for us we've kind of capitalized on. So I think that's an important thing to see the strength be more distributed across different industries than just focused on one or two. So that's been kind of a positive observation we've seen in 2018 and into 2019.

Great. Thanks. That's really helpful color. And then just one follow-up. It seems like your investments and focus on shortening your sales cycles is working to bring your contract durations come down a little bit. I guess, looking to next year, how would -- how do you expect your duration to trend? And what kind of impact would you say that would have on ACV growth?

So we would expect the contract durations to slightly come down -- continue to come down. We don't think we're going to be moving to one year contract. I mean, sometimes will do a one year contract, when it strategically makes sense for a new customer, for instance. But it will come down, we believe from 3.5 years and probably come down kind of somewhere closer to the three years to 3.25 years. So, not a massive shift down. We believe that's critical for our flexibility so that we can actually not have additional objections when customers want to buy Pega. Cloud Choice is certainly a great differentiator, so is our ability to be flexible in the contracting structure, and we view that as a differentiator as well. So we do think it will come down slightly, and we think that that is a tool that we use to help keep our growth accelerating.

So it's interesting one of the things that I'm proud of the company because when you make enormous shifts like this, it can be a problem and obviously it wasn't in 2018. We moved from a company that was 100% TCV, total contract value, where there was an enormous incentive to sign five-year deals to a company that was 100% ACV with a little bit of sweetener for line. And I think we did that without missing a beat. We're there as a firm. And I don't imagine that in the foreseeable future, you'd ever see the duration go under three on average that's just not the discussion in the buying mentality. Sometimes when you're dealing with a client, who's not really sure, if he's going to be able to do a one, but boy, that's really the exception.

Great. Thanks so much. Thanks, Alan. Thanks, Ken.

Thanks, Ahmad.

[Operator Instructions] We'll take our next question from Mark Schappel with Benchmark.

Hey, guys. Let me start off by saying that nice job on the quarter. A couple of questions. So, Alan, with respect to your two principal product lines BPM and CRM, did any particular one of those drive the revenue upside in the quarter, or did any particular one of those drive the business in the quarter?

It's pretty balanced. The reality is that the front office has become an increasingly important place for us, that's sometimes in the guys of marketing where one of the world's largest banks, for instance, shows us on Pega Cloud to drive every contact and customer engagement across the channels it's amazing Pega Cloud win against our competitors as you would expect. And that sort of thing is happening very exciting. But also people want efficiency and being able to tie that customer engagement all the way through to being able to operationalize it, that middle out story we told at PegaWorld it's resonating. And I'd say, it's quite balanced which gives us a lot of comfort as we go forward.

I would add one small piece of color to that, Mark, which is earlier in the year I was at an Investors Conference -- earlier in 2018, I was at an Investor Conference and an investor came up to me and said, hey, the most common thing we're hearing is digital transformation, that was in like January of 2018 and I remember hearing that thinking that's interesting. And so, I think what you've seen in 2018 is digital transformation or the operational efficiency has been -- has really kept pace with the front office or the CRM part of the business which over the last few years has not been the case. CRM has been actually growing faster. So, I do think that that's a -- that's really great for us given that we do so well on both sides of that.

Great. And then with respect to the BPM business, I know that it's accelerated this year beyond the normal, say 6% to 8% growth rate. I was wondering if that acceleration carried into the December quarter.

It did. Yes.

Good. And then I guess just as a follow-up to the prior questions on the sales force, besides just adding headcount, what are some of the other initiatives that you're planning that to focus on in the coming year with respect to the sales force?

Yeah, we've been looking to get our enablement and what we call validation up to another level of sophistication. So, we've implemented formal video recordings, independent grading of salespeople being able to really show that they've mastered the key messages. We've tied this into what we call integrated selling programs where we really try to get the materials and the content on the website and the messages that people would use in engaging in clients to be very well integrated and part of this sort of more validated effort. And we've really, I think, done an improved job of concentrating our forces and making better choices about where the sales teams should spend their time. That came out of a lot of work earlier in the year, really beefing up the operations area and the analysis functions, which I'm very excited will continue to help us, as we grow the sales force. Normally, you expect the performance of -- as you increase the sales force, you typically expect average performance to decline. I mean, that's just normal and sensible, because sensibly there are newer people and you've got them assigned to, obviously not the absolute optimal clients because your first people would be assigned there. But I know I think we with these tools have the ability to maintain and even improve productivity as we grow. So, that's something we feel good about.

Okay, great. And then finally is it fair to assume that the company is still committed to the 2022 targets of 15% to 17% revenue growth and operating margins of 23% to 25%?

Let me reframe that 2022 target. We are committed to Rule of 40. We would -- we actually believe there is more value if we can get there on a 25% revenue growth and 15% operating margin. But certainly 17% revenue growth and 23% wouldn't be a terrible outcome either, but we are striving to accelerate our growth. So, I think -- think about the commitment being the Rule of 40 and the balance of the two which is in that -- which is kind of the way I framed it and I think that's -- and yes, the answer is yes to that.

Great. Thank you. That's all.

Thanks Mark.

We'll now take a question from Stephen Bersey with MUFG.

Hey, guys. Just wondering how we should think about your implementation times for cloud versus a traditional rollout? And specifically is there any differences really on the planning side?

Yes, the cloud rollouts are faster. The simple reality is not having to depend on the client to provision. For a large client that can take 60 days, sometimes even a little more out of the schedule. So, in terms of really trying to get value to customers in 90 days which has been something we've been really talking about and promoting. The cloud has facilitated that and we have dozens of instances during the year where customers achieve that with what I would describe as meaningful obligation. We're not talking about little BFFs with some of the stuff that's out there focuses on, we're talking about things that are generally going to be intrinsic to the business.

Got it. And any standout verticals or modules that were either introduced or you think have more to go that you'd like to highlight?

Well, I think that one of our journey at a time CRM which is whether that's in terms of doing some of the next best action or being able to fulfillment of something that people want to be able to do across a couple of channels and do that what we call micro journey or journey at a time where you don't have to go rip out a whole channel to really insinuate this into a channel. I was recently visiting one of our great clients in Europe Rabobank and they were using our technology for both what they call real-time relevance which is how they describe decisioning and 8, 10-Ks management. And they were in a position where they were simultaneously rolling out new client capabilities in a true omni-channel way as opposed to the old fashion way people have historically done things where you end up having to get the people in the channel to build the stuff out of channel of all the time. So it's really exciting I would say to see a lot of the customer engagement CRM-type capabilities getting taken off in that way.

Thanks. And maybe on the second half business momentum, you skewed towards the second half. I know you're not guiding for the year after but does that roll into Q1 that strength in Q2? Or do you think there's a similar mix next year?

So that's a great question, Steve. So what you should see is if you think about where we are in the cloud transition, the first year is where you take a big hit. You take a big hit the second year largely because the first part of the second year, you still are in a heavy transition. As you get towards the back end of 2019, you start to come out of that. And that doesn't then go away in the first half of 2020, meaning you don't start to come out of the transition positively then revert back, it's a continual coming out. So 2020 as a year should actually be much more subdued in terms of the cloud transitioning effects, 2021 will even be less than 2020. And when you get to 2022 there really is no impact anymore. So I don't think there's a significant shift in the linearity or the seasonality of when revenue hits in the quarters. I think what you're seeing in 2019 is a more back-end loaded because that we're still earlier in the cloud transition.

Hey, that’s great. Thanks for taking my questions.

Thanks, Steve.

And it appears there are no further questions at this time. I'd like to turn the conference back to Alan Trefler for any additional or closing remarks.

Thank you very much. We're excited about where we are. We love the potential of this market and what we can do with it and we're working hard. And I know Ken would love to see all the investors at PegaWorld on June 3rd. Thank you very much everyone.

This concludes today's call. Thank you for your participation. You may now disconnect.