Rafe Brown – Chief Financial Officer Alan Trefler – Founder and Chief Executive Officer.

Steve Koenig – Wedbush Securities Mark Schappel – The Benchmark Company LLC Brian Murphy – Merriman Capital, Inc.

Greetings, and welcome to the Pegasystems Third Quarter Fiscal 2014 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Rafe Brown. Please go ahead, sir..

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 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 forward-looking statements are contained in the company's press release announcing its Q3 2014 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 September 30, 2014, its annual report on Form 10-K 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 obligations 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 Inc..

Thank you, Rafe. I'm going to talk a little bit about what we've seen going on in the quarter, as well as how we're thinking as we enter our planning process for 2015 relative to where we're thinking of investing and what we think is going to be important going forward.

Relative to Q3, it was a solid quarter, continuing what has been a strong performance year for Pega. I'd note that Q3 is often a challenge because business can slow down in the summer leaving a tremendous amount to get done in September.

In this year, the mood across Greater Europe was rather sour, though we've seen some lightning event mood in October. And I'll talk about that a bit more in a second. Overall, we continue to be very optimistic about how our software is being adopted on our long-term growth opportunities.

As discussed on previous calls, we continue to position our business beyond the traditional tech categories like BPM and other alphabet soup into instead being a basis for strategic digital transformation. We see digital transformation initiatives as being increasingly important to our customers and absolutely central to the growth for our business.

This quarter we've seen new wins and meaningful increases in our relationship with companies, including those from our original banking and insurance markets like AIG, which continued its broad advertisement in Pega as part of their enterprise strategy for global -- clients, putting a single backbone sort of architecture across 40 countries around the globe.

This initiative is strategic to their business, but they regularly talk about it in their investor presentations, and a perfect example of the meaningful work we do with clients, or Charles Schwab, which is going to be using us to provide case workers the user experience they need to more efficiently complete client request.

But I'm always excited about the expansions of market we've been going into more and more in recent years.

Business for example like extensions at Cisco, for order scheduling and backlog management in the supply chain order management area, we're providing visibility to the business and their partners to ensure on-time deliveries and increase customer satisfaction, or General Motors OnStar, this is another sort of Internet of things type opportunity, I'll talk about that in a moment, where if you have a GM car and it hits a tree or something unfortunate happens, it calls the Pegasystem, and we do that not just in North America but for them in China as well.

They have expanded their relationship with us to prepare to – deal with how they intent to deliver new services in 2015 is naother example of exciting expansion, land new clients like Amazon, showing the applicability of our technology well outside those original financial services markets.

And the ultimate test of our software is how it operates in real life, and we saw important new go lives at many clients.

To pick out a few that is interesting, of the Transport Management Center in Australia, which is another interesting Internet of things used case, where they're using the Pegasystems to be an interface to change incidents occurring on their road networks and helping them both monitor what's going on the various highways and it will operate with existing motorists around the incidents making sure that both information exchange and the incident management process is optimized.

A major, major outsourcers of medical claims, who in Europe went live with our customer process management technology are using the system to manage insurance claims on behalf of travelers when there's been a medical emergency, or Robobank, which has rolled out the commercial sales and servicing platform hooked right into the Internet environment that allows small and medium enterprises to apply for credit online and to initiate service processes on their loans.

While one of the nations – U.S's massive wireless carriers for an omnichannel solution that standardize offers and guides interactions across retail and call center agents for retention, prioritization, compliance, the system was rolled out to over 25,000 care agents and over 20,000 retail agents on iPads.

So it's exciting to see both the new clients and the existing customers continuing to deepen their investment in Pega technology. Now, as I mentioned to be offset, our sales and service business in Europe had a particularly challenging quarter. Even markets such as Germany, which had been strong for years, seem to slowdown.

We continue to have some macroeconomic concerns about the global economy, particularly in Europe. However we do have a best pipeline of work, and in October, we saw progress on some of the U.K. and EMEA business that have installed at the end of September.

Despite the challenges in Europe we're pleased to be sowing a year-to-date 21% license revenue growth increase, and the backlog has grown in addition 18% over Q3 of last year. Looking elsewhere internationally, I've just returned from a trip to Asia, and I was particularly impressed with the progress we're making in Japan.

We opened our office several years ago at a particularly unfortunate time, it was immediately before the earthquake and tsunami, obviously difficult time we work through and we continue to invest. And now, the results are coming in, and we're very exciting.

We held a very successful digital transformation summit while I was there and got tremendous enthusiasm from both clients and prospects. It's clear to me this will be a here strong market for us going forward. We also announced that in Turkey we acquired a local partner that we've worked within recent years.

This will help us provide additional local sales, delivery, and support resources. It's interesting because Turkey has become a real hotbed of additional transformation.

We actually, recently had half-a-dozen executives from Isbank, Turkey's largest commercial bank come to Cambridge and they were doing one of the most interesting transformation projects, that I've seen, as they're looking to really try to digitize and take advantage of what they can do in that growing economy.

So what, overall we think that international will be important and that we can show traction. I'll be in Europe both later this month and then in December, as part of our digital transformation road show and making sure that we'll be investing time with clients and prospects to see what we can do about making that area as strong as possible.

And though we expect challenges in Europe to persist for the reminder of the year, we feel we're well positioned for both weak and strong economies. And we traditionally have been able to offer our clients both the abilities that drive the revenue in good times, and improve efficiency and cost savings in bad times.

You can remember how well we weathered the 2008 and 2009 recession. We did extraordinarily, because we were able to move on messaging in more difficult economies to really show the importance of simplification in cost saving.

And we are actually – we're jiggling our message to make sure that we can stress some of those things in the economies that are maybe struggling a bit, as we go forward. Relative to where we are going, we are going to be continuing to invest in our products and our marketing to take advantage of what we think of extraordinary opportunities.

And the investment will continue through the end of the year, and we as we're thinking about planning for 2015 we think it's important to make sure that we continue to be a leader in these key areas because we are confident it will payoff.

We're going to continue to build on our strong offerings in key horizontal areas of customer services and support, sales and onboarding, marketing in what we call "next best actions," as well as the operations that are automated by our core Pega 7 Platform.

And to make sense, we're verticalizing our applications so that our customers better see, touch and understand the value proposition. For example, this past quarter, we launched a new commercial underwriting capability for the insurance industry, and an Equifax connector for the financial services industry.

We continue to see interest from our customers in the core areas of technology, which I call "SMAC," Social, Mobile, Analytics, Cloud and the Internet of things. And we're seeing good uptake and enthusiasm around how these technologies are served by and with the Pegasystem.

Now, the cloud is becoming increasingly more important to our customers as they look for increased flexibility, agility and speed as well as decreased cost, and especially as we think of opening up our markets, we believe that this will be increasingly important to us.

We're seeing actual demand and increasing our capability in this area and think it will be increasingly important in 2015, and already showing rapid growth, as Rafe will talk about in a bit.

We think that our ability to offer both on-cloud and on-premise offerings is bringing a great level of flexibility and benefits to our clients for their strategic applications.

We're also integrating the technologies we acquired earlier this year are core into our application, really unifying that, so placed to the strength of this single model that is what differentiates us from a lot of our competitors within the go, and lots of stuff together, and frankly not having worked terribly well.

We recently announced a major new release of our customer service app that unifies the technology we have around social from MeshLabs and around what's called co-browsing it, user interface technology operating center to work with their clients over the phone and over the web. And we were seeing a lot of interest in these capabilities.

Our Pega customer service technology engages customers while maintaining context and visibility, and gives them traction across channels and across devices, unifying the social media of the mobile apps, live chat or browsing and in-person service.

And I will tell you the new interface, what we've released is beautiful to work with, and yet extremely powerful to support the important applications and complexities of significant organizations. Its intelligent guidance takes CSR step-by-step recommendations to deliver personalized service experiences appropriate for each customer.

So in addition the product work which we are excited about, we are also continuing to invest in marketing to improve our awareness among key audiences. We've really worked to deepen the skill set of our marketing staff and aligned our team to better deliver programs that will contribute to pipeline and we've been working to update our messaging.

You should see as we roll into the New Year, some important new releases on our Web site as the team is working hard to make us enter 2015 with a very strong and a highly refined sort of messages.

Our new positioning that I talked about applications engineered for evolution is resonating well with customers, and we are going continuing to pitch this message. I mentioned in the last call that we had sort of found about difference between the price and applications that people want to address with their technology and with their software.

On one hand there will be what we call "confirming business applications," these are ones that may have significant impact on the business, but don't really have to be differentiated. They allow our business to change the way they run, so that it matches the software.

And frankly a lot of the SaaS players in the space are being successful offering this technology. By contrast we want to specialize it, what we call strategic business applications. Those are organizations we'll use to differentiate.

That will need to be different, and need to be – well, frankly, able to allow them to offer their clients what they need, where they need it, and they're going to have to be able to evolve, to deal with the needs of markets, products, regulations, competition.

Now, well, out of the box features are important for these applications, and we're working hard to make sure we're adding them. The ability for an organization to print itself rapidly in the software and most importantly change is absolutely critical.

And given the increased importance of software organizational success, we see these strategic applications as frankly creating a $30 billion plus industry that allows companies to really take advantage of our technology, and apply it to drive better business outcomes and business success.

Our strategy is to be the leader in enabling strategic business applications using our unified model-driven software, that Pega 7 architecture we talked about.

Model-driven means delivering a straightforward development environment that even enables business people to directly generate and change the strategic business applications, either, while working more efficiently with your IT dribbling.

Its benefits include faster time to market, increased business differentiation, and continual business and organizational agility. Now, Pega will deliver strategic applications for sales, service and marketing based on Pega 7, as well as supporting clients who wish to further extent Pega 7 as a platform across the enterprises.

So in summary, though the current economic climate is challenging, we are very optimistic about the future, we continue to be inspired by the great work that clients are doing to transform their businesses, and very excited about the role our software is playing in this strategic initiatives. And we think we've got great prospects as we go forward.

To provide some more color on the financial results, let me now turn this over for additional discussion by our CFO, Rafe Brown..

Thank you, Alan. So this third quarter of 2014, please note we are reporting both GAAP and non-GAAP results. A full reconciliation of our GAAP to non-GAAP measures is provided in the financial tables of the press release issued earlier today, and is available on the Investor Section of our Web site.

As we've discussed in the past, quarter-to-quarter comparison do not necessarily reflect the underlying momentum of our business, as the timing of a small number of large transactions can significantly impact our results. To provide the best look at how our business is performing, let me run through the results on a year-to-date basis.

Year-to-date non-GAAP total revenue was $424 million up 19% year-over-year.

Year-to-date non-GAAP license revenue was a $157 million, up 22% year-over-year, and year-to-date non-GAAP cloud revenue stood at $13 million up 135% over the prior year, still approximately a third of that revenue growth is from Antenna, which we acquired in the fourth quarter of 2013.

As a percentage of year-to-date non-GAAP revenue, license cloud and maintenance revenue stood at 72% of total revenue, up from 69% for the same period of 2013. This is a direct result of our stated strategy of growing our higher margin revenue items faster than growth of professional services and training.

Looking at our results on a geographic basis, non-GAAP revenue in North America grew 25% to $255 million on a year-to-date basis and stands at 60% of total revenue. Revenue from EMEA was approximately $139 million on a non-GAAP basis, up 11% year-over-year, and year-to-date Asia Pacific business was up 16% year-over-year.

It should be noted that our European sales were below our third quarter targets.

We believe that this is attributable to a combination of factors, including timing of a number of larger transactions which we believe will land in coming quarters, as well as the macroeconomic factors which have resulted in some of our customers taking to more cautious approach to license commitments.

The contribution to non-GAAP revenue recognized from term of subscription licenses for the nine months of 2014 was 45%, up from 38% for the same period of 2013. This contribution percentage varies quarter-to-quarter based on the mix of revenue recognized from term versus perpetual licenses in a given period.

On a year-to-date basis, non-GAAP professional service revenues were $114 million up approximately $8 million from the same period last year. While we are pleased, overall gross margin have remained strong, professional service margins face significant headwinds in Q3.

The net result being that non-GAAP gross margin stand at 69.2% on a year-to-date basis, compared to 70.2% for 2013. And taking a closer look at our professional service margins, there are couple of key points to understand. First, as discussed above, business in Europe was particularly challenging this past quarter.

These challenges impacted both license and professional services revenue, and while they're significant focus on our professional service utilization rates, we're still trending below our targets. Secondly, when margins for implementation of Antenna offerings have improved, they remain below the margins of our core professional service business.

We continue to incur a higher cost with inherited Antenna customer projects, and while we anticipate steady improvement in this area, we expect this to be a source of pressure on professional service gross margins for several more quarters.

Now, turning to the rest of the income statement; we posted year-to-date non-GAAP operating margin of 11.8% compared to 14.7% for the same period of 2013. Year-to-date non-GAAP operating expenses were approximately $244 million, up 24% from 2013. As we discussed in our Q2 call, we are making a number of significant investments in our technologies.

You may recall that our year-over-year R&D run rate jumped as a result of both the Antenna acquisition, which was principally a technology and technologist acquisition, and as we discussed n Q1, a re-classification of cost for marketing into engineering.

As Alan mentioned, our sales and marketing efforts continue to ramp with additional investments supporting enhancements to our digital marketing presence and brand positioning. We believe these investments will drive continued growth, yielding both deeper relationships with existing customers and extending our reach to new users.

Turning into earnings; on year-to-date basis, we posted non-GAAP earnings totaling $32.1 million. On a non-GAAP fully diluted EPS basis this totaled $0.41 per share. It should be noted that our earnings were impacted by an FX charge of $2.5 million or $0.02 during the quarter.

Now, to discuss license and cloud backlog; we compute license and cloud backlog by totaling two elements; deferred license and cloud revenues as posted on our balance sheet and off-balance sheet license and cloud commitments that are signed, but is yet unbilled.

As a reminder, you can find details on both elements on our 10-Q and a summary table in our press release, both of which were filed earlier today. We finished the quarter with $334 million of total licensing cloud backlog. For year-over-comparison purposes, this total backlog as of Q3 2013 was $283.

Thus as of the end of Q3, backlog has increased $51 million or 18% over the prior year. Turning now to cash; year-to-date, the company has produced $98 million of operating cash flow, an increase of 18% over the prior year. Free cash flow, which we define as operating cash flow less CapEx was $93 million, up 17% over the prior year.

And we finished the quarter with total cash and marketable securities of $229 million. Year-to-date, the company has re-purchased 608,000 shares for $12 million, and at the end of the quarter, we had a balance of $2 million available for repurchases for the remainder of the year.

On headcount, we finished the quarter with approximately 2900 employees, up approximately 26% from the same point last year. In summary, we are pleased with our results for the first three quarters of 2014.

This said, we are working hard to meet our targets for the year and are looking forward to updating you on what is traditionally our biggest quarter in just a few months. With that, operator, we will open the call to questions..

Thank you. (Operator Instructions) Our first question today is coming from Steve Koenig from Wedbush Securities. Please proceed with our question..

Hi, guys, thanks for taking my question.

I'd like to – if I may, just decompose our data thought with little more granularity on this quarter, how much that you think was – it sounded like there were some slip deals, how much of that was on from those deals, and did any of them close, were there any execution issues or anything that can be tweaked on execution, and what's the likeness in specific industries?.

Sure, a couple of things. There was couple of things that rushed down the quarter, sort of bounce out that could have just has easily balanced in, some which have already. And in terms of a miss, it wasn't a disastrous miss, obviously we are not sounding enormously enthused up in quarter one.

I think the weakness was really very much concentrated in some of the key areas. And we have made some changes there though I think that some of it was just – it was a tough September, frankly, in some of the European – in U.K. and Europe in general. The mood was just pretty shower is the way that I would describe it.

I think what sort of really happened with the unduly with the quarter is there has been a lot of business in the pipeline in Q4 and we are out there pushing to make sure that we do every little bit of them that we can..

Yes, okay. And If I could just follow-up, Alan, on that particular traffic, you provided a little color last quarter that given the strength in the first half, your guidance was unchanged per your mutual policy, but you thought probably you'd – it was likely you'd come in ahead of this for the year, which seems very plausible.

Is that still your feeling now? Can you comment on your thoughts last quarter?.

Well, I think that from a revenue point of view, I think we are likely to modestly exceed what we had talked about at the beginning of the year. The reality is that we had a lumpy business. We were extremely enthused that we were good at pulling a lot of revenue on the first half.

Q3, yes, I think if I look at this compared to where we are historically compared to guidance, at the start of year, if you go back the last several years, I think historically compared to guidance we are further ahead than we've been in any of the recent years. Once again, still a lot of business to close, because Q4s are always big for us..

Yes. Okay, great. I'll leave at that guys, and thanks a lot for your help..

Okay. Thank you, Steve..

Thank you. (Operator Instructions) Our next question today is coming from Mark Schappel from Benchmark. Please proceed with your question..

Hi, good evening, thanks for taking my call.

Rafe starting with you, your revenue in the quarter, I think you gave year-to-date, what was the specific internal revenue for the quarter?.

Yes, thank you for that. One of the things that is going on with Antennas, we are rapidly working to integrate Antenna into the rest of the company.

And due to that integration of both the products and the sales force, other than really maintenance and hosting revenue, which are discreet and easily be tracked, it's really not feasible for us to identify the revenue from new arrangement fully attributable for Antenna. And you'll see some discussion of that in the 10-Q.

Now, I'll say, I didn't breakout quite a bit of detail of this in the second quarter. So you can extrapolate from that and it would be very, very close. And at that time we are on track to have the Antenna total revenue at around $22 million for the year.

So if you use that figure you're going to be terribly close, so it's just that we can't get that discreet detail at this point..

Okay, great, thanks.

And then with respect to operating cash, I'm -- remote at the moment, just wondering if you could just give us the other quarterly operating cash flow and free cash flow for the quarter?.

Sure. So for the operating cash flow on year-to-date basis was $98 million and then the free cash flow was $93 million..

How about for the quarter though, I don't know ….

Let me just flip to the right page here. So operating cash flow for the quarter was $24 million, free cash flow for the quarter was $21 million..

Great, thank you. And then, with respect to the foreign exchange, I mean, obviously there was a big head total earnings.

But what about the role play in the top line?.

We've looked at that closely. It's relatively small, largely because we takes a good chunk of our revenue off the deferred revenue, which is captured as deferred revenue and it's added to historical rate and then amortizes in at that historical rate. So it tends to provide a delayed effect whenever there is any sharp FX movement.

It's less than a 1% impact on overall growth..

Okay, great..

The bottom line impact is more significant..

Right, and the ….

Negative..

Yes..

Okay, great.

Alan, turning to you here with respect to Europe, did you – maybe just go into little more detail where you're seeing the particular weakness in Europe, I mean, was it in big deals in particular, was it in certain verticals and certain industries?.

So I think it was sorted in general. I think it builds just an anxiety that's settled over Europe if you can remember, there has been a lot of debate about what's going to be happening in terms of – slowness in interest rates et cetera, and it was a bit of a pause. Having said that, we've seen some energy return in October.

So we are not calling out the alarm bells, but I think that we are not the only company that's seeing Europe as being weak with this quarter, I think. It's actually fairly – I'd expect you'll see that and will continue to see that for lots of fronts. Having said that, we know what to do; we slip a back to cost savings.

We stressed the ability to simplify operations, and I think to pay for itself. And Joe, you can still get even pretty meaningful deals. You don't get generally whaled to pay for themselves, but you can get some of the marlet and tuna, which can be in sub 10 million category, but it still can be somewhat meaningful.

You can still do things in the $3 million, $5 million, $7 million category. When times are tough you're just not going to do the super big deals in that environment. I'm not sure we are really counting on it– Europe anyway though; to tell you the truth..

And with respect to that slowdown, I mean did you see evenly in the quarter or it was in the last week or two?.

Well in Q3, the visibility of the slowdown is always in September. I mean basically things are pretty slow, especially in Europe, in July-August. And so, it's all about when people coming back from their vacations, getting back engaged et cetera.

So what we should – I think also we had a couple of customers where they had some management changes and other things, but I think ultimately they're going to be very, very good for us. But anytime you get some of those changes, the bunch of big announcements for executive changes at some of the U.K. banks was hit over in the summer.

And I think ultimately that's going to be very positive, and we have every reason for it to be positive. But inevitably anytime we have those changes, it's always a little positive..

Great, thank you. That's all for me..

Thanks. Our next question today is coming from Brian Murphy from Merriman Capital. Please proceed with your question..

Hi, thanks for taking my question. Alan, so with some of these transformational projects that you're going after, obviously, messaging is important and it's certainly require a large complex communications effort, and there has been focusing on that pretty acutely this year.

When I look at your web site now, I see a big difference from the past, just in terms of the volume of the resources that you have up there. And the way that they're organized I think it's really well done.

And my question is I'm wondering if you're seeing any impact in the pipeline yet in terms of regeneration, and closed rates sales side, are there any early indication that those initiatives are working?.

Well, so I'll tell you that we've made some changes, and I'm glad likely you've seen. There is a very, very substantial pipeline changes that the new marketing team has brought in.

We've actually made very, very significant introductions of new talent into the marketing team and they have been working extremely hard, but you should expect that wave to hit at the beginning of January and that's really where we've been planning when we dealt with the marketing team, I think we decided we were open to really stepping back and thinking what would take to get our game up to the whole next level.

So I think what you have seen so far, my CMO actually describes as "lipstick on a pig," to quote call him. So you should have very high expectations for what is expected to do in January..

Okay. It sounds good, thank you..

Thank you. We have reached the end of our quarter-and-answer session. I'd like to turn the floor back over to management for any further closing comments..

So I'll just say that our folks here are working hard, the opportunity is actually tremendous, and we get very strong reinforcement of that.

And as we think about the things we are looking to do next year in terms of both the meaningful improvements and broadening of our marketing presence, what we've talked about the past is opening the aperture of being able to go after many more accounts than we've historically gone, which has traditionally been the Fortune 400.

And as we see the client successes and customers willing to come to these transformation summits or do case studies for us. I'm very excited that we have a highly differentiated products and technology. We have the capability to deliver it. We have an increasing part of the ecosystem, that's helping us get good visibility.

We're very, very excited, little bit hard to close the year and look forward to telling you about our 2015 plans on our next call. Thank you..

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day. We thank for your participation today..