Welcome to the Pega Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Kenneth Stillwell, CFO. Please go ahead, sir.
Thank you. Good evening, ladies and gentlemen, and welcome to Pegasystems Q2 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 Q2 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 31st, 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. With that, I'll turn the call over to Alan Trefler, Founder and CEO of Pegasystems.
Thank you, Ken, and thank you to everyone who's joined today's call. This year has turned out to be an extremely volatile business environment. Our clients face challenges related to the pandemic, labor shortages, the war in Europe. Everything is causing global disruptions. As well as, of course, rising inflation, high oil prices, supply chain challenges, economic insecurity, and most recently, currency exchange headwinds. Some of these trends actually make the need for our software even more pronounced. In fact, we believe Pega is uniquely suited to help enterprises manage through such uncertainty. However, it does impact the market. With the threat of recession looming, we've pivoted to lean more heavily on our build for change messaging. We've been updating our marketing and sales positioning, which you can see on pega.com.
In an environment where efficiency and productivity are paramount, our low-code software platform for AI-powered decisioning and workflow automation helps demanding enterprises work smarter, unify experiences, and adapt instantly so they can tackle what's next. At Pega, we're taking the volatility and macroeconomic environment seriously. We're making cost management as much of a priority for us as it is for our clients, with us having a focus on operational efficiency and limiting increases to our cost structure. We've taken steps to make sure we're staying close to our clients by removing some of the layers that have crept in over the last few years. By ensuring our talent is directly connected to clients, we believe will both improve outcomes and our long-term relationships.
At the same time, we continue to focus on innovation to ensure we're able to provide the most advanced technology platform for our clients' needs today and into tomorrow. Ken will talk about some of the financial impacts on our business in a few moments. Now in terms of some highlights, since we last spoke, we've continued to enhance our software and drive strategic partnerships to make it easier for clients to be productive and address their customers' needs with our market-leading Pega Infinity software. For example, we launched an updated component that makes it easy to embed Pega into Salesforce environments to further automate customer service workflow. Called Pega Process Extender for Salesforce, it's now available on the Salesforce AppExchange and allows organizations an easy way to drag and drop Pega Infinity workflow automation and AI-powered decisioning directly into existing Salesforce Lightning deployments.
This makes the whole experience operate within users' familiar Salesforce desktop, even as Pega drives the business logic and workflows. We're also very excited about the low-code app factory concept, where we're pleased to see our clients adopt our governed approach to low-code development. The goal is to have clients, you know, get the benefit of speed and collaboration capabilities of our development platform, while at the same time ensuring they're building apps that can evolve, scale, and deliver value well into the future. It's very important that there be governance capabilities because over the years, people have often tried to drop in little systems to do an improvement here and improvement there. Sophisticated organizations realize that that leads to just the next generation of technical debt, and they find themselves trying to rip out all the Lotus Notes apps or all the SharePoint apps.
By us having a governed approach, we can share best practices and make sure that the right capabilities are baked into every low-code project and have them all hang together with this Pega App Factory concept that brings business and IT together in support of organization-wide deployments. This is coupled with our Pega Process Fabric that makes distributed workflow applications tie together to create a single view of work that might be done for a specific purpose or that might be related to a specific customer relationship. The case study that Ford Motor Company presented at our recent PegaWorld is a great example of this approach. They've embraced best practices to deploy the Pega App Factory, which enables citizen developers to create applications while following governance guidelines with support from an IT coach.
Ford's created a center of excellence and shared platform teams have joined forces to deploy the App Factory apps while working with Pega to develop best practices and alleviate IT backlog. Now, another exciting development is that we've extended our cloud choice offering by expanding our multifaceted partnership with Google Cloud to help our joint customers accelerate their digital transformation. We've also made the Google Cloud environment available on Pega Cloud as a fully managed as-a-service offering. We acquired Everflow, an innovative process mining software company whose intuitive software will enable Pega clients to uncover and fix hidden process inefficiencies. These can often bog down organizations, and making them visible is key to improvement. Combined with Pega's market-leading AI-powered decisioning and workflow automation capabilities, this will evolve process mining beyond traditional static modeling to deliver real-time process optimization.
What we sometimes refer to as true hyperautomation on an enterprise scale that will improve operational efficiency and customer experiences. Finally, we continue to really receive industry recognition from leading analyst firms. In late May, Forrester named Pega a leader in the Forrester Wave for Real-Time Interaction Management. This is how you use AI to make decisions to provide a next best action to the customers of one of our clients. Out of 14 of the most significant players in this broad category, Pega received top scores in the current offering and strategy categories, and the highest score possible in 25 of 28 criteria, including the highest possible score in the market presence categories. Forrester said, quote, "Pega sets the gold standard for sophisticated enterprise deployments.
Its value-based approach and innovation track record earn Pega near perfect marks across our strategy criteria. I'm also really pleased that just today, Forrester released its core CRM solutions report, in which Pega receives the top score in the current offering category, as well as the highest score possible in 16 of 35 criteria. Out of four companies that were considered leaders, Pega received top scores in categories including CRM user productivity, assistance, guidance, next best action, digital sales, customer success, actionable insights, and omni-channel engagement. The report states, "Pegasystems offers exceptional automation and process management within its CRM. Pegasystems' vision is one of an autonomous CRM, where automation offloads repetitive work and AI assists users, increasing their efficiency and the customer experience. Pegasystems uses real-time customer context and journey data to anticipate customer needs and proactively, even preemptively engage.
Reference clients stated that Pega provided a quote, "one-stop shop for our frontline team," and praised the product's configurability. Really pleased to hear that sort of assessment. I'm also very proud of the work our team continues to do to ensure Pega is creating and maintaining a diverse and equitable culture. Most recently, we were recognized as a best place to work for disability inclusion, scoring the highest possible score of 100 on the Disability Equality Index, which is recognized as one of the most robust disability inclusion assessment tools. Very proud of this recognition for how Pega supports its people and communities by providing a safe and inclusive work environment. Congratulations to the many at Pega and around the world responsible for this recognition. Now, you may have noticed that we put out a second press release, and I'll just talk for a moment about it.
We've noted interest in our technology over the years. From organizations interested in leveraging our workflow capabilities to launch their own workflow-based applications into the market. To address this need, we today announced a new product called Pega Launchpad, a cloud-based low-code application development platform that will empower anyone to efficiently build and launch B2B software as a service application for commercialization. This is a long-term strategy that will be run as a separate commercialization unit, giving Pega new routes to market through an expanded third-party ecosystem and without requiring the involvement of our sales force. We'll be working with a select group of early adopters for the remainder of 2022 as we prepare to roll out more generally in 2023.
Once application providers are ready to bring new products to market, we'll work together through a revenue-sharing model that we expect. Now, I'm going to circle back to PegaWorld for a moment. I hope you were able to join PegaWorld in May. If you missed it live, I encourage you to watch the replays on pega.com, and there are terrific sessions available, especially the inspiring client stories told in their own words. Through our virtual PegaWorld events, we have been successful over the last several years. Nonetheless, I'm very excited to bring our live event in Las Vegas back in play next year as we get back to a more normal cadence of in-person meetings with clients and prospects. There's been a lot of change on that front.
I attended Davos this past May in person, was able to see many of our most senior client contacts in person. I mentioned a new briefing center being built on our last call. Some of you saw that on the Investor Day. It's now fully open and has been booked with client and prospect meetings and has gotten a great reception, and we're excited about the customers coming to visit us. In summary, we're operating in an environment of significant volatility, one that our software is uniquely suited to address, but one that obviously puts lots of pressure on lots of businesses. We continue to structure our business and evolve our software to both address the needs of our clients to maximize our ability to respond quickly to changes in the market.
Our transition to a subscription business and our loyal and stable client base are meaningful contributors to our ability to remain successful in today's business climate. We continue to be very excited about the significant opportunity in front of us and confident in our team to deliver on that opportunity. To provide more color on the financial results, let me turn it over to Ken Stillwell.
Thanks, Alan. To begin, a few reflections on our first half results and our outlook for the rest of the year. Pega Cloud mix and the strengthening of the U.S. dollar negatively impacted our reported revenue and earnings per share. As a result, I'll speak a little more about currency this call than usual. As the U.S. dollar gets stronger, our recurring annual contract value, ACV, and our backlog balance denominated in other currencies decreases in value when translated into U.S. dollars, and revenue from other countries becomes smaller as well. A very big highlight for the quarter is Pega Cloud. Pega Cloud continues to be extremely popular. As a result, the Pega Cloud mix was much higher than planned, impacting our reported revenue and our earnings per share. Pega Cloud mix in the first half of 2022 was the highest it's ever been.
For the first half of the year, Pega Cloud was 70% of new client commitments. We're focusing on operating leverage with an even greater amount of discipline to ensure our Rule of 40 target is achieved in 2024. As you review our financial results, you'll see that we've clearly been making progress on operating leverage, primarily by slowing overall headcount growth in 2022. Although our constant currency ACV growth was 19% in Q2, we expect economic headwinds and crosswinds to negatively impact ACV growth for the full year. During our subscription transition, the most important metric to measure our success continues to be growth in ACV. ACV grew 19% in constant currency and 14% as reported year over year to $1,028,000 million.
The strength of the U.S. dollar significantly impacted year-over-year ACV growth as reported from Q2 2021 to Q2 2022. The currency impact of that year-over-year strengthening of the dollar on our ACV was approximately $40 million, with the majority of that impact hitting in Q2 of 2022. In fact, the dollar strengthened so much that our recurring ACV balance decreased from Q1 2022 to Q2 2022 on an as-reported basis, solely due to the strengthening U.S. dollar. It's important when measuring our business to look at a longer time horizon than one quarter. We've said we focus on total ACV growth for a full year, and we're really 2022 cycle.
That said, to date, our team has demonstrated over our history that it can produce ACV growth during difficult and uncertain times. It's important to point out that we do see economic uncertainty, which could reduce incremental ACV growth in 2022, and we're managing the business accordingly. More on that later. Moving to backlog, we ended the quarter with $1,126 million of backlog. The strength of the U.S. dollar was approximately a $57 million impact on our total backlog balance when looking at year-over-year growth. Turning to revenue. Revenue for the first half of 2022 reached $651 million. Total subscription revenue reached $521 million. Subscription revenue is about 80% of our total revenue for the first half of 2022.
Pega Cloud revenue is our fastest grower and reached just under $184 million for the first half of 2022. Total revenue growth in the first half of 2022 does face a tough compare, as many of you are aware. You may recall that we recognized over $30 million of revenue from one large deal in the first half of 2021, and the Pega Cloud mix was 15 percentage points lower. Therefore, year-over-year revenue comparisons are not as meaningful for the first half of 2022 because of those two items. We are currently in the final phase of our subscription transition, which we expect to complete in 2023, with the financial results normalizing for the full year 2024. Our Q2 results, like our Q1 results, showed additional signs of improving operating leverage and management of cost.
Total gross margin was 72% for the first half of 2022. As I mentioned a few minutes ago, we plan to focus on cost management, ensuring that we reach the Rule of 40 target in 2024. Like all enterprise software companies, we're navigating through a high inflation environment, a global pandemic, a war in Europe, and growing concerns of a global recession. In the face of these challenges, we've continued to grow ACV at a respectable pace to date. However, given the significant and unpredictable macroeconomic factors that I just outlined, we're going to provide a little more clarity on our view for the second half of 2022. We believe ACV growth for the full year will slow to around 16% in constant currency, about 5% less than we had planned for the full year.
We want to make it clear this adjustment is to our 2022 outlook only. Moving to our revenue outlook. We see three key factors negatively impacting our revenue growth for the full year 2022. First, as we described in our investor session in June, our plan assumed Pega Cloud would represent a little more than half of our new client commitments in 2022. However, Pega Cloud has represented 70% of new client commitments in the first half of 2022. I know many of you will view this mix shift positively, but as we've said, a 20% or so increase in Pega Cloud could lower 2022 revenue by $80 million. A higher than expected Pega Cloud mix would also cause ACV growth and revenue growth to diverge in 2022.
That's because Pega Cloud revenue is recognized ratably, typically over the contract period, which approximates three years. Second, the strength of the U.S. dollar is expected to negatively impact our full-year revenue results. Third, we anticipate that the increasing economic uncertainty may lengthen sales cycles and push some deals into 2023. If ACV growth slows as a result of this dynamic to the 16%, as I mentioned in constant currency in 2022, that would have an impact on total revenue as well. In total, we believe these three factors taken together could negatively impact full year revenue by approximately $120 million-$130 million.
We do not expect a proportionate impact on earnings per share due to the cost-saving initiatives that I spoke about, where we expect to mitigate the revenue impact by over $100 million of that revenue shortfall by achieving significant cost savings. Naturally, there are a lot of moving parts in what I just said, which make it hard to forecast precisely. What are we doing to respond through all this? We will manage the business in a way to address the potential ACV growth slowdown and make up for more than half of the impact of our Pega Cloud mix shift, and that's. I think that's a pretty impressive statement that we're making, that we actually are going to end up being more efficient with the business based on the revenue and the ACV that we will achieve. Let me explain what I mean.
We don't need to grow the size of the organization at the pace that we have the last few years. We've added some pretty significant go-to-market capacity in 2020, 2021 and 2022, and we're going to focus the rest of 2022 on execution. We think this is the right time for us to reap the benefits of the significant investments we've made in hiring over the last few years. To remind everyone, we're targeting the Rule of 40 in 2024, and we will attempt to achieve the highest growth rate possible in getting the Rule of 40. Our business is resilient, and I remain confident in our ability to deliver on our long-term strategy to be the leader in digital transformation. Let me remind you of some of the reasons that I feel that way.
First, about 80% of our revenue is now subscription, thanks to our successful execution of the ongoing and near completion of the subscription transition. Our recurring revenue is supported by very high net retention rates. Second, if you look back to 2000, Pega has grown through every recession before, including some tough ones, and we've seen what clients stick with and what they invest in. Third, we serve the world's largest clients in core verticals such as financial services, insurance, healthcare, telecommunications, and government. In challenging economic times, unfortunately, small and medium-sized businesses are often the ones that struggle the most in the near term when compared to larger enterprises that have strong financial profiles to withstand short-term shocks. Last, our digital transformation solutions feature unique capabilities and provide benefits that are critical to our clients going through transformation.
Our core value proposition has proven important to our clients and has helped Pega to grow through uncertain economic times. In summary, we've built a resilient business and we will continue to provide best-in-class solutions to the world's largest clients, even during tougher times. Despite the uncertain global economic outlook, it's an exciting time in Pega's history. We're wrapping up our subscription transition that we started in late 2017, and we're entering our next phase of growth as a company. As we wrap up the transition in the next year or so, we're confident that we will exit the transition as a much stronger business with more predictable revenue and back to cash flow levels that are even in excess of what we achieved before the transition.
As a Rule of 40 company, we'll be capable of generating free cash flow each and every year because of the dependency and the reliability of the relationships that we have with our clients. Winning companies invest time and resources into reimagining their business models to unlock higher growth and greater profitability. The best companies successfully execute to make that imagination reality. Now, I'm really proud of the work our team and our over 6,000 employees have done over the last five years to transform Pega's business and unlock the company's potential. Thank you to everyone at Pega. As always, I'll be on the road and excited to see everyone face to face at a number of conferences over the next 45 days or so. I hope to get a chance to see many of you during the upcoming events.
One additional point, very excited to reiterate what Alan said, which is, can't wait to see everyone at PegaWorld live next year. It's been too long. With that, operator, please open the call for questions.
Thank you. Ladies and gentlemen, if you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. We'll pause for just a moment to allow everyone an opportunity to signal for question. We'll now take our first question from Rishi Jaluria from RBC. Your line is open. Please go ahead.
Oh, wonderful. Hey, Alan and Ken. Thanks so much for taking my question. Maybe a few here to clarify and then, you know, appreciate all the details, especially around, you know, FX and what you're seeing. Maybe I wanna start by talking about macro and a two-parter here. You know, number one, would love to know what are you assuming, Ken, when you're talking about getting to 16% ACV growth exiting the year? You know, are you assuming macro is stable with what you're seeing right now? Are you assuming some level of deterioration further from what we're seeing? Then maybe the second part of that, there's obviously a macro impact on numbers already, you know, four points of currency from Q1 to Q2 on the ACV side, some of your large cap peers that have already kind of reported and talked about macro-
Could you repeat your last, like, 10 seconds 'cause it got cut off?
You broke up a little bit, Rishi.
Oh, I apologize. Let me get off that. Okay. So yeah, I was just maybe just starting with the macro side, right? What do you see? What are you assuming in terms of further macro deterioration, or is it gonna be stable? And the second part, you know, given the detail we've seen on the ACV side and cost and currency as a result of, you know, macro that you've seen so far, can you maybe be a little bit more specific about how it's manifested itself, be that in longer sales cycles, smaller ACV lands, pushed out deals, anything like that? And then I've got a follow-up.
Sure. I'll take the first part of that and then Alan, you can add some color to that. We are not assuming that the market will stay exactly as we've seen in the first half. We are assuming that sales cycles will elongate from where they are, that the buying cycles will be tighter. We are assuming that as you get closer to the end of the year, that companies will be responding to cost management initiatives, some of which will help us because we can be a solution, some of which may put pressure on just general buying patterns. I wouldn't suggest that we think everything's gonna stay as it is now. We do see that there's some further decline in the economic landscape between now and the end of the year.
We're also not seeing this as an elongated product, but we don't, you know, we don't know what to expect through the end of the year as people start budgeting for next year. That's why we thought about, you know, providing a little bit more clarity around what we think is at risk, which is our ACV growth for the full year. One last point, that ACV growth declining from 21% - 16%, just to kind of give you directionally what that means. It kinda means that our incremental ACV growth year-over-year in dollars would be somewhat flat year-over-year. Meaning the growth in incremental ACV dollars would be relatively consistent with what we grew in 2021.
Still growth, but as you can imagine, growth on a bigger number is a slightly smaller percentage. That's kind of how we see it manifesting itself through the year. Alan, thoughts on some of the discussions that he mentioned about customer buying.
Yeah. I think Ken's right. There is some elongation of sales cycle. Also I think a lot of this, the impact, I believe, is and will continue to be significantly related to the companies you're dealing with and the types of companies you're dealing with. You know, the large, sophisticated traditional buyers that for many years were our only buyers, and let us grow at you know a 20% ACV growth rate, I think that those are much less susceptible to the many pressures and a willingness to go forward than companies you'd think of as mid-size or certainly smaller ones.
We have an opportunity, and we are recalibrating our energies to really focus on those deep and really important relationships with organizations who, based on everything I've seen, are going to be looking to themselves to save money, improve their workflows, continue to invest. I think that focus makes it easier for us to operate within some of the spend envelopes that Ken was talking about, which we're taking very, very seriously, more than frankly, when we were trying to really jump up our growth rate to some degree regardless of cost. We're not in that business for the second half of this year and going forward because, you know, frankly, I think the market will respond to exactly what we're doing. We have a big chance to influence what happens. We're not just subject to what's going on in the macro environment.
All right. Great. That's really helpful. On the business, maybe I wanted to drill specifically into Cloud cRPO. We saw that decelerate from 31% growth in Q1 to 14% in Q2. You know, even if we add back in six points of FX, that still gets us from a decel of 31 %- 20%. Maybe can you walk us through what's going on specifically on Cloud cRPO and maybe why we shouldn't be worried about that too much as a leading indicator of future cloud growth slowing down. One more follow-up, and I promise that's it.
Sure. The one thing that we are seeing, and we've seen it probably for a couple quarters, but I think we're starting to realize that clients really are transitioning into leaning more towards consumption-based buying patterns, right? Which means that, you know, they're looking at like, kind of almost Rishi, like a minimum commit with variable usage as they drive additional usage. What that does lead to is it does lead to the net effect of that is a slight decline in the duration of our cloud RPO. Just a slight, not like going from, say, three years to maybe 2.75. Some of the optics of RPO is driven by that.
You can kinda see that if you look over the last few quarters. Also to add to that, we in 2022, the first half of the year was not a big renewal year, right? In terms of Pega Cloud contract renewals, then it tends to be toward the back end of the year in general. Every once in a while you'll have a quarter where you may have a few clients. Those two factors, I think, make the optics look a little bit confusing to your question. Some of it is just buying patterns. Clients are not committing necessarily to three or five year contracts all the time.
They might be committing to a three-year contract with a slightly lower minimum and then having consumption buying patterns above that. That results in less going into RPO in some of those contracts, if you follow me.
Got it. Helpful. Last one, just on cloud gross margin. Obviously been on a nice upward trajectory for the past, really two years. This is the first time we've seen it decline like this sequentially, you know, in a meaningful way on the Q2, right? Going from 70% to about, you know, a little bit up to 77%. I guess, was that FX or were there other factors that led to cloud gross margin declining sequentially? How should we think about that going forward? Thank you.
That's a great question. That's because the majority of our costs for Pega Cloud are in the U.S., in U.S. dollars. You have more currency impact on the top line than you do on the bottom line. In a lot of the other aspects of our business, we have natural hedges because we have the cost in the currency where the dollars are. Our costs are more skewed to the U.S. because our AWS contract is in U.S. dollars.
Got it. That's really helpful. All right. Thank you so much, guys.
Yep.
We'll take our next question from Steve Koenig from SMBC Nikko. Your line is open. Please go ahead.
Hey guys, thanks for taking my questions. I'll stick to one question and one follow-up here. I wanted to, by the way, congratulate you on the Forrester evaluation. Sounds like a great validation of your technology leadership. First question is on the financial side. Couple of moving parts here. Maybe it relates to your prior answer, but on Pega Cloud revenue, you know, the sequential revenue growth in cloud was very light and so I'm wondering if you can square that with a higher cloud mix.
You know, maybe also related to that more broadly, RPO bookings were down pretty hard year on year, and I'm wondering, like, how much of that was, you know, a surprise in terms of weakness in new client commitments relative to your internal expectations, and how much of that was a lighter renewal schedule, if you could just parse that out. Just one follow-up for Alan. Thanks.
Yeah. Q2 was a very light renewal schedule, and Pega Cloud, the mix of Pega Cloud was impacted by currency by approximately the same as our overall revenue. So the mix of revenue by geography isn't exact, but directionally close to our overall revenue in terms of the currency impact. Yeah, RPO, currency impact on RPO for a lower renewal quarter in Q2 in the first half, but also our net ACV growth in Q2 was not as strong as well. So the combination of net, you know, our ACV growth in Q2 was not as strong as Q1. Not a big renewal quarter plus currency. That's kind of what's happening in RPO.
Okay. Sounds good. Thanks for the color. Maybe we'll follow up a little bit more on the callback. Alan, Pega Launchpad. That's really interesting, and I know you've been working on a lot of this stuff for some time as part of the Phoenix initiative. I'm wondering if you could give us some color on what you know what are kind of the milestones, both maybe technically and business-wise, on establishing a vibrant third party marketplace? You know, any thoughts on monetization? Does Pega pricing need to become more transparent? Are there any early alpha customers or partners you can talk about? Thanks very much. That concludes my questions.
Sure. We have been working on a lot of these pieces for some time as part of the Phoenix initiative , you know, which obviously feeds a lot of the technology that we bring forward and bring to market here. You know, Pega Launchpad concept is that we know that there are organizations that themselves want to develop IP, bring it to market, that have sort of a workflow flavor to them. To be candid, the platforms that we saw out there were not remotely well suited to being able to do that, you know, we thought, and we've talked to a number of people and companies about that. We wanted to begin having discussions on this and thought the best way to do that was to just publicly say, "Yep, we got this.
We're gonna begin talking with early adopters." I'll be able to answer those questions with much greater clarity and specificity, after we're another 90 or 120 days into this. I'm gonna take a little pass on that, but it's not for lack of enthusiasm. I think.
Mm-hmm
It's a very exciting place to be.
Great. Thanks, guys.
We will now take the next question from Pinjalim Bora from JP Morgan. Your line is open. Please go ahead.
Hi, this is Noah on for Pinjalim Bora. Thank you for taking the question. Can you explain what you're seeing in terms of demand from public sector customers and just any color on the rate of new IT engagements within public sector would be helpful? Thanks.
Yeah, I can talk to that. I think that, you know, public sector has been pretty shaken by the pandemic, and a lot of the solutions that have gone into public sector to just make them work, particularly at some of the large organizations, governmental organizations we do business with, you know, are widely seen to be, you know, scotch tape and bailing wire. There is a, I think, a healthy appetite in large agencies to continue and even accelerate the workflow automation that we already do for a number of them, going forward. I think the demand in public sector will continue to be strong. Having said that, as we all know, public sector is not a place that tends to buy rapidly, and they tend to wanna buy very much on a consumption style basis.
You don't get the, you know, the big multi-year deals with lots of things sort of on the come based on expectations. It really is a line of business that I describe it as sort of building an engine of success. That as you go and as you develop greater confidence and a greater footprint, it builds on itself. But the market opportunity there is huge. We are very much going to focus on what I would describe as federal and large states here. I think that plays to our strength and that also plays to the people who'll be buying.
Thank you.
We will now take the next question from Vinod Srinivas from Barclays. Your line is open. Please go ahead.
Alan, Ken, thanks for taking my questions. I just want to, maybe look to the past a little bit, talk about buying patterns going into, you know, the COVID period and, you know, the second quarter of 2020. Just wanna get a sense of, you know, are things kinda similar to right now versus back then? Kind of at what point did you see sales cycles improve and customers reengage more meaningfully then? Are you seeing any early signals of that where maybe a similar pattern might play out? Thanks.
I can start on that one because I unfortunately remember those days well. I think that the difference between Q2 of 2020 and Q2 of 2022 is noticeable because of the following. When we were in Q2 of 2020, we didn't know what the future looked like. I think there was a question about was this gonna be like the shutdown of world economies. Remember, people couldn't get food and paper towels and toilet paper. I mean, it was we were scrambling. We didn't know how long it was gonna be. I think there was a lot of angst about just what was this thing we were dealing with.
I think the level of uncertainty and confusion and stress was high. I remember looking at the unemployment increase, excuse me, of, you know, I don't know what, whatever it was, like, you know, X million people that went into that filed claims in one week. In today's environment, what I see is people more going through a typical economic reset, right? They're saying, "We know what's coming. We gotta manage our budgets. We need to slow hiring. We need to think about projects that will help us optimize our business." You know, they this happens, you know, every, whatever, you know, five to 10 years, whatever the recession cycle happens to be.
I don't view it as being comparative to Q2 because of the level of just general mass confusion in the market that happened for a few months in the middle of 2020. That's my perspective. I think this is much more. I do feel like people know what's coming. They may not know how bad it's gonna be or how long it's gonna last, but we've been through recessions before. I kinda that's my perspective. Alan?
Yeah, I would agree that the atmosphere back then was much more of, you know, confusion, who knows what's gonna be, how long it's gonna be for, will we be able to, you know, get the right staff, support the business at all. There were little bursts of, "Oh my god, we've gotta automate something," but there was an insanity to it that people said, "I've gotta do it in 10 days or a week." By the way, we delivered some pretty amazing systems in that time to support things like the paycheck, you know, the Paycheck Protection App. I was just talking to one of our very large banking customers who said that they'll never forget what they were able to do in a week with our system when they were just trying to hold on there.
The time now is just a lot more rational, right? People expect the dimensions are gonna fall into or just how long is it gonna be tight. People extremely interested in, you know, the low-code piece is very, very valuable because people are extremely interested in being able to continue to run their systems without necessarily the same, frankly, depth of engineering talent that some of those end companies have been able to depend on or in some cases now even afford, depending on what's happening with cost. I would describe this as a much more, frankly reassuring time than if you go back to the point where every week was a new terror.
Got it. I appreciate some of the color on that. Then just one follow-up for me. Can you maybe speak to just kind of the sales execution during the quarter, how you kind of feel about that? Also, are you seeing any customers ask for like more, you know, pricing concessions or more flexible payment terms given kind of the macro environment? Thank you.
I'll just answer the second one first. Our bread and butter customers are the ones that we're particularly focused on going forward are not the ones who need payment concessions, you know, candidly. You know, people always like to ask for things, but they're just not. That's not the part of the market that we're you know going to focus on and go through. From the sales execution point of view, you know, as I think a lot of you know, we've undergone a lot of change from a go-to-market management perspective. A lot of that change happened during Q2. We're right in the middle of it all. I'm sure that didn't help us getting things together.
I believe we're now largely through what I'll describe as, you know, the phase one of change management, which is understanding what we wanna do from a structure and a, you know, a positioning point of view, et cetera. We still have a lot of work to do, as we go through the next couple of quarters. You know, the reset, I would say, of our business to being a cost-effective grower, really worrying about cost, et cetera, that has, I think, taken a hold in the psyche of the organization as a whole and in the go-to-market organization. Now I believe we have a plan that we can execute on, a strategy that makes enormous sense, you know, based on having done this for a long time.
We know that there is the demand there in our customers. There's no doubt that customers appreciate, particularly the ones we're talking about, the way our software can really uniquely help them deal with, you know, their own pressures and their own confusion. You know, I'm feeling good about that. Obviously, the first half of this year was pretty volatile. I mean, we know, you know that there were some management changes that were quite significant that happened. You know, all of that happened in the last five months. You know, unquestionably, that would have some impact on Q2. By the way, we're not happy with what the outcomes were. You know, we're committed to changing it and, you know, we're not happy that 16% is a good number going forward.
It just might be the, you know, realistic one to think in terms of for where we are this year.
I'll add one piece of color. Clients I have not seen. I see a lot of the client interactions, as you might imagine. I don't see clients deciding to try to get the same amount of value out of Pega for a lower amount. I do see clients trying to manage you know, cost increases as a result of inflation, right? Like naturally, CPI is a much higher number and, you know, and there's an expectation in the market that technology companies will receive some increase in the annual spend, and that clients are more focusing on trying to manage that, as we are trying to manage that as well, because we expect to get, you know, increases to help offset our cost increases of our team members, et cetera. That, I think is a focus area, but not general spend reduction. That's not something we've seen.
Thanks. Appreciate the detail.
Yep.
We will now take the next questions from Kevin Kumar from Goldman Sachs. Your line is open. Please go ahead.
Hi, thanks for taking my question. Alan, given the macro environment, are there any changes in the types of use cases across the customer base, whether that's customer engagement or customer service, other areas of automation? Curious where you're seeing the most appetite.
Yeah. In the real-time interaction management space, which is, you know, think of that as AI-powered decisioning, there's, when the economy goes through the sort of change we've seen in the last 90 days, we shift our emphasis from cross-sell, upsell to retention. You know, we have and we do a lot of very, I think, effective work in the areas of retention. Certain use cases, sometimes referred to as compassionate, hopefully, collections, which is where you try to figure out how to be the smartest about, you know, if you're a business getting paid. Those are examples of use cases that accompany the sort of recessionary push that once again, we've seen before. We see the same thing happening now. Those discussions get a lot of attention as well.
On the workflow space, you know, automation and transparency, being able to handle a workforce that's distributed and not likely to ever come together again, but you wanna be able to manage them. Those, once again, are the apps, what we sometimes refer to, and you'll hear us talking more and more about what we call the process fabric as a way to weave an organization together. Those are the types of use cases that go with these times. You know, the thing I'll say about all of those is those systems tend to be pretty big systems when it, you know, not all at once necessarily, but over time, those become very, very meaningful.
That's helpful. Thank you. As you integrate the Everflow Acquisition, how has customer traction been there and how should we think about ACV uplift on deals where process mining is used?
I think process mining is primarily a vehicle to be able to make the customer more effective at deploying your software. I think that more than a, you know, very significant increase in ACV on the deal, I think you will see an acceleration of consumption and use, and that leads to, you know, in effect, larger parts of the business being in a position to cost justify and rationalize the purchase. I view it as contributing to ACV more by helping promote volume than by kicking the prices up 20%, right? It's discovering the opportunity and optimizing the opportunity, which lets you go bigger, particularly in these big companies.
Just to clarify, just to make sure that's crystal clear, we are not in the business of selling user-based licenses as our exclusive go-to-market, where you keep price upticking every single feature function. What Alan's talking about is clients get more value by putting more automated transactions through our system, and that's the way the ACV goes up because they're paying on kind of a, quote, "consumption-type model." That's kind of the connection there, just to make sure that's clear.
Yeah. Per user pricing, we think in this world is sort of an anachronism because everybody wants to move to one form or another of non-user activity, right? Whether it's customers doing work themselves, whether it's parts of the system landscape actually doing fully autonomous work, you know, that sort of hyperautomation. Our standard approaches tend to talk about, you know, how many units of work get done by the customer, and that's where process mining can accelerate as opposed to like, you know, a more user model. I know some other people do, but I don't think that's a very forward-looking model for companies that do automation.
That's helpful. Thank you for taking my questions.
We will now take the next questions from Joe Meares from Truist. Your line is open. Please go ahead.
Hey, guys. Thanks for taking my questions. The first question, I apologize if you'd already said this in the prepared remarks, but could you just give us some clarity on, you know, the cost initiatives that you're talking about? I think you said it would be more than half of the decline caused by the Pega Cloud, but could you just clarify that?
Yeah, sure. I know the wording is tough sometimes to get through clearly. We anticipate that the combination of the three factors, Pega Cloud mix, currency, which is the smallest of the three, and the impact of our ACV target, will reduce revenue from where we kind of initially thought it would be by about $120 million-$130 million. You might say, "Oh, well, that means there's an impact to EPS by that same amount." No, to the contrary, we're actually maintaining. We believe we have the staff that we need to get through 2022, and quite frankly, to hit our 2023 objectives as well.
That efficiency that we would get by maintaining our cost structure consistent with where we are now will get us over $100 million of that $120 million-$130 million of revenue decline. We won't get all the way there. We might, but we're not signaling that we think we can get all the way there, but we will get, you know, almost all the way there. What I was saying, Joe, was I was saying, we'll make up the ACV drop, we'll make up the currency, and we'll get more than half of the way there on the cloud mix. That's the. All of those three add up to over $100 million of mitigation.
That's perfect. Super helpful, Ken. Thanks. I appreciate it.
Yep.
Just as a follow-up. Last quarter, you spoke about several new products, including enhancements to the Pega Customer Decision Hub and Voice AI and messaging solutions for customer service. Just curious if you have any early customer feedback on those, any positive stuff you can point to there. Thanks so much for taking the questions.
Yeah. You know, we continue to get just excellent feedback on the Customer Decision Hub. You know, that's the Real-Time Interaction Management piece that I was talking about that Forrester just lauded. You know, that continues, I would say, to be by far the industry-leading product in that segment. The new capabilities are in use and being, I think, being widely enjoyed. The Voice AI is rolling out slowly. We've got some pilot work that we've been doing. I think it's enormously exciting. To be candid, I think that a lot of organizations are just trying to stabilize that part of their business. They're if things get a little more normal, I think that's going to pick up.
You know, right now, there's just an enormous amount of what I describe as contact center exhaustion, where people who are running those things are just trying to deal with making sure they've got the staff and that they're able to just keep them running. That's probably going a little slower than I'd like, but, you know, that was never gonna be a big part of a number of hours for this year.
Thanks again.
We will now take the next question from Mark Schappel from Loop Capital. Your line is open. Please go ahead.
Hi. Thanks for taking my question. Ken, starting with you. With respect to the macro, just to be clear here, are you saying you're seeing lengthening sales cycles and project delays in your business today, or are you just trying to get ahead of the curve with your comments?
Great question. I would say I'm seeing a little bit of lengthening sales cycles, but nothing, I would say, material to lead me to an absolute conclusion. I'm more trying to get ahead of where I think the market will be for the rest of the year.
Okay, great. You know, with respect to the sales cycles, are you seeing that in any particular geography more so than others?
Europe. I can let Alan speak too, but certainly Europe is much closer to the front lines of the conflict in Ukraine, Russia, and they are seeing things like energy, resources, food. They are much more disrupted than certainly the United States is and even APJ. Personally, I think Europe is, you know, in a tough place right now.
Okay, great. Thanks.
Yeah. I think customer mood.
Alan
Go ahead.
Go ahead.
I'm just gonna say customer mood in some of those countries, just harder to get their attention.
No, I understand. Alan, final question here, and it's around Launchpad. I believe in your prepared remarks you mentioned that the product would be run as a separate commercialization effort. I was wondering if you could just go into a little bit more details of what exactly that means.
Well, it means that we're able to take a couple of very entrepreneurial people who we already had on staff, and we're going to create a largely virtual team, but we're not gonna commingle that at all with the current go-to-market and the current messaging. You know, we see that as a separate product, using experience, obviously, that we've had for many, many years to inform it, that we'll go to market through a separate channel. Partner-sold channels, sold by actual organizations that have the IP that they want to sell. I'm really, really looking to insulate the core business from any sort of disruption so we can really focus on doing as well as we collectively can do this year.
Great. Thank you. We will take the next question from Joseph Marincek from JMP Securities. Your line is open. Please go ahead.
Hi, team. Thanks so much for the question. Alan, would love to hear more about Google Cloud. I know it's early, but how's that partnership progressing thus far, and maybe what are your early learnings? One for Ken. Can you give us an update on net retention? How's that metric trended, and maybe how's your thinking about it on a go-forward basis? Thank you so much.
Sure. The Google relationship, I would say, is terrific. You know, we work with them, and we've been able to work with them to, you know, stand up this capability. I think you know, just being able to offer customers the ability to use Amazon credits or Google credits, up that they may have committed to also, I think, get customers excited. That relationship is deep and, very, very positive and, you know, I'm also pleased to say that Google is a client, which is wonderful when a company like that decides that they wanna use your stuff internally. That, I believe, is gonna work out very, very well. You know, Amazon has been a terrific partner and we love working with them also.
The reality is, as they move into, say, the medical field, as they recently have done, in a greater quantity, and as they've obviously been deep into retail, that means that certain of the very large clients that we want to sell to have well less attraction to using them as a platform. It doesn't actually impact. It's not even visible to a customer whether they're running, you know, Pega Cloud on Amazon or on Google. Some companies have their own standards and their objectives in that regard. Now we're just in a position to give that extra dimension of client choice, which is always good. Ken, you wanna talk about-
Yeah. On net retention, that's a really good finish to the questions because it's one that we haven't really touched on. Directionally, I've always talked about if we have 20% ACV growth, that 15% of that 20 would be with existing clients, and the other 5% would be net new logos. That is a directional number, but that is not far off. When you think about us, our ACV growth declining by some percentage, the majority of that decline would be our expectation of getting ACV from net new logos, right? I think our net retention number is not going to decline much if our overall ACV declines because that is our bread and butter. That is actually where we're gonna put our capacity. That's where we've always got the majority of our bookings.
Our focus is gonna be really heavy there, especially in any type of a less than certain economic environment. You should always stay close to your clients because they're going to deepen their relationship with existing vendors. That is just the trend. I think our net retention rate will hold pretty steady to what it's historically been. Maybe, maybe it might drop by 1% or so, but not much. What will happen is we will probably, you know, just being pragmatic, we will chase new logos less.
Super helpful. Thank you both.
With that, I think we're at time. I'd like to thank all the folks who participated or listened to the call. You should know that we're working very hard. We're taking the needs of our shareholders very seriously. I'm hopeful that we'll be able to report some good things in a quarter. Thank you very much.
This concludes today's call. Thank you for your participation. You may now disconnect.