Pegasystems Inc

NASDAQ:PEGA

Earnings Call Transcript 2022-Q3

[Operator]

Good day, and 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 Stillwell, COO and CFO. Please go ahead.

[Kenneth Stillwell, COO & CFO]

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 a result of new information, future events or otherwise.

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

[Alan Trefler, Founder & CEO]

Thank you, Ken, and thank you to everyone who has joined today's call. I am 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 reassessed 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 a non-GAAP 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 in the 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, conumenous ministries and are expanding their use of Pega's workflow automation to deliver pay and pension services to the Ministry of Defense. And that 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 your hands-on experience with it and have 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 U.K. and Europe, after 2.5 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 standard 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 have been with us funding our software since 1984 through multiple generations of the technology, and obviously, a rapidly changing and extensively changed technical and business landscape.

At this event, we have 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 [indiscernible] 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 themes. 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. And they want help in tackling short-term challenges while supporting your long-term strategic goals.

As I said, I believe that Pega 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, tubs 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 addition of Pega Infinity, which we announced last week. This newest release helps transform how organizations quickly deploy apps, create smarter workflows, deliver better experience on our 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, let's them make better decisions and let's them improve business performance.

We also continue to receive recognition from leading analyst firms and other third parties. Earlier this month, Pega 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 and 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 4 criteria, and Pega received the 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 assist users, increasing their efficiency and improving the delivered customer experience.

Now 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 that 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, I continue to be proud during these 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 there's people who 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 Stillwell. Ken?

[Kenneth Stillwell, COO & CFO]

Thanks, Alan. 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 multiyear subscription transition, growth in annual contract value, or as we refer to an 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 Pega Cloud 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. Pega Cloud bookings were the largest contributor to backlog growth in the quarter. Pega Cloud backlog grew additionally by a very high pace at 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 U.S. dollar, the euro, the British pound in the Australian dollar. For example, the persistent strengthening of the U.S. 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 of both ACV and on backlog.

And then moving to the status of our subscription transition. We're in the final phase of our multiyear 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 ACV 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 ACV add 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 gross margins and increasing sales and marketing operating leverage are two key drivers of our plan to achieve Rule of 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 3 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 shortfall 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 Cloud gross margin improved 400 basis points, increasing from 67% in Q3 2021 to 71% in 2003, 2022. And on a trailing 12-month basis, after several quarters -- several years, excuse me, a quarter-on-quarter growth of 200 to 300 basis points or more, the quarter-over-quarter on 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 installed base with tremendous additional opportunity that we have not yet have.

In addition, this installed base is led by the firms that will be able to most successfully weather, and if 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 of 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 12, 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 '23, and we are excited.

Operator, please open the line for questions.

[Operator]

[Operator Instructions] Our first question comes from Kevin Kumar with Goldman Sachs.

[Kevin Kumar, Goldman Sachs]

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.

[Alan Trefler, Founder & CEO]

Sure. Well, 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, Public Affairs. We also have, as we've done for a long time, continue to work with, well, many other departments from IRS to Marshalls, et cetera.

But we're seeing some very, very strong interest from foreign governments as well. When I went through Australia, Canberra, which is the capital, and there is a lot of work that we're doing there. In the U.K., I met with some of the people where we are actually delivering the recruitment system for the U.K. 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 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 they often can get big, which is something we, I think, do unusually well.

[Kevin Kumar, Goldman Sachs]

That's helpful. 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 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?

[Kenneth Stillwell, COO & CFO]

Sure. So there's a couple of parts to that, Kevin, that I'll touch on. First off, our operating cash flow for 2022 does have some kind of nonrecurring 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 that's -- there's 1 -- 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 receivables. 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, 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.

[Operator]

Our next question comes from Steve Enders with Citi.

[Steven Enders, Citi]

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 some of these kind of delayed deals in some of the past activities that we saw in the first half versus [audio gap] some opportunities coming in? And then how should we kind of think about for the year, you talked about 16% ACV growth last quarter, the target for the year. actually wanted to get an upside of execution here.

[Alan Trefler, Founder & CEO]

Sure. So we don't give guidance [indiscernible] we assessed because we made the 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 the 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 we're not completely issuing 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 slip 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.

[Kenneth Stillwell, COO & CFO]

And Steve, I'll add 1 additional thought on there. So Alan mentioned a couple of things. One, the breadth of the performance, meaning the contribution from lots of clients was really healthy. There 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 breath of engagement with so many different clients.

The second point is, you may remember me saying this, but with the change in our sales strategy, sales leadership and kind of our refocus 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, etcetera, to existing logos much more productive. In general, so then at Pegasystems, 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.

[Steven Enders, Citi]

Okay. Great. That's very helpful couple of context there. I guess, kind of more like broadly, just thinking about the macro, and I know it is kind of a challenging time right now. How are you kind of viewing the pipeline and the opportunities as we think about 4Q? 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?

[Alan Trefler, Founder & CEO]

Well, the style of engagement that we've been doing in the last several months, since we reoriented here, the sale of engagement is quite a bit different. It's not a lead response style where you have to worry in the same way about "deals" slowing down conversion during different parts of the funnel. That's not the style of selling. This is a full engagement style, understand the client strategy demonstrate how we fit into that.

And I actually think those deals are much more reliable in terms of being, frankly, influence and control by us because it's not a mass or a 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 the success that they've seen.

This idea of the app factory 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 of 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.

[Steven Enders, Citi]

Thanks for taking the questions.

[Alan Trefler, Founder & CEO]

Sure. It is nice selling to organizations that are going to be through at the other end. That is the other real advantage, I think, of this sort of style of going to market.

[Operator]

Our next question comes from Pinjalim Bora with JPMorgan.

[Noah Herman, JPMorgan]

This is Noah Herman on for Pinjalim. The first, just any major changes you've seen in the demand environment, specifically in the U.K. 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?

[Kenneth Stillwell, COO & CFO]

Let me take that second part of the question, Alan, and then maybe you can give your perspective on APAC and EMEA. So as Alan mentioned earlier, we're not in the business of guiding quarterly. What I would tell you is where we said we were going to be 16% constant currency ACV.

We were 16% constant currency ACV for Q3. That's certainly confirming indication that Q3 was kind of a step on that journey. The 1 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? That's the big wild card, right, is currency.

In terms of the fundamentals of our business, we anticipated that the economic environment was going to be 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 -- that reports to the U.S. dollar. And Alan, maybe on EMEA and APJ in terms of the demand environment, your perspective?

[Alan Trefler, Founder & CEO]

Sure. Well, 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 is 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 U.K. 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 are going to transform in ways that will let them become more efficient.

There's more of an interest, I would say, in the demand environment around cost savings and retention than there is about trying 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 a 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 1 in 2.5 weeks because there's frankly so much demand for friends who want to talk to us. And I think that will translate into business ultimately. 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.

[Operator]

Our next question comes from Joe Meares with Truist.

[Joe Meares, Truist]

I apologize for the background noise. I swore, 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.

[Alan Trefler, Founder & CEO]

I think that they were -- I was probably a little more worried than what actually happened. When you're in the early bits, it's not uncommon for things to elongate because people will put -- sometimes they'll put extra levels of controls on spending. It's anecdotal, it's not statistical, but I didn't really see that happening in a meaningful way.

Yes, 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 Ken as CFO or COO tries to stop something from happening. I think that actually bodes well for the level of attention we're getting.

[Kenneth Stillwell, COO & CFO]

I would add 1 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 see that. So that's the 1 area that I would say we probably -- our focus area is probably 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.

[Joe Meares, Truist]

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 process.

[Kenneth Stillwell, COO & CFO]

Yes. So the great news is we've achieved that mitigation as we sit here in October. So now we're looking to see how much more progress we can make through the rest of this year and in '23 to prepare ourselves for our Rule of 40 targets in 2024. So we're really happy. 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 we're done kind of things. We want to run a good business, and we're far away from Rule of 40 right now, and we need to get there. And so that's -- this was kind of that really positive step that we made in 2022.

[Operator]

Our next question comes from Steve Koenig with SMBC Nikko.

[Steven Koenig, SMBC Nikko]

One for Ken, that's kind of a multipart about the numbers, and then a question for Alan. So let's say, 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.

We're -- sorry, they were $139 million, up $139 million. So it did a huge bookings number that didn't translate as much ACV. ACV was still good, but just a huge putting number. So was that -- were there some -- a lot of renewals in there? Was it a big renewal quarter for cloud.

And then maybe just the other one on the numbers is maintenance RPO has been down year-on-year, two quarters in a row. Is that the beginning of a trend? What should we expect? And is that a function of clients migrating from term to cloud? And then a follow-up for Alan.

[Kenneth Stillwell, COO & CFO]

Sure. So let me start by just throwing 1 thing out, Steve, which is currency. 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 Pega Cloud outside and maintenance outside the U.S. So the first thing is currency is a factor. Yes, there were renewals in Q3 that a larger pace than there were in Q2, for sure, that's why Q2 RPO and I mentioned that there's not -- renewals aren't linear, which is why Q2 had an RPO was a little bit slower growth. That was just a little bit of a cycle that we go through.

But Q3 was more of a kind of more of a normal kind of renewal quarter. But also there's a couple of factors. One is correct. The other one is sometimes when we -- Pega Cloud, the booking doesn't actually start an ACV in the quarter that it gets booked in. Meaning the effective date could be the next quarter, and you probably remember this or even could be a couple of quarters out. And so some of that will get into backlog, but not actually get into ACV yet. So almost like 10% up ACV, so to speak, right? So that's that.

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 helpful.

[Steven Koenig, SMBC Nikko]

Yes, absolutely. That's super helpful. Great. And my follow-up for Alan. Alan, you made some commentary about the culture and about the employee morale essentially in the post-pandemic times. And that's encouraging to hear, especially amidst cost control at Pega. I'm wondering if you could comment on kind of, I guess, one of the elephants in the room that was distracting in Q2 was the lawsuit.

And which is -- I guess that's gone to appeal now where you guys are in the process. But how does that -- what kinds of questions are employees asking? And how does that kind of play into the kind of motivation and alignment within Pega and questions you may be getting about that from employees?

[Alan Trefler, Founder & CEO]

Sure. I would tell you that the staff very broadly, and obviously, we have some long-standing 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 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 does -- it's not the easiest time to be the employee in a high-tech business in the circumstances. But the other thing is for those who've been around a long time and can talk to those who are perhaps even newer, 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 question from a staff member that we call them Ask Anything. And we get asked a lot questions.

I think between good communication and I think a heritage, we've been able to keep the company together and keep the company solid. And 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, different difficult years. I think that great companies are resilient companies and have real greed. And I do think that greed is something we don't like. So I'm...

[Kenneth Stillwell, COO & CFO]

I'm going to just add 1 other perspective on that, Steve. The thing that really engages our employees and get them fired up is their interactions and the solutions that we do with our clients. And our client engagement is at really all-time highs. And I think that shows just by the breadth of our performance in Q3.

So I think that's really another factor that is very important to us because we're -- 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 aspect. And we're so deeply engaged with our clients. You really can see the value that we're providing because of how tightly connected we are. So that's also a very positive momentum at times that kind of weird times like what you mentioned.

[Operator]

Our next question comes from Vinod Srinivasaraghavan with Barclays.

[Vinod Srinivasaraghavan, Barclays]

I know you had said you weren't updating your guidance. But when you did formulate guidance in 2Q and you are reassessing, can you just talk a little bit about your overall guidance philosophy? Did you build a buffer into guidance? Or are you one of those companies who doesn't really do that and should we just really expect you to hit what you spelled out there?

[Kenneth Stillwell, COO & CFO]

Yes. So I think over the last 3 to 4 years, Vinod, was very hard for us to really peg and specifically a revenue and EPS number and because of the shift to Pega Cloud 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 or a year compared to what it was, say, in 2018, when a 10% shift would impact us immediately by $40 million 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 they doesn't always shake out the way. I would say revenue is we try to do 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 in kind of a beat and raise kind of model because we're not guiding each quarter. But we didn't -- we hadn't created 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 a reasonable estimate of what we could get to, which we feel we made a lot of progress there. So I would say we really tried to be as accurate as we could and where we thought we were going to land.

[Vinod Srinivasaraghavan, Barclays]

That's helpful. And just 1 more for me. It was good to see the Rule of 40 expectation reiterated. But I wanted to kind of talk about the kind of the weighting between growth and margins there given that some of the demand headwinds seem to be improving and you have those sales office improvements. Do you have any changes to the weighting of the factors? And ideally, like what would you like to see?

[Kenneth Stillwell, COO & CFO]

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 of 40 model is that if your 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, right, because your growth is better and your bottom line profitability is better. So our approach has been not to shoot for a growth number that is unachievable when we think of Rule of 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 cost 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 have in 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, anything -- any thoughts to add there?

[Alan Trefler, Founder & CEO]

I think that's on target. We're certainly investing in growth. We want to be a company that grows well. We've, in the past, said that we could grow 20% ACV a year and 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.

[Operator]

Next question comes from Joey Marincek with JMP Securities.

[Joey Marincek, JMP Securities]

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?

[Alan Trefler, Founder & CEO]

Yes. I think -- so there's a lot in 8.8 that I think is exciting. The additions to the app factory capabilities, 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 a little stand-alone things, which -- but 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, as you know what that was five 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 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 processed AI, which is bringing artificial intelligence into the process so that it can 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 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 the 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 about functional in terms of helping [indiscernible] apps and more technical in terms of being able to plug into other systems, which is obviously something that's super key for us.

[Joey Marincek, JMP Securities]

And then can you just give us a quick update on the Everflow acquisition? What is sort of the feedback and demand been like from customers on those new process line capabilities?

[Alan Trefler, Founder & CEO]

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 the other pieces. So yes, there's interest. I saw a demo just yesterday with the client who seemed quite impressed. And I think it's going to turn out really well.

[Operator]

And our next question comes from Fred Havemeyer with Macquarie.

[Fred Havemeyer, Macquarie]

I wanted to check 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?

[Alan Trefler, Founder & CEO]

So I think -- and Ken can comment on this as well. Of course, it comes up with customers. In fact, 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 them listening and reading what we put on our website because we've put some stuff up that I think helps provide some color.

And 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 in our ability to not have the conversations get unduly shaped. 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 comment or...

[Kenneth Stillwell, COO & CFO]

I would -- yes, I think everything you said makes sense. I think, Fred, the reality is when you have an announcement like that, a press release that's a newsworthy item, of course, clients need to understand, need to understand 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 is. And I think that our clients have universally been very pleased with our engagement on that.

And 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, certainly, I wouldn't say that, that chapter is closed because the appeal is in process. But I do believe our clients are very comfortable with the engagement that we've had with them from my experience.

[Alan Trefler, Founder & CEO]

As one of them said, they get sued all the time. So it's not a foreign concept. So not that anyone enjoys it, but it's not at all foreign to any big bank or insurance company, certainly.

[Operator]

This concludes today's question-and-answer session. I will turn the conference back to Alan Trefler for any additional or closing remarks.

[Alan Trefler, Founder & CEO]

Right. 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 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.

[Operator]

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