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spk07: Welcome to the PegaSystems Third Quarter 2022 Earnings Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ken Stilwell, COO and CFO. Please go ahead.
spk10: Good evening, ladies and gentlemen, and welcome to PegaSystems Q3 2022 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, will, could, should, estimates, may, targets, strategies, 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 fiscal year 2022 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 2022 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, 2021, 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 the result of new information, future events, or otherwise.
spk11: And with that, I will turn the call over to Alan Treffler, founder and CEO, Pegasystems.
spk00: Thank you, Ken, and thank you to everyone who's joined today's call. I'm pleased with this quarter's results. In fact, this is by far the best quarter we've had this year. As we discussed last quarter, we've become very focused on how we manage our business with a goal of balancing growth and profit to be a Rule of 40 company as we exit 2024. We assessed our business outlook in July, and Q3 is a positive indicator that we are making progress. We continue to make operational efficiency a priority, limiting increases to our cost structure until we're confident of tangible benefits. And you can see evidence of progress in our results. On an on-gap basis, year-over-year operating expense increased less than 3% in Q3, the slowest year-over-year growth in operating expenses we've seen for years, despite a high inflation environment. Ken will talk in more detail about the numbers in a few minutes. At the same time that we've been working across our business, we've been doing a special focus with regard to how we go to market and our client focus. We've realigned the organization to really focus on the largest global clients, where we believe we have the most upside for profitable growth. We know there is significant opportunity to increase our presence with these clients who know us, trust us, and have often already experienced success using our software. Take the government area, for instance. We have a robust heritage of success working with many of the largest government agencies around the world to help them achieve modernization goals and transform the digital experience for their staff and constituents. And we continue to increase our presence. For example, in Q3, we expanded our footprint in the U.S. Department of Justice and Veteran Affairs, as well as the state of California, who are using our intelligent automation capabilities to improve efficiency, ultimately providing better experiences for their constituents. Also, last quarter, we expanded our work with a U.K. shared services program out of the Cabinet Office. They provide workflow automation services to numerous ministries and are expanding their use of Pega's workflow automation to deliver pay and pension services to the Ministry of Defense. And we've been conducting events like a Pegathon at one of the largest U.S. federal agencies. It started with low-code workshops that were attended by over 300 of our clients' employees to learn about Pega and get their hands-on experience with it. And it culminated with hundreds of participants in a live build event to showcase their innovations. I was thrilled because I was able to spend nearly half of the quarter meeting with key clients and partners, including a run through Asia Pacific, India, Singapore, Australia, and then on to the UK and Europe. After two and a half years of being unable to visit clients, it was really energizing to get back on the road in a significant way. I met with some of our most strategic and longest-standing financial services clients at Sibos, a premier financial community conference that had over 8,000 attendees. And I had a chance to spend time with our two very first clients who've been with us running our software since 1984 through multiple generations of the technology and obviously a rapidly changing and extensively changed technical and business landscape. You know, at this event, we had more than 90 significant meetings with clients, and I met personally with about 45 clients and partners. It was great to hear their confidence in our ability to help them solve their pressing business challenges. And I'm gratified to hear that Pega continues to be seen as a critical strategic partner in digital transformation efforts. And many of them talk about their intentions to further invest in Pega. Back at home, we've been very busy hosting clients and partners at our Cambridge headquarters, at our new Edge Center for Innovation. In Q3, we held more than 20 meetings with clients like Ekmea from Europe, Ford and Siemens, giving me more opportunities to connect in person with some of the key people. I've heard a few consistent things. One is our clients continue to face multiple issues like we talked about last quarter, from labor shortages to rising inflation to supply chain interruptions, and many are bracing for a recession. They want help in tackling short-term challenges while supporting your long-term strategic goals. As I've said, I believe that Paget is uniquely suited to help enterprises manage through such uncertainty while building for the future. And in an environment where efficiency and productivity are paramount, our low-code software platform for AI-powered decisioning and workflow automation helps demanding enterprises work smarter, unify experiences, save money, and adapt quickly. At times like these, we also know that many organizations prefer to do business with partners they know and who inspire confidence because their products have worked and are providing strategic value, even as economic environments change. Now, part of that confidence I think comes from our continued focus on innovation to deliver the industry's best technology platform for our clients. Since we last spoke, we've continued to enhance our software to make it easier for our clients to be productive and to address their employees and their customers' needs. I'm really excited about the latest edition of Pega Infinity, which we announced last week. This newest release helps transform how organizations quickly deploy apps, create smarter workflows, deliver better experience for employees and customers with enhancements throughout our software suite. New features empower brands with enterprise-wide pragmatic AI that works behind the scenes to increase efficiency, speed innovation, and improve customer interactions. This improves end-user experiences and helps deliver better apps. Combining AI with automation in a well-architected platform helps employees with their productivity, lets them make better decisions, and lets them improve business performance. We also continue to receive recognition from leading analyst firms and other third parties. Earlier this month, Pago was named a leader in Know Your Customer, or KYC Solutions, by Charters Research, a leading risk technology analyst firm that focuses on this important sector. Know Your Customer standards are designed to protect financial institutions against fraud, corruption, money laundering, terrorist financing, and are increasingly important for international banks, and we see tremendous interest in this area the report evaluated the 32 most significant kyc providers across four criteria and pega received the highly highest possible scores in three of those categories and in september we were recognized by gartner as the highest ranked vendor out of 14 in its 2022 critical capabilities for salesforce automation the report states Pegasystems offers exceptional automation and process management within its CRM. Pegasystems' vision is one of autonomous CRM, where automation offloads repetitive work and AI assists users, increasing their efficiency and improving the delivered customer experience. Now, as you likely know by now, Little makes me happier than clients who are willing to go on public record with their success stories. And we've just posted two new videos on Pega.com you might want to take a look at. QBE, a global insurer with policyholders in 140 countries, recently completed a video testimonial you can find on our website. They leveraged Pega Intelligent Automation to free up over 50,000 of employee time a year. 50,000 hours of employee time a year. And W&W, a leading German financial services group, also completed a video describing their use of how Pega supports their customer engagement and how they've gone about to create a Pega Center of Excellence to support and guide their transformation initiatives. Now, regarding our company culture, difficult post-pandemic times, of our resilient and passionate team, their commitment to our clients, partners, the communities they serve, and to each other, and looking to create a vibrant, diverse, and equitable culture. I'm happy to see how our people are adopting a rule of 40 mindset across the company to bring the sort of value to our constituencies. And as people are getting back together in person, I'm seeing teams combining meetings with volunteer or fundraising activity for the causes they believe in. This is fostering terrific collaboration and providing support for causes that matter to our clients as well. I continue to be inspired by the generosity and kindness of our people towards each other as well as towards those in need. So in summary, I'm pleased with our results this quarter that show progress towards adopting the rule of 40 vision, making that happen. I believe the discipline and focus we're driving in our go-to-market strategy is absolutely the right approach, and I'm excited about the way it's feeling and what we're seeing. And though we continue to operate in an environment of significant volatility, we believe that our software is uniquely suited to address these times, and that we have appropriately changed how we are going to market to make that clearer to our clients and prospects. To provide more color on the financial results, let me now turn it over again to Ken Stilwell. Ken?
spk11: Thanks, Alan.
spk10: Our team executed very well in Q3 in what was, as Alan mentioned, very uncertain times. I'm really happy with the way we finished the quarter, given the economic environment that all of us are facing. In fact, it was the strongest quarter of the year for us. We had more 1 million plus purchases by clients in Q3 than any other quarter this year. And our business was particularly strong in financial services and had some nice contributions from our public sector. As we continue our multi-year subscription transition, growth in annual contract value, or as we refer to it, ACV, continues to be the most important metric to measure the success of our business. In Q3, total ACV grew 16% in constant currency year-over-year. Our ACV growth was powered by PegaCloud ACV growth of 39% in constant currency year-over-year, which reached $416 million. Pega Cloud ACV reached 40% of our total ACV for the first time, and it continues to be our fastest growing ACV component. We've clearly made some good progress in improving our go-to-market execution in Q3. And I want to remind you that Q3 2021 was a strong ACV growth quarter. So Q3 2022 faced a relatively tough compare. The second most important metric to measure the success of our business during our subscription transition is growth in remaining performance obligation, RPO, or backlog. Total backlog grew 18% in constant currency year over year. PegaCloud bookings were the largest contributor to backlog growth in the quarter. PegaCloud backlog grew additionally at a very high pace in constant currency year over year of over 30%. Volatile foreign currency exchange rates continue to reduce our reported results, which is why we're focusing on being very clear with our constant currency performance. We are primarily exposed to changes in the currency values associated with the US dollar, the euro, the British pound, and the Australian dollar. For example, the persistent strengthening of the US dollar negatively impacted ACV growth. When normalizing exchange rates, From Q3 2021 to Q3 2022, total ACV was reduced by $58 million year-over-year. We've included charts in our earnings release to illustrate the currency impact on both ACV and on backlog. Moving to the status of our subscription transition, we're in the final phase of our multi-year subscription transition, and we expect to wrap it up in mid-2023, as previously communicated. In this final phase, we expect profitability and cash flow to normalize, positioning PEGA to achieve the Rule of 40 as we exit 2024. As a reminder, we define Rule of 40 as a combination of ACB growth and free cash flow margin. Given our best-in-class enterprise solutions and robust renewal rates, we think there is tremendous untapped earnings power in our company. We are already seeing tangible results from the efforts to refocus our go-to-market motion. Our sales productivity has begun to improve in Q3 and was better than the first half sales productivity, an indication that our strategy to refocus our sales team on organizations with the highest propensity to purchase is working. Our go-to-market strategy focuses our sales teams on deeper client relationship engagement to tackle the considerable additional opportunities they have to expand their relationship with Pega by deploying new applications, expanding volume and capacity on existing solutions, and embracing the digital business era. We measure sales productivity by comparing net new ACB ad in the period relative to sales and marketing spend. We plan to continue driving strong expansion purchase activity going forward to drive ACV and backlog growth. Improving Pega Cloud's gross margins and increasing sales and marketing operating leverage are two key drivers of our plan to achieve Rule 40 as we exit 2024. It was encouraging to see improvement on both of these levers in Q3. Moving to our outlook. for the rest of the year. Through the first three quarters of 2022, Pega Cloud represented just under 70% of our new client commitments, which is higher than the 50% we expected when we set our plan for the year. Just to remind you, a higher Pega Cloud mix negatively impacts reported revenue in the current period. In Q2 2022, we communicated our intention to implement cost-saving initiatives to reduce the impact of the previously announced revenue shortfalls on our profitability. I'm happy to share that we've made great progress against those cost-saving initiatives, and you're already seeing the impact of that work flow through our financial results. In Q3 2022, Pega Club gross margin improved 400 basis points, increasing from 67% in Q3 2021 to 71% in 2003-2022. On a trailing 12-month basis, after several quarters, After several years, excuse me, of quarter-on-quarter growth of 200 to 300 basis points or more, the quarter-on-quarter growth in sales and marketing expense has been flat for the last two quarters. As we continue to navigate a very uncertain economic environment, especially in Europe, we plan to do what Pega does best, deliver best-in-class mission-critical solutions to the world's largest clients. Pega has successfully grown revenue through difficult economic times in the past by focusing on large enterprise clients who have the highest propensity to purchase Pega and receive value from the solutions that we offer. We are fortunate to have so many marquee customers in our install base, a tremendous additional opportunity that we have not yet tapped. In addition, this install base is led by the firms that will be able to most successfully weather, and have proven so, even prosper during difficult economic times. In our experience, many large enterprise clients consolidate vendors during times like these, which is one of the reasons why we're currently focusing less on capturing new logos, as we believe, given high inflation and economic uncertain outlook, enterprises will focus even more on automation and digital transformation for efficiency gains, a demand catalyst for our intelligent automation product portfolio. In conclusion, I'm really pleased with our Q3 2022 results and really proud of our team. Given that we have some distractions in the first half of the year, it's great to see this positive Q3 performance and the business heading in the right direction. This is by far the best quarter we've had this year, given the combination of growth in ACV, Pega Cloud, and Backlog. While at the same time, we're making progress managing the business and much more of a focus on operational discipline and profitable growth, as we progress on our journey to achieve the Rule 40 as we exit 2024. Seeing us finish with a strong Q3 gives me confidence in our ability to finish the year well. I'm looking forward to seeing many of you as I hit the road for face-to-face investor meetings in November and December. I also want to encourage all of you to mark your calendars for our Investor Day on Monday, June 12th, which will be held live and in person at PegaWorld in Las Vegas, Nevada at the MGM Grand. That's right, PegaWorld is live in 2023, and we are excited.
spk11: Operator, please open the line for questions.
spk07: Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment.
spk08: Again, please press star 1 to ask a question. Our first question comes from Kevin Kumar with Goldman Sachs.
spk03: Hi, thanks for taking my question. Alan, I kind of wanted to touch on the public sector. I think you made a comment there on seeing relative strength there. I know Pega recently created a new entity of service to government customer base, so maybe a little bit on the rationale for the creation of that entity and what you're seeing from a demand perspective in the government sector relative to some of the other verticals would be helpful. Thank you.
spk00: Sure. Well, you know, it's interesting because we're seeing – good interest in the government sector, not just in the U.S., where I mentioned the work with the Department of Justice, Veterans Affairs. We also have, as we've done for a long time, continued to work with, well, many other departments, from IRS to Marshals, et cetera. But I was seeing some very, very strong interest from foreign governments as well. When I went to Australia, I passed through Canberra, which is the capital of And there is a lot of work that we're doing there. In the UK, I met with some of the people where we are actually delivering the recruitment system for the UK Navy and Air Force. And as you think about what's happening here, the programs in many cases that were rolled out during the pandemic had a lot of bailing wire in them. And people have had to and have wanted to go back and see if they can actually make sure that they are more stable and more secure. And there's still a strong, strong need for efficiencies in government that our software is being, I think, very well regarded for. So, you know, I think the rationale for liking the government space is that they tend to have lots of workflows. The workflows tend to be complex and complex. Yeah, they often can get big, which is something we, I think, do unusually well.
spk02: That's helpful.
spk03: And then I wanted to touch on kind of some of the cost rationalization and kind of improvement on efficiency. I guess maybe touch on free cash flow conversion, Ken. I know there's some volatility on a quarterly basis, but be curious if cash flow margin is trending in line with your expectations and Should we expect that to track ahead of other metrics like operating income and net income as we kind of near the end of the model transition? Thank you.
spk10: Sure. So there's a couple parts to that, Kevin, that I'll touch on. First off, our operating cash flow for 2022 does have some – kind of non-recurring headwind because of the legal expenses that we've added back to our non-GAAP EPS related to some of the legal discussions that you're well aware of. So there's one just to highlight that as a starting point. But yes, our operating cash flow, our working capital is staying relatively consistent as we scale. We've been doing a very good job on our DSO and accounts receivable. So certainly nothing there happening. And we know that cash flow is never a straight line. for a company like Pega that has a lot of client engagements that have typically been initiated at the end of the year in Q4. So certainly our billings are not linear through the year, not unlike other enterprise software companies. But we are, I believe that when we finish the year, we're going to have positive operating cash flow as we expected, even given some of the headwinds that I mentioned. And then when we get to next year, we'll be kind of that next step toward Rule of 40, and then in 2024, you know, we'll be a Rule of 40 company. So the cash flow is trending as expected. It is still negative in this part of the year because, like I said, the billings are not as heavy in Q2 and Q3.
spk09: Got it. Thank you both. Yep.
spk08: Our next question comes from Steve Andrews with Citi.
spk09: Hi, great.
spk14: Thanks for taking the question here. I just want to ask about the strong sales execution that happened in the quarter here. I guess, how much of that was driven by, you know, some of these kind of delayed deals and some of the productivity that you saw in the first half versus, you know, some of the opportunities coming in?
spk12: And then how should we kind of think about, you know, for the year? I think you talked about 16% ACV growth. last quarter's target for the year. How should we all think about that going forward given the execution here? So we don't re-guide during the year.
spk00: We did re-accept because we made such a major set of changes to the way the go-to-market organization was structured. And I would tell you that the improvements in Q3 were, in my view, almost entirely as a result of their changes. It's not like deals slipped and suddenly came in. That wasn't it at all. A big part of what we did is we reoriented ourselves to saying, look, we have many hundred customers who are writing us checks every month or quarter, and we need to spend time on them. We need to make them successful like us. And In reality, the upside in those organizations is mind-numbing. It's tremendous. It's ample for our sales goals, frankly, for the next couple of years. So you're not completely eschewing a new name, but basically saying we're going to stop chasing them, which I think had been pretty materially the way we were going to market a while ago. I think the results of our change in focus is what drove the better results in Q3. It wasn't a whale or two or a big slipped deal or two, as Ken said. It was very balanced. And that makes me feel good that the things we're doing are right, even as the economy is obviously seen as tough.
spk10: And Steve, I'll add one additional thought on there. So Alan mentioned a couple of things. One, the breadth of the performance meaning contribution from lots of clients, was really healthy. Sometimes you hit a quarter with, like, just one big deal or two big deals. That wasn't our Q3. That's really promising. Probably the most optimistic thing in the quarter is that presto in engagement with so many different clients. The second point is, and you may remember me saying this, but with the change in our sales strategy, sales leadership, and kind of our refocus, You know, we did experience distraction in Q2, and that even carried into July, as I mentioned previously. So even that said that we even had part of Q3 that had some level of distraction, and we still executed well. And I think the reason why that may be is because – and some of you may have heard me say this before – Selling, upselling, expanding, cross-selling, et cetera, to existing logos is much more productive. In general, this isn't a peg a thing, just in general, it's always more efficient to sell to an existing client than a new logo. So naturally, that helps with our rule of 40 as well, and I think there's some of that happening in Q3 as well.
spk14: Okay, great. That's very helpful context there. I guess kind of more broadly, just thinking about the macro, I know it is a challenging time right now. How are you kind of viewing the pipeline and the opportunities as we think about for Q? Has there been kind of any change in either deal dynamics, things slowing down, or deals potentially coming in a little bit smaller than expected? How should we kind of think about what you're seeing in the current environment?
spk00: Well, the style of engagement is, that we've been doing in the last several months since we reoriented here. The style of engagement is quite a bit different. You know, it's not a lead response style where you have to worry in the same way about, quote, you know, deals slowing down. conversion during different parts of a funnel. That's not the style of selling. This is a full engagement style, understand the client's strategy, you know, demonstrate how we fit into that. And I actually think those deals are much more reliable in terms of being, you know, frankly influenced and controlled by us, you know, because it's, it's, not a mass or market motion. That's especially true for organizations where we already are doing things that they're building on. And as Ken said in his examples, they decide they're going to put new workloads on. They're going to move to a different department. They're going to do an analogous function. They're building on a success that they've seen. This idea of the app factory, right? which we talked about at the last quarter and have really, I think, been talking about a lot since the beginning of this year, is I think really taking hold where customers are in effect setting up factories to be able to do increases in the automation and increases in the use. And we've taken steps to encourage customers to do that, to make it easier for them to get started on projects, And I also think that's going to lead to greater reliability, even in a difficult, and it is a difficult, economic environment that some of these organizations are facing.
spk09: Okay, perfect. Thanks for taking the question.
spk00: Sure. It is nice selling to organizations that you know are going to be through at the other end. You know, that is the other real advantage, I think, of this sort of style of going to market.
spk07: Our next question comes from Pendulum Moore with JP Morgan. Please go ahead.
spk02: Hey, everyone. This is Noah Herman for Pendulum.
spk15: Thanks for taking the question. The first, you know, just any major changes you've seen in the demand environment, specifically in the UK and APAC? And then for the full year, are there any changes to the revenue guidance that you laid out last quarter in terms of some of the impacts? Thanks.
spk10: Let me take that second part of the question, Alan, and then maybe you can give your perspective on APAC and NMEA. So, as Alan mentioned earlier, we're not in the business of guiding quarterly. What I would tell you is we said we were going to be 16% constant currency ACV. We were 16% constant currency ACV for Q3. That's certainly a confirming indication. that Q3 was kind of a step on that journey. The one factor I think that is not related to us guiding, but just to keep this in mind, I mean, you know what happened with the dollar in Q3, right? So just that's the big wild card, right, is currency. In terms of the fundamentals of our business, You know, we anticipated that the economic environment was going to be, you know, deteriorating as we went through 22 and probably into 23. But I think we're executing well in that. But currency is definitely a prolonged and significant headwind to a company like Pega that has, you know, that reports in the U.S. dollar. And, Alan, maybe on EMEA and APJ in terms of the demand environment, your perspective?
spk00: Sure. Well, and obviously since we're selling in local currencies just about always, because customers expect that, obviously the sale can get haircut by what the dollar has done. And that's just the way it goes. I would tell you I've been in both, significantly in both APAC and in the UK and also in continental Europe in just the last seven, eight weeks. And the demand environment, I would tell you, it is not pushing things off. It is not hard to get the meetings you want to get. People are interested in how they're going to transform in ways that will let them become more efficient. You know, there's more of an interest, I would say, in the demand environment around cost savings and retention than there is about trying to to boost revenue. That's not true in every business or every environment, but I would say generally. But that's exactly what we would expect and what we have seen before historically when the world has recessionary or inflationary pressures. So I felt really good coming off those trips. And in fact, it was so good, I'm going to do another one in two and a half weeks because there's frankly so much demand for folks who want to talk to us. And I think that will translate into business ultimately. You know, that's what this is all about. So I think it's stronger than you would believe reading the headlines is, I guess, the way I would put it.
spk09: Yeah, that's great, Collar. Thank you so much.
spk07: Our next question comes from Joe Mears with The Truist. Your line is open.
spk13: Great. Thanks so much for taking the question, and I apologize for the background noise. I swear I'm not in a nightclub right now. I'm just curious. Last quarter you mentioned that in the second half you were expecting sales cycles to elongate, and I'm just curious if in Q3 they elongated more or less than you were expecting coming into the quarter.
spk00: I think that they were – I was probably a little more worried. than what actually happened. You know, when you're in the early bits, you know, it's not uncommon for things to elongate because people will put – sometimes they'll put extra levels of controls on spending. I – you know, it's anecdotal. It's not statistical. But I didn't really see that happening in a meaningful way. So – Yeah, I would say that was probably a smidge better than I might have been afraid of going into the quarter. I think part of what's happening is some of the scrutiny, I think, is actually occurring earlier in the process so that customers who are not going to be willing to do something are more likely to not engage as opposed to scrutiny coming later in the process where, you know, Ken is CFO or COO, you know, tries to stop something from happening. I think that actually bodes well for the level of attention we're getting.
spk10: I would add one other thing, Joe, and that is in this environment, I think the biggest headwind and the sales cycle is actually related to new logos. It's related to companies that don't know the vendor and actually have to go through a prolonged process to kind of pick the vendor and onboard a new area. So I think in our position of selling and deepening engagement with existing logos, kind of that headwind doesn't really exist as much. So I do think in tougher economic times, new logos, I mean, I think any company would tell you this, but we see that. So that's the one area that I would say, you know, we probably, you know, our focus area is probably, you know, driven by some of that intuition that we know that new logos are going to have elongated sales cycles. But with selling to existing clients, you do have at least a couple of those objections are reduced.
spk13: Super helpful color from both of you guys. I appreciate it. Just as a follow-up, I think last quarter you mentioned you were expecting to get somewhere over $100 million in OpEx savings to offset that revenue headwind you were going to see. I'm just curious how far along you are in that, in that process. Thanks so much.
spk10: Uh, yeah. So, uh, the great, uh, the great news is, um, is, you know, we've achieved that mitigation as we, as we sit here in October. So, uh, you know, now we're, uh, you know, now we're looking to see, you know, how much more progress we can make through the rest of this year and in 23 to prepare ourselves, uh, for, for a rule 40, uh, targets in 2024. So, uh, we're really happy. I mean, we've, we've, The team at Pega, I think, made a lot of progress in Q3. And I don't think this is something that – this isn't like a we're done kind of thing. We want to run a good business, and we're far away from Rule 40 right now, and we need to get there. And so this was kind of that really positive step that we made in 2022.
spk09: Thanks again, guys. See you, Joe.
spk08: Our next question comes from Steve Koenig with SMBC NICO.
spk07: Please go ahead.
spk06: Hi, gentlemen. Thanks for taking my questions. One for Ken that's kind of a multi-part about the numbers and then a question for Alan. So let's see, Ken, just trying to understand the numbers and what they say about the nature of bookings. Two observations here that maybe you can help explain to me how these true up. So first thing is, Cloud ACV was up 12 million, which was nice. But cloud bookings were up a whopping 139 million. Sorry, they were 139 million, not up 139 million. So, you know, it did, you know, huge bookings number that didn't translate as much ACV. ACV was still good, but just a huge booking number. So was that, were there some, you know, a lot of renewals in there? Was it a big renewal quarter for cloud? And then maybe just the other one of the numbers is, you know, maintenance RPO has been down near and near two quarters in a row. Is that the beginning of a trend? What should we expect? And is that, you know, a function of clients, you know, migrating from term to cloud? And then a follow-up for Alan.
spk10: Sure. So let me start by just throwing one thing out, Steve, which is currency. Okay. So don't lose track of that. Currency hit every number that you just said right there because we actually do a reasonable amount of packet cloud outside and maintenance outside the U.S. So the first thing is currency is a factor. Yes, there were renewals in Q3 that were at a larger pace than there were in Q2, for sure. That's why Q2 RPO, and I mentioned that, you know, there's not, you know, renewals aren't linear, which is why Q2 had a RPO with a little bit of a slower growth. That was just a little bit of a cycle that we go through. But Q3 was more of a, kind of a, more of a normal kind of renewal quarter. but also there's a couple factors. One is currency. The other one is sometimes when we peg a cloud, the booking doesn't actually start in ACV in the quarter that it gets booked in, meaning the effective date could be the next quarter, and you probably remember this word, even could be a couple quarters out. And so some of that will get into backlog, but not actually get into ACV yet. So it almost like pens up ACV, so to speak, right? So that's that factor. On maintenance, there are some clients that are over time moving to Pega Cloud, moving to more modern contracts, and increasing their relationship with us that were previously on perpetual maintenance arrangements. But also maintenance does have probably one of the biggest components of currency is actually in maintenance as well. So that's kind of the color there. Hopefully that was... Got it.
spk06: Yep. Yeah, absolutely. That's super helpful. Great. Thanks. And my follow-up, you know, for Alan. Alan, you made some commentary about the culture and, you know, about the employee, you know, morale, essentially, in the post-pandemic times. You know, and that's encouraging to hear, you know, especially amidst cost control at Pega. I'm wondering if you could comment on, you know, kind of, you know, I guess, you know, one of the elephants in the room that was distracting in Q2 was the was the lawsuit, and, you know, which is, you know, I guess that's gone to appeal now, you know, where you guys are in the process. But how does that, what kinds of questions are employees asking, and how does that, you know, kind of play into the, you know, kind of, you know, motivation and alignment within PEGA and questions you may be getting about that from employees? Thanks very much for your help.
spk00: Sure. I would tell you that the staff very broadly, and obviously we have some longstanding staff as well, has, I believe, a lot of confidence that we write our own software and that we've developed these things. Frankly, they know how Pega is pretty differentiated from other lots of the companies out there. So I don't think the staff has given much credibility at all to some of the assertions. And I think the reality is that there are also people who were with us during these time periods. And let's just say those of us who were there have a very different assessment and understanding than some of what has been claimed. So I actually think they're holding up really well. It's not the easiest time to be the employee in a high-tech business in the best of circumstances. But the other thing is, for those who've been around a long time and can talk to those who are perhaps even new or brand new, The staff understands that as a team, we're pretty scrappy. So some of the anxieties you might have with companies who hadn't weathered various storms and been around a long time, we don't have any of that. And I think that helps a lot. We also try to be extremely transparent with the team. We have Q&A sessions where we'll take any questions. I'm a staff member, you know, that we call them ask anything. We get asked a lot of interesting questions. You know, I think between good communication and, you know, I think a heritage, we've been able to keep the company together and keep the company solid. And, you know, that's in the face of all of the – obviously this has been an extremely difficult year. having been preceded by a couple of pretty extremely difficult but different difficult years. I think that, you know, great companies are resilient companies and have real grit. And I do think that grit is something we don't like.
spk10: I'm going to just add one other perspective on that, Steve. The thing that really engages our employees and gets them fired up is their interactions and the solutions that we do with our clients. And our clients' engagement is at really all-time highs, and I think that's showed just by the breadth of our performance in Q3. So I think that's really another factor that's very important to us because all of us at Pega are here to help our clients. That's why we're in business. So I think that's a really important factor. aspect, and we're so deeply engaged with our clients, you really can see the value that we're providing because of how, you know, how tightly connected we are. So that's also a very positive momentum at times that, you know, kind of weird times like what you mentioned.
spk09: Great, great. Well, thank you, guys. I appreciate it. Thank you.
spk08: Our next question comes from Vinod Sreenvasaragavan with Barclays.
spk07: Please go ahead.
spk04: Hi. Thanks for taking my question. You know, I know you had said you weren't updating your guidance, but when you did formulate guidance in 2Q and you were reassessing, can you just talk a little bit about your overall guidance philosophy? You know, did you build a buffer into guidance, or are you one of those companies who doesn't really do that, and can we just really expect you to hit what you spelled out there?
spk10: Yeah, so I think in over the last three to four years or not, it was it was very hard for us to really peg and specifically a revenue and EPS number. And because of the of the The shift to PegaCloud and the variability that was happening in that shift, like the percentage. So that was kind of a much bigger factor over the last few years. I would say in 2022 and going forward, that's less impactful within a quarter of a year compared to what it was, say, in 2018. when a 10% shift would impact us immediately by $40 or $50 million against a number that was much smaller in terms of Pega's revenue. So I would say we have a little bit more certainty there, but there is some variability there with the Pega Cloud mix. There's also a little bit of variability with the timing of renewals and bookings that may actually have upfront revenue recognition, like client cloud, as we call it, term licenses. So there are some things that we do our best to try to peg it, but it doesn't always shake out the way. I would say revenue is we try to do a kind of a best efforts to get to what we thought the number would land at. We did not build a ton of, we weren't building a cushion and kind of a beat and raise kind of model because we're not guiding each quarter. But we didn't create a stretch number either. So I think we tried to come up with what we thought was a reasonably accurate number. And then we factored in the cost savings that we were targeting and we felt like was you know, a reasonable estimate of what we could get to, which we feel, you know, we've made a lot of progress there. So, I would say we really tried to be as accurate as we could of where we thought we were going to land.
spk04: Thanks. That's helpful. And just one more for me. You know, it was good to see the rule of 40 expectation reiterated, but I wanted to kind of talk about the – you know, kind of the weighting between growth and margins there, you know, given that some of the demand headwinds seem to be improving and you have those sales efficiency improvements, you know, do you have any changes to the weighting of the factors? And ideally, like, what would you like to see?
spk10: So I'll give you my perspective and then Alan can weigh in if he has additional thoughts. So the beauty of the way that you build a Rule 40 model is that if you're growth, if you set your growth expectations at a reasonable target, and then get your margin to match. If you outperform on your growth, it actually helps you twice because your growth is better and your bottom line profitability is better. Our approach has been not to shoot for a growth number that is unachievable when we think of Rule 40, but to make sure that we're building a margin profile that gives us a rule of 40 probability based on a reasonable growth target. That said, of course we want to grow faster, right? We want to grow as fast as we can. What we're not willing to do, though, is throw costs at a growth number. We want to be very thoughtful and very profitable in how we think about that growth. And I think that's kind of a little bit of a different approach than what we had the last few years where we were making some bets in areas that were a little bit longer payoff periods. And that's why our strategy changed this year. So that's kind of my perspective. Alan, any thoughts to add there?
spk00: I think that's on target. We're certainly investing in growth. We want to be a company that grows and grows well. You know, we've in the past shown that, you know, we could grow 20% ACV a year, and, you know, that's a lot better than 16, to be blunt. But we're not going to do it with the style of trying to hit 35% growth and spending as if that could be financed in any way. It's got to be balanced. And I think that message... has gotten to the company, and I think the staff is buying into it.
spk09: Okay, great. Thank you. Appreciate the questions.
spk08: Our next question comes from Joey Marinchak with J&P Securities.
spk02: Hi, Dean. Thanks so much for the question. First, Alan, I was hoping you could talk more about Pega 8.8. Which capabilities are you most excited about? And then maybe at a higher level, How do you sort of think about your overall development strategy? Thank you so much.
spk00: Yeah, I think there's a lot in 8.8 that I think is exciting. The additions to the app factory capabilities, you know, which we're already seeing some excellent adoption of, where it makes it easy for organizations to, put in automation but do it on a platform that has enterprise scale capabilities as opposed to little stand alone things which candidly I think some of the other players in the low code space are more likely to be kind of the reincarnation of Lotus Notes if you know what that was many years ago and being able to tell organizations that we can give you a structured way but also a way that's fast and that you know, builds on things that may be familiar to you. I think those are some terrific additions to it. The whole area of what we call process AI, which is bringing artificial intelligence into the process so that it can, you know, predict which types of things are going to miss their service level, make it possible for you to pay greater attention to them and prioritize those sorts of things, I think are great. also key. We've added some really nice capabilities to the whole user experience. And with the work on what we call the digital experience API, we've made it so that customers can use a Pega experience or they can use candidly their own, but do it in a way that's super flexible and quite a bit different than what alternatives are in the marketplace. So there are things that I think are both functional in terms of helping people with apps and, you know, more technical in terms of being able to plug into other systems, which is obviously something that's super key for us.
spk02: That's super helpful. Thank you so much. And then can you just give us a quick update on the Everglow acquisition? What is sort of the feedback and demand been like from customers on those new process-flying capabilities? Thank you.
spk00: We're demonstrating them. There's a lot of interest. I think that process mining is one of those interesting things because I think the purpose of mining processes is to be able to automate them and have them operate better. So that's a perfect example of the sort of acquisition we like to do where it really fits very strategically with what our product line is, with what we actually do with workflow automation, with robotics, and and the other pieces. So, yeah, there's interest. I saw a demo just yesterday with a client who seemed quite impressed, and I think it's going to turn out really well.
spk08: And our next question comes from Fred Havemeyer with Macquarie.
spk07: Please go ahead.
spk05: Hi. Thank you. I wanted to check in on a different part of the lawsuit. Without discussing the lawsuit specifically, I wanted to understand, has that come up in any or rather in your conversations with customers generally? And if so, is it shaping any of your customer conversations at all?
spk00: So I think, and Kim can comment on this as well, of course it comes up with customers. In fact, if... If they don't bring it up, we'll bring it up because you don't want something to be hanging out there. I would say that our conversation with our customers has shown a lot of respect for the longevity and independence of Pega as an entity. And I would say that our customers have been tremendous. I think it's just been terrific in terms of... you know, them listening and reading what we've put on our website, you know, because we've put some stuff up that I think helps provide some color. And, you know, we're not going to get into the things that will become more visible as our appeal goes forward because the appeal process is just beginning and these things go agonizingly slowly. But I've been really pleased with the way customers have responded and our ability to not ask the conversations get unduly shaped. You know, I think the conversations need to be about what they need and what we can do for them. And I would tell you that they have stayed that way. Ken, do you have any comments?
spk10: I mean, yeah, I mean, I think everything you said makes sense. I think, you know, Fred, the reality is when you have an announcement like that, a press release, you know, a newsworthy item, of course clients need to understand, need to understand, you know, what happened and as much as we can tell them. And we've been very clear to point out. We have a spot on our website that actually spells out exactly the facts, not opinions, but the facts around what this is and what it isn't. And I think that our clients, you know, have, you know, universally been very pleased with our engagement on that. And, you know, as evidenced by the fact that we had the most $1 million deals in Q3 with our clients that we've had. So I think, you know, certainly I wouldn't say that that chapter is closed because the appeal is in process. But I do believe our clients are happy. are very comfortable with the engagement that we've had with them, from my experience.
spk00: As one of them said, they get sued all the time. It's not a foreign concept. Not that anyone enjoys it, but it's not at all foreign to any big bank or insurance company, certainly.
spk09: Thank you very much for that. Thanks, Mike.
spk08: This concludes today's question and answer session.
spk07: I will turn the conference back to Alan Treffler for any additional or closing remarks.
spk00: Great. Well, thank you, everyone, for dialing in and listening. I think the Pega team has been working very, very hard. I think we're invigorated by the new software we've put out. We're invigorated by the ability to engage more directly with clients as the Pandemic period has ended, and there is a lot of enthusiasm for becoming a better run, more efficient company and bringing those benefits, you know, candidly to our stakeholders. And I like the feel of it, and I like the energy, and we're going to go back to work for you. Talk to you soon, everyone. Thanks.
spk07: This concludes today's call. Thank you for your participation and you may now disconnect.
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