Pegasystems Inc

NASDAQ:PEGA

Earnings Call Analysis

Strong Performance and Strategic Focus

Pega's earnings call reveals a strong third quarter performance for 2024, characterized by record cash flow levels and robust growth in Annual Contract Value (ACV). The company's shift to a targeted go-to-market strategy has significantly improved sales efficiency, helping to achieve ACV growth of 14% year-over-year in constant currency. Additionally, integration of their GenAI Blueprint into client engagements has enhanced deal closure rates and reduced time to value. This strategic focus positions Pega to capture further growth as they advance client shifts towards Pega Cloud.

Pega Cloud Driving Growth

Pega Cloud continues to be a driving force behind the company’s expansion, with a remarkable 26% growth year-over-year in constant currency. The leadership team's ambition is clear — they aspire to exceed $2 billion in ACV from Pega Cloud in the coming years, illustrating the significant upside potential in transitioning from traditional term licenses to cloud-based offerings. Currently, Pega Cloud accounts for less than 50% of total ACV, indicating that further migration and engagement can yield substantial revenue growth.

Record Cash Flow Generation

The company reported nearly doubling its cash flow from operations to $250 million alongside generating $246 million in free cash flow for the first nine months of 2024, solidifying its position with consistent cash generation. This marks eight consecutive quarters of positive free cash flow following the completion of their subscription transition. Effective management has allowed Pega to allocate capital for share buybacks, enhancing shareholder value while maintaining flexible liquidity to manage financial obligations.

Future Guidance and Market Dynamics

Looking ahead, Pega expects to conclude 2023 with a strong Q4, although it will face a more challenging year-over-year comparison due to prior high performance. The team remains optimistic despite not providing a revised target for ACV growth, aiming rather to exceed past targets as they continue to execute their business model effectively. The company will need to maintain its focus on new client acquisition and accelerating existing client volumes, especially as maintenance revenue is anticipated to decline in the upcoming years.

AI and Market Positioning

Pega’s innovative AI offerings, particularly the GenAI Blueprint, are central to transforming customer relationships and expanding their operational scope. This new capability is fostering enhanced dialogue with clients, driving deeper engagement, and accelerating digital transformation efforts within client organizations, bolstering Pega’s competitive positioning in the market against rivals such as Salesforce. They believe that the combination of agentic AI with traditional workflow processes provides a sustainable competitive advantage that cannot be easily replicated.

Conclusion: Momentum for Continued Success

Pega's executives are optimistic about the company’s momentum and energy as they approach the end of 2024, generating solid performance indicators and promising growth prospects. The successful implementation of their strategies is leading to improved client engagements, strong financial results, and a clear path forward focused on cloud migration and AI innovation. The company is well-positioned to end the year successfully and set the stage for future growth, emphasizing the importance of continued execution on their strategic initiatives.

Earnings Call Transcript 2024-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. My name is Krista, and I'll be your conference operator today. At this time, I would like to welcome everyone to Pegasystems Inc. Third Quarter 2024 Earnings Conference Call. [Operator Instructions] I will now like to turn the conference over to Peter Welburn, Vice President of Corporate Development, Investor Relations. You may begin.

[Peter Welburn, executive]

Thank you so much, Krista. Good morning, everyone, and welcome to Pegasystems Q3 2024 Earnings Call. Before we begin, I would 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, forecasts and guidance 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 2024 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 2024 results 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, 2023, and other recent filings with the Securities and Exchange Commission.

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 turn the call over to Alan Trefler, Founder and CEO of Pegasystems.

[Alan Trefler, executive]

Thank you, Peter, and thanks to all who are joining today's call. I'm really pleased with our performance for the first 9 months of 2024. The team is executing extraordinarily well, and I'm optimistic about the momentum that's evident in our results. The energy is palpable across the company, and our sales teams are fired up. It's great to see that we're driving profitable and balanced growth across industries and geographies while delivering transformational innovation. The enormous excitement we're seeing from our AI offerings especially Pega GenAI Blueprint is fundamentally changing the way that we engage with prospects and clients. Our distinctive AI approach is showing clients how they can accelerate their digital transformation and move to become autonomous enterprises.

Blueprint is now part of virtually every client and prospect discussion. It continues to inspire our prospects, our clients and partners with possibilities, and they're continuing to evolve. It has profoundly changed how we engage, sell, deliver, and is helping us work to get in with clients more deeply and across bigger pieces of their business. The number of new Blueprints continues to grow dramatically. It's helping us identify opportunities to accelerate growth and creating additional momentum for Pega Cloud, which is growing at a faster rate than even we predicted, and Ken will discuss in more detail. The tremendous engagement from clients and partners is also accelerating innovation. As together, we're continuously discover new ways to leverage and to improve Blueprint.

For example, we've recently added support from many additional languages and added a new collaboration feature that summarizes who is making changes to the Blueprints to help our clients collaborate among themselves. As a reminder, you can experience Blueprint for free by going to pega.com and searching on Blueprint. But I think perhaps most importantly, this is unique to Pega. And I don't think it can be easily if ever replicated by competitors without a major rework of what they do. And this is just our opinion. We're getting that feedback from clients, partners and industry experts who are also saying that Blueprint is one of the most compelling examples of actually putting AI to work that they see something I heard last week when I was in EMEA and met with some of our largest clients.

This changes how we operate, and I think gives us a distinct competitive advantage and an approach to monetization of AI that is not dependent on product SKUs, but rather reflective of building and growing strategic long-term client relationships. For example, recently, one of our large multinational financial services clients asked us to help improve their team's "digital saviness". So we have organized more than 40 Blueprint exploration sessions over 4 days, giving about 800 employees hands on experience with Blueprint. The team was so impressed they've asked us to help programmatically put Blueprints into practice and included citizen developer training to broaden the people who can get access to this AI.

Our European client that provides health care services has given Blueprint to nurses, caregivers and others from across 11 hospital networks. So they can directly design and rethink their workloads that they need to do better service for their citizens. To date, they've created more than 150 Blueprint. And recently, our team used Blueprint to identify and accelerate potential pipeline in new areas of business with a long-term insurance client. This level of excitement about Blueprint and the client engagement that's driving is candidly unprecedented in Pega's history, and as the entire company and our partners stoked. I want to talk a few minutes about what we're hearing from clients and how we're responding.

Our clients are focused more than ever on digital transformation. It's good on -- it's become imperative that they see as critical to their competitive survival. And in talking with them and thinking about what we're doing now and into the new year, we believe we're uniquely positioned to help our clients with this journey in 3 ways.

First, support through rethinking and replacing legacy applications. It's common for our clients to have lists of the applications they hate, the ones they want to replace. And there's an increased urgency to modernize these apps so they can both leverage AI and also move to the cloud, which many of these are not able to do. We see a huge opportunity to help them rethink and replace this ever-growing technical depth.

Blueprint deploys AI to eliminate the drag of legacy applications. And it connects the whole process of rethinking the app with the Internet and with AI in a way that really helps drive both the right way to do things and faster outcomes. Clients can import information about applications and then use Blueprint to update, enhance or completely reimagine their workloads and then execute quickly and effectively. We'll continue to enhance our offerings to support clients in these efforts, and we'll be introducing new capabilities this year and next.

I've been speaking with partners and clients about this over the past few weeks, and the response to this legacy transformation vision has been universally positive. The power of this approach is clients aren't just lifting and shifting applications. Blueprint allows them to rethink their workflows while moving them on to a modern cloud platform, which brings me to the second advantage we believe we have.

We believe we are an ideal modern application platform for the types of business that involve workflows and involve getting work done. Recently, Gartner noted that "overlapping automation capabilities are driving market consolidation" and prompt the enterprise application leaders to search for platforms that can cater to the end-to-end needs of a wide range of automation use cases. They actually introduced a new concept to address this. They call it BOAT, business orchestration and automation technologies. This describes what we also see in the market, and it's really the convergence of robotic process automation or what we used to call RPA, business process automation, BPA or BPM and low-code application platforms.

Gartner describes BOAT as a class of software technologies that allow enterprises to automate and orchestrate end-to-end business processes while connecting multiple enterprise systems of record through any applicable integration records.

Now Pega for much of its history has been saying almost the exact same thing. And this is exactly how we think about our center-out business architecture bringing together the process automation, orchestration and using AI to have decisioning that helps make the right decisions at every moment and making it work across front-end channels and across data sources. We believe we're perfectly positioned to be the business orchestration and automation technologies platform for our clients.

And that platform sets our clients up for the third advantage Pega delivers, a path to what we refer to as the autonomous enterprise. Our mission to change the way the world builds software, that starts with building the software around the outcomes that clients want to deliver, helped organizations maximize the potential for automation and AI.

We have spoken before about this approach to building outcomes and workflows in a way that is center out. This is radically different from others who still build their software around user screens or around database structures. And we believe that those approaches are fundamentally ill-suited to a world that expects ubiquitous self-service and agentic automation.

Center-out is the right architecture for AI agents because it's built around outcomes. It's built not around the screens, not around the database tables, but in fact around what the organization is trying to deliver regardless of the screen it is, regardless of the database that it has to go to get the information. And it allows us to define things in ways that we can make really good decisions. We can drive optimized outcomes and do it across the channels and the back ends. And the approach not only allows for automation, it also helps ensure governance with agents following defined best practices in predictable ways and in ways that we'll be able to pull in a human for assistance when appropriate, however, doesn't assume that it's human-driven.

We've already seen the fruits of this approach in our e-mail and message agents, which have automatically processed hundreds of millions of e-mails and messages for our clients, all while adhering to best practices and regulations and reliable outcomes. And Pega GenAI Knowledge Buddy, an agent that can retrieve and synthesize information from an enterprise knowledge base is delivering answers with attributions that employees can trust and Pega GenAI Coach an agent that delivers the structure and data in a Pega Case to provide real-time guidance for users to help ensure that they're working in the most effective way what the system is not able to handle everything completely automatically.

So our upcoming release Pega Infinity 24.2 contains enhancements to Coach, Knowledge Buddy and/or data virtualization architecture and more. You'll see that news next week. Now there's nothing I love better than spending time with clients. While I was in Europe last week, I met with dozens of senior contacts and partners and with some of our most strategic customers. Those meetings were frankly all incredibly positive and in every interaction, we talked about how Blueprint and our approach to AI could accelerate their digital transfer [ mix-generic initiatives. ] And I would tell you, I see that our customers and our partners are senior, and it's terrific to hear how they're using our software to make positive tangible impacts on their organizations.

So in summary, I'm very pleased with how we performed for the first 9 months of the year. And I would tell you that the strong profitable growth has been coupled with the levels of innovation in the way that we bring both intelligent automation and intelligent decisioning to market that I think put us with an innovation agenda that is top shelf.

Pega GenAI Blueprint continues to generate excitement and has fundamentally changed how we engage prospects, clients and partners in a very positive way. And I believe our approach to AI really focused on changing the heart of the business of our clients. That focusing on business outcomes rather than just coding faster is markedly different from what we see out there in the market and I believe we can help our clients and prospects to understand that, and it's going to provide a competitive advantage and support long-term client relationships. We will continue to deliver tangible and I believe groundbreaking solutions focus on providing real value in a strategic and architectural manner. And given that our approach and architecture are unique, I think we have a tremendous long-term opportunity and engine for growth.

With that, let me turn this over to Ken.

[Kenneth Stillwell, executive]

Thanks, Alan. It's fantastic to see our team consistently deliver solid quarters of profitable growth for the third time this year. Clearly, we have momentum, and we're executing very well. Annual contract value grew 14% in constant currency and 16% as reported year-over-year. Our ACV growth acceleration was powered by Pega Cloud which grew 26% year-over-year in constant currency. Pega Cloud represents the vast majority of our net new ACV in the quarter and for the year. Our team is selling Pega Cloud as our primary offering, which is a pretty significant change from our approach several years ago.

Overall, our ACV growth acceleration in Q3 was powered by the successful execution of our strategy. As you may recall, 2023, we shifted our go-to-market strategy to focus on our target organization model. By minimizing distractions and having our sales teams laser-focused on the right organizations, we have greatly improved sales efficiency and effectiveness. This change, coupled with our latest GenAI innovation has enabled us to significantly increase client engagement. Pega GenAI Blueprint is having a profound impact on the way our sellers and partners engage with our clients and prospects around the world. It also enables us to expand our addressable market with existing and new clients by helping them to modernize legacy systems that were not in scope before but are in scope now.

Last week, for example, I attended Pega 7th Annual Government Empowered Conference in Washington, D.C. It was great to see government agencies at the event like Social Security Administration, the Department of Justice, the IRS and Veterans Affairs, each agency is using Pega to build modern platforms that will allow them to deliver more effectively on their missions. With Pega GenAI Blueprint, and our new FedRAMP high certification, Pega has never been in a better position to help government organizations transform employee and constituent experience.

We get asked all the time, what's the significance of AI? I'll tell you that our conversations with clients have massively changed. Now we lead with AI. We talk with potential new logos and clients about our GenAI Blueprint innovation. It's going to help them rethink differently about digital transformation and accelerate that thinking. We also talk with them about how we bring our best practices together with the best practices from the Internet in a way that creates productivity. We're starting to see early signs that our unique approach to GenAI is positively impacting deal closure rates, reduced time to value, increased expansion rates and improving our partner relationships. It's clear to me that Blueprint activity is translating into ACV growth acceleration, and it provides us with a fantastic opportunity to accelerate Pega Cloud migrations as well.

Moving on to cash flow through the first 3 quarters of 2024, we nearly doubled cash flow from operations and free cash flow. We generated [ $250 million ] of cash flow from operations and $246 million of free cash flow, both record amounts for the first 9 months of the year. Q3 2024 was our eighth consecutive quarter of positive free cash flow after completing our subscription transition. My view is that free cash flow is really the true thing that matters in terms of creating shareholder value, the amount of free cash flow, the consistency of free cash flow and actually more importantly, the growth of free cash flow. So if you start there, do you believe that premise, then you go upstream from that. What's the most important metric that is the leading indicator to drive expanded cash flow. It's the amount of billings that you have with your clients and how fast those billings are growing, that is annual contract value.

So ACV represents subscription billings which ties cash collections, which ties to free cash flow generation. Now that we've completed our subscription transition, our free cash flow trajectory, as I mentioned, is well anchored. Then we have ample liquidity to pay off our convert that is due in March. Also, you'll likely notice that we started buying back shares in Q3 and continue that activity through the end of the quarter, spending about $12 million on share buybacks. The Board also increased an authorized repurchase amount of an additional $250 million. We're evolving our Rule 40 mindset to deliver profitable growth, increase free cash flow per share, which is the right strategic balance of capital allocation and key to delivering increased shareholder value over time.

As I look forward we are in a fantastic position and have an amazing opportunity to help our clients digitally transform our business and migrate to Pega Cloud. You've heard us recently mention our commitment to dedicated leadership around Pega Cloud adoption, and that's why we named Frank Guerrera as our Chief Cloud Officer in the third quarter. As I explained during our investor session in June, we aspire to exceed $2 billion in ACV in the next few years. Today, Pega Cloud ACV is less than 50% of our total ACV. That means there's a significant opportunity for us to accelerate Pega Cloud.

I've received feedback from many of you that it's helpful when I share some thoughts about modeling. So I'm going to continue to do that. First, Q4 2023 with a very strong net new ACV quarter for us. So we do face a tougher compare in the final quarter of the year. That said, we're still confident that we will finish the year strong. And as targeted in the past, we will be a Rule of 40 company as we complete 2024. As a reminder, we define the Rule of 40 as the combination of our ACV growth and our free cash flow margin adjusted for items such as restructuring charges.

Second, we continue to experience success in moving clients to Pega Cloud as that trend gains momentum, we expect term license revenue and maintenance revenue to decline over time as that revenue moves to Pega Cloud. Currently, we anticipate declines in maintenance and subscription revenue for the full year 2024 versus 2023. That said, I want to remind everybody that the accounting for term licenses is not as predictable as the accounting for a SaaS business. So there can be some variability in those numbers.

Last, as you're modeling Pega Cloud revenue, I want to point out that there is typically a delay of a few quarters in between the time that net new Pega Cloud ACV is added and when it translates into Pega Cloud revenue.

In conclusion, we're focused on closing the year strong. We've managed the business very well in 2024 with accelerating ACV growth and record free cash flow and cash flow from operations. I'm really happy with our team's performance. I also want to congratulate our sales team for a great first 9 months of 2024 and best of luck finishing strong in the fourth quarter. Specifically, our client-facing teams around the world have done an amazing job with our go-to-market transformation. We are clearly executing very well. I'll also add that the energy as we entered Q4 is as high as it's been in Pega for many years.

And with that, operator, please open the call for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Steve Enders with Citi.

[Steven Enders, analyst]

I guess maybe just to start, I want to ask on the momentum that you're seeing with Blueprints and maybe what impact is that beginning to have on either ACV, the acceleration we saw in ACV in the quarter are on the -- on the pipeline and what that looks like for Q4 and into '25.

[Alan Trefler, executive]

Yes. I think Blueprint has lifted all boats is the way I describe it. And I think it's done that because when clients see it and internalize allows them to think differently about their business. Even if we were already talking to them, so they didn't get the advantages of Blueprint early in the sales cycle, I think really helps convince them that Pega is an organization that they should count on and continue to grow with.

We've also begun to show off another Blueprint that we are going to be releasing around the end of the year for our decisioning capabilities, which are going to bring a lot of the same AI-powered analytics to helping our customers do next best action, which as you know, is a very, very important part of our business. So I think Blueprint is just changing the overall attitude and that has -- it sounds like I can tease apart the pieces that are related to Blueprint because it is so incredibly pervasive and just changed the engagement.

[Steven Enders, analyst]

Okay. Got you. That's helpful. And then I guess maybe just on the ACV acceleration that you are seeing here for 3 quarters in a row now. But can you just maybe help us think about maybe what is helping to drive that acceleration? Like are there certain use cases or industries or geographies that are helping to support that? And I guess, secondarily, does this maybe change how you view that, I guess, initial 11% annual guide that you've had for ACV growth for the year?

[Kenneth Stillwell, executive]

Yes. So Steve, this is Ken. So a couple of things. One, we are seeing accelerated ACV growth in every region, the U.S., EMEA and APJ. So I'll start there. not every vertical is accelerating at the same level so that when you get into verticals and geographies, naturally, you're reducing the sample size. So -- but I would say across the globe, geographies are all growing. They're all accelerating. The second part of that is where are we getting it from? We're getting it from new logos? Are we getting it from new workflows? Are we getting it from existing clients, increasing the volume, it's really across the board.

We've had net new logo growth in Q3. We had expansion of new workloads with existing clients. We've had actually expansion of existing workloads with new clients. We've actually had a little bit of the start of some migration Pega Cloud. I mean we're still very early in the migrations, but we have had some. So I think it's just that across the board, new logos, existing logos, migrations and across the world. So I really couldn't point to just 1 thing and say it's North American health care just making that up. It's not something that is not dynamic, which is incredibly encouraging, which means that Blueprint and the way we're engaged with our clients universally driving acceleration in our business.

When you get to look at the next 2 to 5 years, you say what might this do to change the business? This is a transformational opportunity for Pega to reaccelerate our business back up to levels that we haven't seen for probably 3 to 5 years, right? So I think -- and there's no reason that even those growth rates something that could be a ceiling. We have to execute, of course. So we have to -- and we are going to be dependent on not only our existing clients, but actually exploring new logos strategically in our target [ org ] model, new logos. So great opportunity for us.

In terms of this year, which is the last part of your question, certainly the energy, as I mentioned, in Q4 is high, also the Q4 activity that we have is very high, but also there's always a lot of work to do in the Q4. So I think that we're certainly feeling good about where we are, but we are not in the habit of reguiding. So I think we just feel -- what we want to do is we want to beat our targets. I mean that's a fundamental DNA that we want to have, but we've got to execute, and we've got work to do.

[Alan Trefler, executive]

And Q4 is by far the toughest compare of the year.

[Kenneth Stillwell, executive]

Yes, Q4 is always a tough quarter. The last point I would make is any growth -- in any scenario where our growth would exceed our model for 2024. And that is not -- that's not a reguide is making this clarification. It's probably not likely to lead to any change in our cash flow modeling because the billings happen toward the end of the year. It would give us, however, upside for free cash flow next year in 2025. I just want to make that very clear. So for anyone that's thinking about the relationship between the 2 of those.

[Operator]

Your next question comes from the line of Jake Roberge with William Blair.

[Jacob Roberge, analyst]

And great to see ACV growth continue to accelerate. You all made the comment that GenAI Blueprint is expanding your TAM by bringing new applications into the scope of what you can address. Can you provide examples of that? And is there any thought of pouring any gas or putting more go-to-market capacity behind those initiatives?

[Alan Trefler, executive]

So I think that a big part of the example I would give would be the idea of helping organizations replace some of their legacy systems in a different way. Historically, we used to talk about going into an organization and you're seeing the power Pega workflow or the power Pega decisioning to wrap and renew their existing systems. And that once again built a meaningful business. But what we've now realized with some of these new capabilities and with what AI can do, we can more directly target the systems that our customers just want to kill.

All of these organizations, particularly as they try to move to the cloud and sometimes find that as many as 2/3 of their applications are incapable of being moved to the cloud in their current form. They want to rethink what they've got, but they don't really want to start over. That's daunting. We can use Blueprint, and we can use some of the new capabilities that we continue to add to be able to really target replacement in a way that moves these systems onto a cloud native platform, moves them into a thoroughly modern architecture and lets them both get it to the cloud, but also just run way more effectively and unlock the data that's buried in some of these applications that they just can't get to. So I think that this legacy transformation approach is one that you're going to see us doubling down on as we enter next year, and it is pretty exciting.

Relative to ramping up investment, we've kind of come to enjoy the reality of generating cash and spending our money perhaps more carefully than I might have done earlier in our career. So we're open to do more investments, but I really become a believer that candidly, when we really focused ourselves, we actually increased our growth rate and so we're going to be cautious about opening an aperture too broadly too fast. Though to be candid, there's big opportunities here. They're not going to go away in a year or 3. They're going to be here for quite some time.

[Jacob Roberge, analyst]

Yes, that's great to hear. And then, Alan, it sounds like you've been on the road meeting with a lot of clients recently. Can you maybe just give us a pulse on the market. Is that excitement all around Blueprint? Are you starting to see potentially more budget dollars actually flow into AI and automation as we get into potentially a more normalized budget environment?

[Alan Trefler, executive]

Yes. So customers are really hungry for automation. There's a lot of confusion out there. I mean you only have to read the press releases of the players of these spaces to realize how much noise there continues to be in these markets. And people are trying to figure out. So step back for a second, Pega, if you go back to my PegaWorld keynote, I talked about the 3 forms of AI that we see as transforming organization. And customers tell me what they were to make sense to them. But the noise of the market doesn't match this. I mean that we talk about statistical AI, how we use numbers and machine learning to figure out next best actions. If something that's been done for 15 years, it's something we've done for 15 years.

And it's enormously powerful, and it's not obviated by language models. It's lot of general intelligence, I think, is some cool ideas. But numbers matter and language models don't do so great with numbers. So that's the first form of AI, statistical. The second is what I would describe as AI features. And we've got several dozen of them. Customers will buy some from us. They'll buy some from the accelerators and the magic agents that you hear people marketing and putting out there. And that's fine. So our customers are building some themselves. And there is enthusiasm for those, but there's not the belief that those are fundamentally changing an organization's business.

The thing that we're most excited about is that Blueprint represents, and I think we are uniquely positioned here -- is this idea of AI transformation. The idea is that you use AI to better understand what your current applications are and then use AI to challenge a lot of the assumptions about how an app should be built and then to actually help execute that. We're advantaged that becomes a lot about Blueprint. But the reality is, is that Blueprint itself is not truly at the core. The core is the Pega architecture, the model-driven architecture that knows how to really automate with AI principles and with high levels of channel independents, that Blueprint just happens to perfectly fit into.

So I think that a lot of confusion about AI still, but more when customers see what we're able to do and when they put their hands on, like I talked about how many customers are touching this now, we got a really positive reaction.

[Kenneth Stillwell, executive]

Jake, 1 thing I'll add is just to say, as we check for everybody here. We've got a war in Eastern Europe that's been going on for 2.5 years. We have a conflict in the Middle East. It certainly doesn't look like it's going to end anytime in the next few months. We've got an election in 12 days, and we still don't have inflation in check. So I do think there is still nervousness in the market. That said, I think clients are committed to digital transformation. But I do think there are a lot of market events that are going to cause clients to still be a little bit timid in some of their bigger decisions. And so just a sanity check on that. There's a lot of stuff going on out there.

[Jacob Roberge, analyst]

Yes. That's helpful. Well, congrats again on the great results.

[Operator]

Your next question comes from the line of Rishi Jaluria with RBC.

[Rishi Jaluria, analyst]

And great to see continued momentum in the business. Maybe, Alan, I want to start with you. You talked about what you're doing on the agentic automation, Agentic AI side. Can you help us understand maybe what separates Pega and what you're doing that is truly agentic AI, whether that's tech or use cases and maybe how to it separated from some other large players that have been messaging around Agentic AI themselves, including Salesforce with the recent launch of Agentforce. Any color to help us really understand the differentiation there would be helpful. And then I've got a quick follow-up.

[Alan Trefler, executive]

Sure. Look, Pega and this is something that I think has been visible for a long time because it's part of how we thought about the problem. Believes that you really want to have definitions of how a business works, that it's important to be able to map the processes, where the data comes from, where it's going to end up and there are some people in the agentic world who say, just turn it all over to a language model, it's going to be so smart. It's going to figure everything out. It will be a chain of consciousness and come up with a magic answers. We think that may be true in some cases. And certainly, it's good for entertainment.

But whether our customers' businesses are going to want to run that way, I don't believe regulated businesses are going to be able to run that way. I think a lot of organizations stay comfort in using the AI to define the processes, which, for example, what Blueprint does, as opposed to just saying, "Hey, I'm going to call the agent, and it's going to figure it out", and I'm not going to be exactly sure how I would explain that, but they're pretty smart.

So we have what I would describe as a managed approach and the great news is this left the organization achieve great reliability. Because if you've got hundreds of thousands of people doing something, you turn that increasingly to automation, I think you want to know what they're doing.

And the workflow type approach that is at the heart of Pega fits that model going forward. Having said that, those workflows are intrinsically agentic they, in effect, make it so you know the steps, know how to do certain things and can apply the AI to fill gaps to figure out what field should go, figure out how to best answer or ask a question. And that's where we've married the agentic world with the workflow world in a way that I think fits perfectly. I believe customers are seeing that.

Quite a lot of the agents talk now to some of the early talk in AI in general where it candidly, I think, led to a lot of confusion. Having said that, we're all bought in. We've got agents for years. that are doing things like parsing and responding automatically to e-mails, to stimulate, to working as a chatbot. We just don't want to build the organization around the assumption that there are humans in the loop. We want to build around the work itself. What are the products that a company is offering, what are the services they're offering, how do we capture those in workflows. And then use people where needed, use the AI where need it, use the interfaces where needed and that is exactly what the center of architecture is, which I'm sure many have heard me talk about now for 3 years, 4 years.

[Rishi Jaluria, analyst]

Wonderful. That's really helpful. And then maybe for both Alan and Ken. If we think about maybe the Q4 outlook, now that we're a little bit over through recent to the quarter, how should we be thinking about the potential for budget flush? Ken, I know you outlined it as a tough comp from a strong Q4 last year. I think there are rumblings that Q4 budget flush this year could be even stronger, especially as some of those kind of earmarked AI dollars are put to work before the year-end. Can you maybe walk us through how we should be thinking about the potential for Q4 budget flush from here?

[Kenneth Stillwell, executive]

Well, so -- just 1 clarification there, Rishi. Last year, the reason why Q4 was stronger for us is that we actually had a lot of our business activity that just kind of delayed and slipped into the back end of the year, and that didn't happen this year. So just from the standpoint of Pega, we -- our difficult compare is really just a timing compare of the way to linearity, the way the shape of our growth linked last year versus the shape of the growth this year. In terms of the specific question you asked, and Alan can chime in, in his opinion, I don't put a lot of business comfort around decisions around whether people try to use up budget from one year or another year.

It happens I think that there is a potential. I've read some of the same articles that you have as well. But I don't think -- we're not running our business assuming that happens or doesn't happen. We have a very healthy pipeline, we have very strong engagement with our clients. And if clients then choose to use budget in Q4. Naturally, we'll get our fair share of that. But I don't think we have a strong modeling opinion about whether there's a flush or there is not a flush.

[Alan Trefler, executive]

Yes. I'm a little skeptical. I think there's a lot of CEOs out there. who have directed their procurement and IT arms to try to save money to be [ blunt ]. I mean let's face it, that mood is very prevalent if you take a look at what's going on. So I'm certainly not counting on any sort of flushing going on that's going to be meaningful.

[Operator]

Your next question comes from the line of Pinjalim Bora with JPMorgan.

[Pinjalim Bora, analyst]

Congrats on the quarter. Alan, earlier in the year, I think there was an assumption that we might see a material uptick in the Blueprints created so far in the year kind of going live in Q3. What have you seen in terms of some of the Blueprints going live? And are those go lives starting to impact some of the cloud numbers at this point?

[Alan Trefler, executive]

So I think that we've seen a couple go live. We still have a bunch more in progress. The Blueprint have candidly influenced every sale that I can see in terms of certainly in the last 6 to 8 weeks. We don't have a single sales guy who can't do a Blueprint with a client. And we've gone from -- a salesperson would try to have a bunch of meetings and then try to bring a solution consultant in to maybe the third or fourth meeting to do a client-specific demo. That whole engagement model is already meaningfully changed. And they now do the demo in the first meeting, almost always. And it's client-specific because that's what Blueprint gives you.

The effect this has on business is projects that were already underway, some of the Blueprint is coming in a little too light to really be able to help them. So the stuff that was going live in Q3. We'll see some meaningfully, I think, go live in Q4 and the first half of next year.

[Pinjalim Bora, analyst]

Got it. Okay. One for Ken. Maintenance ACV has declined all 3 quarters this year, which makes sense given the cloud trend. But I'm trying to understand how much of that is just because of mix shift to new bookings being cloud versus kind of on-premise customers making a concerted effort to migrate to cloud. Is that migration piece starting to take hold? Is that going to be even bigger piece in 2025?

[Kenneth Stillwell, executive]

Yes. So Pinjalim, not much we've had some migrations, but not a material amount of them. They will become bigger in 2025 and '26. So you're absolutely right there. Maintenance will continue to decline and probably at a steeper pace in terms of that maintenance decline. But the maintenance decline that will happen at Pega can happen in 2 ways. It could be that someone moves off of a -- historically moved off a perpetual license arrangement into a term license arrangement, which means that the proportion of what they do -- the business that they do with Pega is less maintenance and another one could be a migration to Pega Cloud.

So those are just to clarify, those are 2 ways maintenance could drop. But there haven't been -- we've got some momentum on migrations. We've had some through the year for sure, but it's not a material component of our incremental ACV growth. But you're going to -- to answer the second part of your question, maintenance is going to decline. No doubt about it and going to decline probably at a steeper pace than previous years.

[Operator]

Your next question comes from the line of Patrick Walravens with Citizens JMP.

[Austin Cole, analyst]

This is Austin Cole on for Pat Walravens. My question is about the reversal of the $2 billion verdict by the Virginia Court of Appeals last July. I just wanted to understand -- like to the extent that you can comment, does that have any effect on unlocking sales cycles that might have been tied up with some of your larger clients? And are you seeing any impact from that?

[Alan Trefler, executive]

So I do think that clients were happy to see that erroneous verdict got reversed. And so -- but what I'd tell you is I think that people, particularly of late, have been largely expecting that. That's why you can see a $2 billion change in market cap, right? I mean, that tells you that everybody has sort of discounted it. I think, as a drag on and on and went through the appeal process, discounted to a meaningful amount. Obviously, it had some positive impact. And I'll also tell you that these large buying organizations, all it takes is one group to sort of worry and they can slow things down. So I do think it's not -- it's going to sort of return us to a more traditional cycle, whereas we had, had to go through sort of more sometimes rounds of questions on occasion with this. So -- but yes, we're happy to see that we've gotten through that reversal stage. We've gotten now as we expected it.

[Kenneth Stillwell, executive]

Yes. I think just to add to that, 2022 was a very distracting year for our teams into '23 where just every -- many, many clients want to know what is this thing, what is happening? What's the next? I think once the actual audio was public on the appeal from the fall of 2023, enough clients heard that, that they kind of went, okay, we understand now the significant error as the appellate court called it, right, that happened. And then it was a waiting game to figure out where they landed in terms of the actual appeal.

So I do think incrementally over the last few years, things have gotten better from what was, quite frankly, a very difficult time in '22 because not only were clients hearing it, there was quite a lot of marketing done around the actual verdict as well against Pega. And so we had to really fight some things on multiple fronts. Now that the appellate court has clearly pointed out what we have said since May 9 of 2022, which was this was really just a series of errors that actually caused this. It certainly made those conversations much better, which made it easier for our sales teams, which make our sales teams to be able to spend more time selling. So there's certainly a win there in our favor.

[Operator]

Your next question comes from the line of Dan Ives with Wedbush Securities.

[Daniel Ives, analyst]

Are you -- so are you seeing now from a partner perspective, just even changes were more coming to you in terms of looking to partner, especially as you kind of go into this next phase of cloud?

[Alan Trefler, executive]

I think there's a lot of enthusiasm from the partners. We just had a couple of partner meetings and we do have partners very, very interested in figuring out how they can leverage Blueprint. We've actually had partners create, I think the number is more than 70 now Blueprints that we've loaded in for their use that are private to them that they can use with their customers to try to convince them that they've got some good extra IP to be able to add into it. And so that's actually very encouraging to see more than a dozen partners loading more than 70 Blueprints into our system.

[Kenneth Stillwell, executive]

I also think, Dan, just to point out one other thing. We -- our engagement with AWS and Google Cloud is really accelerating as well. I mean we view them both very, very strong and important partners for us as we continue to move to Pega Cloud, as we continue to accelerate our growth rate with Blueprint in the center of that and us really playing a much bigger role in digital transformation. So they are becoming much bigger kind of market partners for us as opposed to technical partners.

[Daniel Ives, analyst]

And thanks because that's exactly what I was getting to, like does this feel like with the hyperscalers with Blueprint now? And just with the overall strategy relative to even -- when I think where you guys were a year ago? Is it just so much more strategic discussions now when you think even from a hyperscaler in terms of those discussions?

[Kenneth Stillwell, executive]

Absolutely. I mean, not -- there's 2 reasons why there is that much more important. One, we've got $0.75 billion of engagement with our clients that are not on Pega Cloud. And naturally the hyperscalers care about that. And those clients that we have, by the way, are their clients as well. that's one, Dan. The second one is, as we continue to accelerate our growth, leveraging Blueprint, faster digital transformation, we're going to put those workloads on our partners -- on the hyperscaler partners that we have. So we're just in a whole different world of actually the opportunity for us mutually to target organizations where we have common customers. And so that for us is a very strategic differentiator, and we think we've led actually quite frankly to some of our growth this year and also will lead to growth in the future.

[Alan Trefler, executive]

And the work we've been doing to be able to help clients take out their legacy applications is of great interest to the hyperscalers because they are the customers who have gone buys who have made commitments. But a lot of the apps in those customers aren't able to move because God forbid, they're running on IBM mainframe or Lotus Notes. So I was just talking to a customer a little over yesterday about part of their Lotus Notes to stay. And they need to rethink and replace those. But that enables them now to rethink and replace them on the cloud, which is what our whole pitch is here with the legacy transformation that I was talking about.

[Operator]

Your next question comes from the line of Mark Schappel with Loop Capital Markets.

[Mark Schappel, analyst]

And nice job on the quarter. Ken, a question for you. In terms of momentum in the business this year, how much of that would you attribute to changes in the overall demand environment versus, say, the go-to-market changes that were made about a year or so ago?

[Kenneth Stillwell, executive]

I would attribute them to 2 things, honestly. And I don't think either of them are in the demand environment. I would attribute it to our selling transformation that we made. And quite frankly, Alan mentioned something that scarcity is a powerful tool to use for focus, right? And the fact that we actually really focused on driving the right people on the right works and the right level of density has really helped us a lot.

And the second one is, quite frankly, I think I wouldn't minimize the impact of the appeal and helping us with a much more positive engagement with our clients. I mean I think the reality is that was -- that certainly was not hurtful but right for the appeals actually get reversed. But I think it's largely the target work transformation, Mark. I think the market is pretty much the same as what it was a year ago.

[Alan Trefler, executive]

Yes. Honestly, I also think that the product portfolio we have when I think of what we've been able to put together in the last 12 to 18 months, I think it is candidly just more appealing and more effective gaining the interest of our clients. So I would agree, it's not the demand environment, which I think there's still a lot of [ downward ] outlook out there.

[Mark Schappel, analyst]

Great. And then as a follow-up, the September quarter is typically a strong federal period for the company. I was wondering if you could just talk about how the federal business performed this quarter. And maybe just a little bit on the impact of the new FedRAMP High, what the impact that's having on your business?

[Kenneth Stillwell, executive]

So FedRAMP High wouldn't have impacted our business at all because that requires pipeline time to build. And the U.S. public sector was not an outsized contributor to our growth. I mean it's a healthy business, but we -- our growth was not on the backs of a Q3 public sector in the U.S. deal. We -- I've mentioned this before, we don't see that type of a hockey stick in our business around 1 particular quarter in the public sector. It's active, but it's not something that drives our business in 1 quarter.

[Operator]

Your next question comes from the line of Blair Abernethy with Rosenblatt.

[Blair Abernethy, analyst]

Just a question on the product side for Blueprint. Alan, I'm just wondering, where do you see some of the features going for this -- for the Blueprint? What's the road map here? And is there a role or your -- the Everflow acquisition you made back in 2022, the process mining side of things? Just kind of wondering where you're going to take the product?

[Alan Trefler, executive]

Yes. So there is -- the imports the Blueprint are kind of what customers are already doing. We want to use the AI to figure out the best we can from documentation or other things we get about the customer. We've already implemented the ability to import BPMN. Our process mining capability can feed into that because it can actually generate the BPMN that we can then feed into Blueprint. So I do think there's really good alignment between the various piece parts all tied into this legacy transformation elements.

What you're going to see us focusing on going forward with both our '24 release and the work that we do early next year is a lot more work to make us beautifully compatible with clients' open architecture databases and what sometimes referred to as cloud native databases environments, which by the way, the hyperscalers love that sort of stuff. And we have things that are -- have been released or being released and are being built that will just continue to push on that between now and PegaWorld, which is a really big moment for us.

[Blair Abernethy, analyst]

Okay. Great. And just, Ken, just following on your question about vertical -- a couple of responses about the verticals. Any verticals in the third quarter if you'd call out as saying, hey, these were particularly stronger versus others that might have lagged your expectations?

[Kenneth Stillwell, executive]

No, nothing noticeable.

[Alan Trefler, executive]

Yes, it was a really good balance. It was -- I would say it was an unsexy quarter in terms of where we got our growth from. It was pretty much everywhere.

[Operator]

Your next question comes from the line of Patrick Walravens with Citizens JMP.

[Patrick Walravens, analyst]

I was just wondering, Alan, how has the competitive environment shifted for you guys over the last year or 2 with now that you have Blueprint and with everything that's going on in AI? And maybe in particular, when you compete against Salesforce, when do you win? And when do they win?

[Alan Trefler, executive]

So it will be interesting to see what happens with Salesforce given their recent announcements and the changes to their go-to market, I still think we've got a terrific message that says, hey, you might stick Salesforce at your front ended. But unless you want 100% of your business walked into Salesforce, which pretty -- I think, risky thing for a lot of businesses to take. You really need to be able to go across channels and go across back end. That center out message, which you've heard me talk about for a long time. I think that fits perfectly with our AI strategy, and I think customers are seeing it.

It's exciting for me to go visit a client and have them talk to me about Center-out and so I think we are quite advantaged in terms of our architecture. And in terms of the things that we've done literally for decades, coming together to be leveraged by AI. And that's why Blueprint is exciting. It's not a SKU. It's really, hey, this takes the entire Pega staff and reposition it in a way that's tremendously more dynamic, tremendously easier to implement. And I think it's going to open up lots of new opportunities. And that's what we're chasing with all of this. So I think we're really a slight advantage when it comes to an AI and an overall transformation story.

[Operator]

Ladies and gentlemen, that does conclude our question-and-answer session. And now I will turn the call back over to Alan Trefler for closing comments.

[Alan Trefler, executive]

Well, thank you, everybody, for listening. We're very excited about where we are and what we see going on. I think it's going to be an interesting end of the year, and we're going to work and set ourselves up for a terrific '25. Thank you very much, everyone.

[Operator]

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