Pegasystems Inc

NASDAQ:PEGA

Earnings Call Transcript 2018-Q2

[Operator]

Good day. And welcome to the Pegasystems' Second Quarter 2018 Earnings Results Call. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Ken Stillwell, Chief Financial Officer, Chief Administrative Officer and Senior Vice President. Please go ahead, sir.

[Kenneth Stillwell, SVP, CAO and CFO]

Thank you. Good evening, ladies and gentlemen, and welcome to Pegasystems' Q2 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 or 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 2018 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 the forward-looking statements are contained in the company's press release announcing its Q2 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, 2017, 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.

And with that, I'll turn the call over to Alan Trefler, Founder and CEO of Pegasystems.

[Alan Trefler, Founder, CEO and Chairman]

Thank you, Ken. In terms of sort of couple of highlights for the quarter and first half of the year, we are continuing to make progress on our strategic plan, and the movement to the cloud is very encouraging. At the same time, we now are building up the business to pursue a much bigger opportunity in front of us that we're focused on capturing.

As I've often said, it's important to look at our results in context, especially as we are now reporting under the new ASC 606 accounting standards. These new rules have the potential to further exacerbate lumpiness in our quarters associated with term licenses and may result in some comparisons looking on. Our year-to-date result is a good example of why context is important.

We continue to see acceleration in our move to the cloud and recurring arrangement. In Q2, for the first time in our history, cloud represented more than 50% of all new business. And it was 54% in Q2 and grew 37% year-over-year. Now I think this is really terrific for our business long-term. It can make our performance in short-term periods harder to understand. And it's important we think therefore to consider growth in ACV, what's called annual contract value when evaluating how the business is doing.

In this quarter, the accelerated shift to the cloud adversely affected revenue growth and EPS, but you can see the incredibly positive impact on ACV in the ACV chart. We saw a year-over-year growth of 20% in our total annual contract value, which does include maintenance recurring revenue. And we saw strong growth in our term license in cloud ACV of 31% year-over-year. For context, compare this to our full year ACV growth in 2017, but we will meet 20%.

Now, Ken has been showing the ACV numbers since the beginning of 2017. So, those of you who have been with the company for a while will find this quite familiar. Ken will be providing additional financial details momentarily.

Now in terms of what happened in Q2 in many ways at Pega was dominated by PegaWorld in our largest ever product announcement, what we call Pega Infinity. I know many of you may have been able to attend and experience the excitement first hand. For those of you didn't, I encourage you to watch the replays, which are available on pega.com.

The events of the product launch reflected our strategy and focus on delivering the best solutions for digital transformation, which we believe requires both effective customer engagement and digital process automation. More than 70 customers discussed their use of Pega Live, reflecting our unique competitive differentiators.

The six core differentiators which we called out include; first, what we refer to as real time omni-channel artificial intelligence that is self-optimizing and can embed itself seamlessly and work across channels to deliver the right action at every customer touch and optimize those interactions for both experience and value.

End-to-end robotic automation that includes robots, process automation, case management and natural language email box to drive inside optimization and productivity. Importantly, we are the only CRM with robotic automation included. What we referred to as Journey-Centric Rapid Delivery that allows our clients to attack their customer engagement initiatives one journey at a time, rapidly letting them get value and work effectively across channels. 0:05:59.7 where it makes the most sense for them and their clients.

What we refer to as the Situational Layer Cake, which is a unique architecture that allows organizations to quickly specialize, differentiate and reuse their applications across products, regions and channels. And all of this is based on our unique model driven development approach. Sometimes people are talking about Low Code, we'd like to think of ours as No Code that lets business and IT design applications together and then have the system generate, tune and ultimately document the software that it creates.

This empowers the sixth aspect, which we refer to as Cloud Choice. We're the only vendor in our space that are allowed to have clients to the site where and how they want to run their applications without being walked into a single vendor platform. They can run it on Pega cloud, our cloud, a private cloud, the partner's cloud or a hybrid cloud and move between as needed. We think, and we've heard from customers, this is a tremendous advantage.

The PegaWorld presentations included customers like JPMorgan Chase who describe using Pega in its digital transformation initiatives with scalable, secure and agile application development to really impact the customer experience. Aflac, who outlined using Pega also in a major transformation initiative that changed the internal perception of IT from being an order taker to a consultative business partner, really simplifying and streamlining processes, making it possible to work differently and engage with the business and engage with customers very, very differently. And Google, our new client who describe its use of Pega's Dynamic Case Management to automate network maintenance to sustain and ramp down capacity to support its global enterprise customers.

In addition to seeing these differentiators highlighted on stage at PegaWorld, these unique capabilities continue to drive new business. We continue to see a good mix of business across our core verticals platform, applications and geographies. For example, we drove new business in this quarter with the new client, Liberty Global, one of the world's largest international TV and broadband companies with over 22 million customers. They chose Pega as part of their global digital transformation, an initiative they call Atlas, which is designed to provide an always on approach to engaging customers and provide a context-led experience to let them really react to changing needs and market threats. Liberty Global's vision is to be incredibly strategic in the way that it engages with its customers.

FedEx selected Pega as the company's enterprise case-as-a-service platform to support digital automation of a whole variety of processes and aspects of customer engagement and customer satisfaction. This new platform will replace a 20-year old mission-critical set of applications that are used across the global enterprise and rationalize more than a dozen additional case management systems, a part of their customer service, global freight networks, variety of applications.

And, Mitsubishi UFJ Trust, one of the - part of one of the world's largest financial services groups by assets. The Bank extended its work with Pega to support also a multi-year digital transformation to help fulfil their Trust Drives Our Future corporate branding. To achieve that vision, Pega is helping improve the customer experience, loyalty and trust by supporting the Bank's strategies about how to engage with customers.

And this quarter we celebrated GoLive with clients such as Credit One Bank, using Pega to support their rapidly growing customer base to an integrated customer service initiative. Cox Communications, which is using Pega in a new business unit, designed to help rollout net network capabilities. And Vodafone, which continues to rollout Pega globally. This quarter Vodafone Spain went live with the new marketing application that brings together decision making from a customer perspective and ensures relevant touches, while reducing churn and increasing satisfaction.

Now from a technology and ecosystem point of view, as I mentioned, we announced our biggest product launch ever at PegaWorld. What we refer to as Pega Infinity, provides the industry's best in our view, digital transformation architecture, something that really holds things together from end-to-end. We refer to it as the PegaDX, digital transformation architecture. And it does a terrific job of bringing together those six core elements I described earlier, each of which we see as meaningfully differentiating us from competitors and customer alternatives. Now, highlights of this architecture includes the AI, the robotic automation, DevOps capabilities that allow our clients to improve customer engagement, truly automate from end-to-end and more easily build for a change, which of course is our very motto.

Since our last call, we also announced the number of advancements to expand our ecosystem, enhance our offerings and make our software more available to new and additional organizations. We have a new independent software vendor program to bring our solutions to clients with more specific market needs added by partners. A new Pega community to empower people with all experience levels to build software with our coding and understand how to use our products. We've extended the free use of our Pega Academy, which is having tremendous success at bringing new partners, new customers into the mix.

We introduced the Pega Blockchain Innovation Kit that enables banks to see how Ethereum can really be used in our know your customer and client lifecycle management applications, a real I think bonafide and genuine use of this technology. And our partnership with LinkedIn to integrate our offerings and help power engagement strategies across sales and marketing. And of course, it was a pleasure to be able to have Google on stage talking about Pega on the Google Cloud, now a part of our Cloud Choice offering.

We also continue to receive rewards and recognition from the leading industry analyst like Gartner, Forrester. And this past week, Ovum, a noted analyst named us the number one customer engagement platform out of 11 solutions evaluated, and these included companies like Salesforce.com, Adobe, Oracle. And they recognized our Customer Decision Hub as best for its ability to predict the next best action at the next best moment, as well as having an underlying architecture that learn to fulfil and execute.

So, we are continuing to grow the company, we are continuing to bring on new talent. And one of the things I'm really pleased about is we just announced the appointment of Adriana Bokel Herde as Chief People Officer, succeeding Jeff Yanagi who is taking a well-deserved retirement after doing a great job with us for over a decade. Adriana brings more than 20 years of leadership experience in fast growing companies and is recognized as an innovative, high performing leader with the ability to architect, execute and drive business growth. We really are excited to have Adriana continue our focus on bringing high caliber talent into the organization so that we can meet our goals and work to accelerate our growth.

So, in summary, we've had a solid first half in 2018. We continue to see good progress in areas important to the execution of our strategy. The move to cloud and recurring revenue streams, increased engagement with our key clients and prospects, continued enhancement to the key differentiators in our product capabilities and the broadening of our sales force along with improved onboarding and training to try to bring them up to speed faster. We have a strong differentiated offering at the intersection of major growth areas and client needs. And we continue to be very positive about how our software is being adopted and the long-term growth opportunities.

To provide some more color, let me turn this over to you Ken.

[Kenneth Stillwell, SVP, CAO and CFO]

Thanks, Alan. The first half of 2018 has resulted in very positive movements in the business. For the first half of 2018, we experienced a solid increase in new license and cloud commitments, continued acceleration of ACV growth had a noticeable shift towards cloud arrangements.

As we've discussed in the past, our strategy is to accelerate growth with much higher mix of recurring client arrangements. Over time, we can leverage this movement to recurring contracts to expand margin. If one just looks at our reported revenue for the first half, it would lead to an incorrect conclusion. Our year-over-year term in cloud ACV growth exceeded 30% and it's a very important headline and is much more reflective of our overall business momentum.

Also, the significant amount of year-to-date client commitments that were cloud exceeded 50% for the first time in our history. The associated revenue trade-off that occurs with the massive movement to the cloud is normal than expected. In addition, I'll remind everyone that we also had a very large terminal of $35 million that occurred in the first half of 2017, which can add to making a year-over-year revenue comparison an incomplete good measure of our progress against our strategy.

Let me talk a little bit more about the details. Our new licensing cloud commitments grew by over 25% year-over-year. In the first half of 2018, our mix of new commitments was over 86% term in cloud, but most notably, cloud was over 50% of new commitments.

To provide a comparison, cloud as a percentage of new commitments was approximately 20% in the first half of 2017 and approximately 22% for the full year of 2017. We had an anticipated cloud increasing to approximately 30% of our new commitments. So, this acceleration to over 50 well is a pretty significant shift. Conversely, perpetual deals dropped from 57% of new commitments in the first half of 2017 to just 14% in the first half of 2018.

The short term revenue impact of this significant shift is obvious if you look at the top-line revenue. However, there are much more meaningful learnings when you look at the individual revenue elements. If we adjust it for the $35 million term renewal in the first quarter of 2017 and adjusted for our bookings mix that we had modeled for 2018 of approximately 30% cloud, our revenue would have increased approximately 20% year-over-year. If you adjust - excuse me, if you adjust for the extraordinary - excuse me, the extraordinary $35 million term renewal, term revenue would have increased by 30% year-over-year.

Maintenance revenue continues to grow by approximately 10% annually. Our consulting revenue year-over-year only grew by 8%, which is much more in line with our long-term targeted growth rate and our build of our ecosystem so that more of our services work can be done through our partners.

Cloud grew by an amazing 56% year-over-year. So, when you look at the individual revenue elements, you can see our move to recurring and specifically cloud playing out well, though it does require some examination to come to that conclusion.

Our full year guidance was developed using an estimate for cloud at 30% as I mentioned earlier versus the first half actual of more than 50%. Although it is still early, cloud momentum has been accelerating. This is driven by market demand, as well as improvements to our financial incentives for the cloud. As we've said in the past, each 1% shift toward cloud has the potential to reduce full year 2018 revenue. We estimate that to be approximately $3 million per year as the economic value is reflected in ACV but is not reflected in current period revenue when we book cloud.

We began disclosing annual contract value, as Alan mentioned, about six quarters ago. With the impact of implementing a new revenue standard, we believe annual recurring contract value is highly correlated to recurring and predictable cash flows. Our term in cloud ACV grew by 31% year-over-year, which highlights the growth in predictable future cash flows from term and increasingly cloud. Our year-over-year ACV growth of 20% is the highest that we have reported to date.

We have over $0.5 billion of total ACV, which is up almost 40% over the past two years. We have consciously continued our strategic investments in go-to-market capacity, noticing this significant shift to the cloud. We are confident in the market opportunity, our ability to capture our fair share and in ACV acceleration, we are seeing support for long-term value stream that we're creating here at Pega. Of course, there is a lead time in achieving full productivity from these investments - these go-to-market investments. So, much of this will be used to drive our continued growth in 2019.

On a year-to-date basis, our non-GAAP fully diluted net income and earnings per share have been materially impacted by the sharp shift to cloud and the lack of near-term revenue associated with the shift like this. Although, optically the results were confusing during such a transition, we're fully committed to continue to drive to more recurring and specifically cloud. We're also confident that we are not the first company to transition to the cloud and manage through the associated revenue trough that comes with that.

We are disclosing $477 million of commitments from customers that have not been taken to revenue as of June 3, 2018 including perpetual, term, cloud, maintenance and consulting. We have increased the level of transparency related to this disclosure to include all commitments.

Let me help provide some context around how to use this metric when thinking about future cash commitments from our clients. If you start with our unbilled receivables and contract assets that are on the balance sheet of approximately $325 million and add to it this $477 million of customer commitments not taken to revenue and then subtract our deferred revenue of approximately a $170 million to avoid double counting, you will arrive at a balance of $632 million.

This is the total committed future billings from our clients where we have recorded the commitment as revenue already or will recognize the commitment as revenue in the future. Though this is not an apples-to-apples comparison to our pre-606 measure of backlog, this is a measure that can be compared period-to-period and is an important operating metric that reflects business growth.

From a cash flow perspective, we produced $75 million of operating cash flow for the first half compared to $86 million for the first half of 2017. We finished the period with total cash and marketable securities of over $244 million. You can see that operating cash flow is not highly correlated to net income in times where there is a large shift to the cloud. Naturally cash is king and the reason that we focus so much on ACV especially when going through this type of shift.

In the first half of 2018, we returned over $46 million to shareholders through dividends, net settlements of equity and share buybacks. In summary, we are very pleased with our mid-year execution against our strategy and focused on finishing 2018 strong and continuing that momentum into 2019.

And with that, operator, we will open the call to questions.

[Operator]

Thank you. [Operator Instructions]. Our first question will come from Rishi Jaluria with D.A. Davidson.

[Rishi Jaluria, D.A. Davidson & Co.]

Hey guys, thanks for taking my question. I appreciate the color on the cloud business, I mean interest being significantly ahead of expectation. Ken, in your prepared remarks you mentioned that it's a combination of increased demand and financial incentive. Can you expand a little bit on what sort of financial incentives are that are driving customers towards cloud and any changes organizationally that may be need to be made to meet that demand? And then - and obviously, there is a - it's hard to predict the future, but how should we be thinking about that metric in terms of cloud as a percentage of new bookings or new business going forward for the rest of the year? And then I have a follow up.

[Kenneth Stillwell, SVP, CAO and CFO]

Yeah. I'm glad to clarify. When I say about financial incentives to customers, we changed when we went to this year, for the first year, we flipped our entire commission structure in the company to ACV, annual contract value. And historically, we had different rights for cloud versus other types of licenses. Now we're basically treating everything as if it is recurring and as if it is cloud. And that actually gives the sales people a little more of a financial incentive. If they sell - if they end up selling a term license without it running on the cloud, they just don't get comp for the additional revenue as they would get if it ran on the cloud. So, they have an additional incentive. Having said that, I think a lot of it is that customers are interested and that ultimately is what drives, what people buy.

[Rishi Jaluria, D.A. Davidson & Co.]

Got it. That's helpful.

[Kenneth Stillwell, SVP, CAO and CFO]

Does that help?

[Rishi Jaluria, D.A. Davidson & Co.]

Yeah. That absolutely does. So, how should we be thinking about where that directionally is going from here based on your existing pipeline today?

[Kenneth Stillwell, SVP, CAO and CFO]

So, let me make two points on that. So, there - I want to talk about recurring versus non-recurring and then we can talk about cloud second. So, the first thing is, if you look back a handful of years, we had a fairly reasonable amount of perpetual bookings and revenue in each year. And if you look at the first half of this year, I mean we have $35 million I believe of revenue perpetual for the first half of the year versus if you go back into the 2015 timeframe that number was approaching $200 million.

So, the first point is, we are seeing a pretty significant shift that customers like to buy recurring. They are interested in recurring models. And so, that is completely aligned with our strategy and our compensation structure that we have with our field teams.

The second point is, cloud. We are cloud choice. We believe in that, we believe in giving customers the option of dealing with whether they want an inside of their private clouds or whether they want Pega to manage it in our cloud. And the important opportunity there is that customers can have flexibility and they also flexibility if they decide that their needs have changed in the future.

That said, we are seeing customers embrace our cloud at an accelerated rate. We can't predict if that will continue in the future, but normally when you look at the market moving in that direction, cloud adoption tends to continue. And so, we're hoping that that this is a trend that continues.

[Rishi Jaluria, D.A. Davidson & Co.]

Okay. Got it. Thanks. And last question on the cloud and I'll jump off. But Ken, you mentioned just associated headwind, I just want to make sure I fully understand it. So, is that each 1% increase in cloud as a percentage of new commitments that leads to a $3 million headwind? And just kind of putting that together, if that metric stated 50% for the full year relative to the 30% when you initially guided that would be roughly a $60 million top-line headwind on a full year basis assuming no changes. Is that a fair statement?

[Kenneth Stillwell, SVP, CAO and CFO]

Yeah. So, that is a fair calculation. The reason why the three is not a science because it naturally depends on when that cloud deal is booked in the year and I'm sure you realize that. So, that's a factor to consider, but there could be - if our cloud stayed at 50%, you could see that kind of impact to the revenue. Now naturally you would see ACV growth being very stellar for the year if that happened of course.

[Rishi Jaluria, D.A. Davidson & Co.]

Okay. Got it. That's helpful. All right. Thanks, Alan again.

[Alan Trefler, Founder, CEO and Chairman]

Yes.

[Kenneth Stillwell, SVP, CAO and CFO]

Thanks Rishi.

[Operator]

Our next question will come from Steve Koenig with Wedbush Securities.

[Steven Koenig, Wedbush Securities]

Thank you, gentlemen. I appreciate you taking my questions. I'll do - I'll dig into the financials with Ken and then Alan I've got a follow up for you. So, Ken, I think the people might be struggling in the aftermarket a little bit with Pega because it is complicated, but you guys have posted stellar ACV, stellar cloud mix. And in terms of triangulating on what the growth rate of new business is, there's obviously several ways to do it. But Alan mentioned that ACV grew 20%, you mentioned new license and cloud commitments grew by over 25%. And then, on top of that, I know that you guys don't manage sales to TCV anymore and it's not - you don't quite manage at the ACV, but kind of it's a little bit of a combination.

[Alan Trefler, Founder, CEO and Chairman]

Can I 0:29:01.2 Steve, I might have fumbled, but I meant to say - I've stopped talking about TCV percentages entirely because we've got - we've worked to get our company off of it. So, read my TCV comment if I did make it as an ACV comment.

[Steven Koenig, Wedbush Securities]

Okay.

[Kenneth Stillwell, SVP, CAO and CFO]

Total - to clarify, total ACV, Steve. So, our 20% was total ACV which is licensed cloud and maintenance. We don't measure TCV anymore in that way. So, that's an important clarification. But sorry to interrupt you.

[Steven Koenig, Wedbush Securities]

Okay. No problem. So, you said new license and cloud commitments grew by over 25%. And now we know perpetuals were down, I can see that from the Q and that's understandable. How do you think about the growth of your new business, and in particular I'm thinking about in terms of the ways that you quoted your sales people, it looks like it was a pretty stellar quarter? How do we get our arms around that? And I guess a related question would be that new disclosure looks really helpful, do you have a sequential compare for that, a Q1 compare possibly?

[Kenneth Stillwell, SVP, CAO and CFO]

So, I'll take those in order. So, a question that is an easy one to answer that actually touches on your first one is that you might say were your - with your commission payments to our sales team, which is an indicator of kind of that bookings question that you asked, would they have increased by the 25%. And the answer would be, yes, there is a correlation there with the amount of business activity and how we've motivated our sales team.

So, it's not a precise number that because of the way that we comp our team, we don't give a direct ACV, we also encourage a small bonus for multi-years for additional years. But yes, there is a correlation to our business activity growth being in kind of that 25% range. So, that was your first question.

The second question, sorry repeat the second question again?

[Steven Koenig, Wedbush Securities]

I was just wondering if you had a sequential compare possibly for that new disclosure which looks very helpful.

[Kenneth Stillwell, SVP, CAO and CFO]

Sorry, yes. So, we don't. And the reason being is that when we first did disclosure at Q1, we did it which was the only deals more than 365 days, if you remember. And when we got the feedback with that, although that is technically permissible that really wasn't useful. And so, we improved the robustness of the disclosure in Q2, but we didn't have the ability to go back and recreate that.

[Steven Koenig, Wedbush Securities]

Okay. And this is…

[Alan Trefler, Founder, CEO and Chairman]

But going forward you'll get it.

[Kenneth Stillwell, SVP, CAO and CFO]

Yeah. You'll get it going forward though every quarter.

[Steven Koenig, Wedbush Securities]

Okay, great. And if I may one follow up for Alan here. Alan, you spoke about the fact that the reps now have a slight incentive to tilt towards cloud, clearly, clearly the market is favoring cloud, the migration to cloud in terms of new apps for sure, but your mix shift has changed radically and clearly there was a demand for your cloud solutions. Is it simply a matter that Pega unlocked the keys to selling cloud for the sales force or also are there factors related to anything you've done with your product or building customer references or greater use of cloud and production environment as opposed to just test. What's driving the mix shift this year beyond the sales methodology?

[Alan Trefler, Founder, CEO and Chairman]

Yeah. I think we've become in the last I would say 12 months, 18 months much more focused on developing and maturing and growing our ability to top cloud at state-of-the-art levels. We've hired and are continuing to build out a very, very robust cloud skilled and cloud knowledgeable people, and frankly that helped a lot as well. Before we were not as aggressively in that business as we are today. We're going to continue. We're going to stay. We've got a lot of customers interested in signing up et cetera.

So, I don't think it's just a change to the comp plan and any structure of the imagination. And we didn't do anything this economic like other companies have done, we just don't do that stuff. But we have greatly deepened our skill set. We announced on previous call, we announced we brought a fellow named Frank Guerrera who is a really well noted leader in at this point a little over a year ago. And I think he has and he's continuing to really deepen our bench there. So, I'm excited about that.

[Steven Koenig, Wedbush Securities]

Great. Well, thank you very much, gentlemen.

[Kenneth Stillwell, SVP, CAO and CFO]

Thanks, Steve.

[Operator]

Next, we'll go to Greg McDowell from JMP Securities.

[Greg McDowell]

Hi. Thank you. One for Alan and one for Ken. First, Alan, I was at your user conference, had a great time once again and I'd love to ask about Infinity and how you think your investors should track the progress of Infinity. I mean ultimately, I know it's not necessarily a separate SKU, but do you think in the medium term or long-term Infinity will lead to sort of higher ASPs on a per user basis or a per case basis and will allow you to just basically extract more value from your customer base. How should we track it, how should we think about it?

[Alan Trefler, Founder, CEO and Chairman]

Yeah, I think as well. I think that it will both let us get more value and also compete more effectively on lots of settings. There are some of the things I mentioned which you would have seen at the conference, and I think are really highly distinguished is that we enable because we have this real commitment to architecture. We enabled things like robotics, which is trendy these days, though frankly a lot of it doesn't work that well. Robots that can get data out of systems, robots that can do natural language processing of emails. Those are seamlessly put together in Infinity with the rest of the insight we offer in the customer engagement et cetera. And the reality is a lot of the other products out there are really very much piece together, collections of cloud that have been renamed. We think Infinity has really - this future looking architecture gives us just a lot of additional juice in both directions.

I also think that frankly relative to whether this is was the stellar quarter or not, I think we can do a lot better and I think we should be doing a lot better. And that's what this year and next year are going to be all of about, being able to realize some of the return on investment on our technology by actually putting into customers' hand and having to be more successful.

[Greg McDowell]

Great. And Ken, one for you. I mean you pretty materially beat my ACV estimates. And so, kudos on that. I know the headline numbers often are - don't accurately reflect what's going on in the business. But I guess my question is, I really wanted to steal your word, improve the robustness of my modeling for the second half of the year. So, how can you sort of help us improve that term license, perpetual license breakdown and how we should think about maybe seasonality for the back half of the year? I mean it was very helpful to see the re-cash for 606 on a quarterly basis for last year. So, I guess I'm asking what are the land mines, potentially the modeling land mines in the back half of the year we got to watch out for whether it's 7 digit or 8 digit renewals in term or just anything we should be super careful of? Thanks.

[Kenneth Stillwell, SVP, CAO and CFO]

Okay. So, I'll kind of use this as maybe to reiterate something that I talked a little bit about at Investor Day. So, Q4 is always a larger, has always been a larger new business activity quarter. So, you know that. So, just keep that in mind. Q3 and Q2 tend to be about the same level of business activity in our space, now naturally sometimes, there is a variance there and sometimes Q2 is stronger than Q3. But if you see the kind of business activity that we saw in Q2 and you see the kind of cloud percentage that we saw that Q2s and Q3s don't look dramatically different.

I think the question in the wild card for you to model and for us to model quite frankly is the percentage of cloud because that is just not - we are not in a point where we're able to say that that will be 40 or 50 or 30 or 60, it's just it's challenging because customers have choice and they make decisions right up until the last part of the sales cycle around their decision.

In terms of unusually large renewals that I sneak up on you, because that - which is another factor that you mentioned. 2018 is not a large renewal year as scheduled. Now, we could have a large amount of term deals that might translate into revenue in the back half of the year and that will depend on our business activity of course. But this isn't a year where we have a disproportionate amount of renewals. I would say 2018 is pretty much a typical year in terms of renewals, whereas in 2017 we have that very large renewal that made 2017 a little bit unusual.

So, I don't know how much that will answer your question, but it's kind of I'm trying to help connect what we talked about a little bit at investor day and now. I think the biggest wild card is the percentage of cloud and how much that can change the revenue. And I think that's why it's important for us to show you ACV, talk about the percentage of cloud renew, give you a directional impact to revenue when there is a1% shift. And I'll continue to give as much of that information so that you can kind of make sense of what that revenue variance might be based on the cloud mix percentage.

[Greg McDowell]

Fair enough. That's great. Thanks.

[Kenneth Stillwell, SVP, CAO and CFO]

Okay. Thanks, Greg.

[Operator]

Our next question will come from Mark Schappel with Benchmark.

[Mark Schappel, The Benchmark Company, LLC]

Hi. Thank you for taking my question. Just following on the theme of shifting to the cloud. Ken, you September quarter is usually a strong quarter, you're growing upcoming federal business and other governor business and the government historically has been forward adaptors of the cloud. I was just curious if you could foresee your 3Q cloud commitments just kind of reverting back to the 30% range as a result of that?

[Kenneth Stillwell, SVP, CAO and CFO]

That's a very good question, Mark. I would take the public sector out of this answer because I don't think the public sector makes a difference in this discussion. I see cloud interest from our customers and clients and our sales team and the market in general as being very robust. So, I would think that cloud would be very interesting for us to sell and for our clients to buy going forward. Whether 50% what we achieved in the first half is still achievable in the back half, well, that's to be determined. But I don't believe that the movement to cloud in the first half is just a one-time thing and we're going to immediately go back to everything being on-premise.

[Alan Trefler, Founder, CEO and Chairman]

Yeah. It is pretty clear that the 30% number that we modeled at the beginning in the year, though more than it was for 2017 was just unduly conservative. That I would agree with. The federal government spreads, we are working and investing a lot to get approval for what's called the fed ramp offering to the federal government. And to the extent that the federal government has roll on the cloud historically and they have, they've bought a license from Pega and then just chosen to put it off on one of their private or AWS type cloud. When we have fed ramp, I think we will see receptivity in the government. And we're working very, very hard to try to get that.

[Mark Schappel, The Benchmark Company, LLC]

Great. Thank you. And then, Alan, could you just discuss a little bit of a contribution from the channel partners this quarter? And more specifically, are your channel partners - are they - are those deals that they are signing or helping sign, are those shifting to the cloud much more so than the direct deals?

[Alan Trefler, Founder, CEO and Chairman]

I would say there is not a big difference. We do have partners attached to 80% or more of the deals that we do. More often than not, they are not lease selling, because typically - I mean typically our customers want to end up having a direct - we're doing mission critical stuff, so they end up having a direct relationship with us. So, the amount of resale business I would say is typically in the sort of single digits.

I think it's going to go up on absolute basis as we go forward with some of our strategies, but I don't think it's going to radically change, I think it will just continue to grow with the business growing in general. If you are doing a digital transformation, we're squarely in that space, that's a wonderful space to be in. They want to be able to call up the company if there is something that's going on or to really partner with the company. And so, we'll continue to see I think a strong bias towards direct, even if a partner is very involved in helping us sell it, which a number of them are.

[Mark Schappel, The Benchmark Company, LLC]

Thank you.

[Operator]

That does conclude our question-and-answer session. At this time, I would like to turn the conference back over to management for any additional or closing remarks.

[Alan Trefler, Founder, CEO and Chairman]

Yeah, this is Alan. I'd like to thank you all and you should all know we're working very hard. I do appreciate that the modeling question, it's just hard to come up with the satisfactory answer for. I want you to know that we're going to continue to try to improve our disclosures and give the transparency and we'd love people see what's really going on in the business. So, obviously, it does require a stronger look than it might for some other companies. I think that if you do take that look, you will like a lot of what you see. So, thank you very much, and look forward to seeing you all soon.

[Operator]

That does conclude our conference for today. Thank you for your participation.