Good day, and welcome to the Pegasystems third quarter 2021 earnings results conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Pegasystems COO and CFO, Mr. Ken Stillwell. Please go ahead, sir.
Thank you. Good evening, ladies and gentlemen, and welcome to Pegasystems Q3 2021 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, very, 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 of the statement was made and are based on current expectations and assumptions. Because such statements deal with future events, they are subject to various risks and uncertainties. Actual results for fiscal year 2021 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 2021 earnings and in the company's filings with the Securities and Exchange Commission, including its annual report on Form 10-K for the year ended December 31, 2020, 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 will turn the call over to Alan Trefler, Founder and CEO of Pegasystems.
Thanks, Ken. I'd like to say that I'm really pleased with our results here today, and we continue to see strong adoption of our low-code digital transformation technology. Through Q3, our total Annual Contract Value or ACV, which we think is the best indicator of our performance, increased by 22% year-over-year, and our subscription revenue grew 32% year-over-year. The benefits of our recurring revenue model are increasingly visible, and we're happy with our progress. Now to provide an update on the pandemic and some industry trends. Though the status of the pandemic still varies region to region, we are seeing the global economy recovering, and there are positive signs that the worst is behind us. The demand for digital transformation solutions continues to be strong and is expected to be one of the fastest-growing enterprise software markets in coming years.
The IDC reports that the market for digital transformation software is growing globally at about 19% CAGR and is expected to reach $619 billion by 2024. We believe we're in a great position to benefit from the growth in this market. Driven in large parts by the challenges in the last 18+ months, organizations know they must adapt to today's needs while preparing for inevitable additional changes that will come tomorrow. That's where Pega comes in. In an unpredictable world, we help our clients crush business complexity, so they can work smarter, simpler, and faster. Our tagline, build for change, is as relevant as ever, given the imperative that organizations establish a technology and a business architecture that empowers them to adapt and thrive in constantly changing markets.
The Customer Decision Hub, our real-time decisioning engine, helps customers predict their customers' needs, personalize interactions, and deliver across channels to deepen relationships and maximize value. Our customer service solutions leverage automation and AI, so reps can handle any engagement quickly and effectively, ensuring customers get what they need. Our intelligent automation solutions boost efficiency by streamlining any process, often the most business-critical, sophisticated workflows that require a high degree of intelligence and automation. We continue to benefit from offering our customers Cloud Choice, which we pioneered in 2017. Offering cloud alternatives plays perfectly to where we see the future going. Historically, organizations have thought of and implemented cloud as a collection of islands, and that's fine for many types of cloud usage. However, Pega is often used as a strategic backbone for an organization.
In those cases, clients will often wanna weave Pega into and across their existing cloud infrastructure. That's what Cloud Choice does. It lets Pega become part of their fabric, part of a client's strategic future, improving their effectiveness and fostering a longer-term commitment to Pega. It's going to recommend that CIOs are aggressively skilling up on cloud capabilities. This makes our cloud solutions more effective, whether we're operating them or the client is. It's good news for us and our clients because we support both options. Regardless of how our clients deploy, they benefit from the same industry-leading software and all that comes with it. A center-out approach that puts the outcomes they are achieving at the center of their solution. Design thinking that brings people and technology together to design and deploy innovative solution in weeks or even days.
The industry's only low-code platform built with a prescriptive approach through business and IT collaboration. We're proud of how central our software is to the strategic operations of our clients, many of the most recognized and successful brands on the planet. We're most successful when we engage with the senior leaders in these large enterprises, where the focus is on strategic big bet initiatives that are crucial to their success. That means the commitment on both sides can be very significant. Once clients experience the value we bring, we have tremendous opportunity to deepen and expand those relationships. For example, on the commercial side of our business, in this last quarter, we expanded our footprint with three of the world's largest telecommunications companies, three of the world's largest financial services companies, and three of the world's largest healthcare companies.
Just this past week, our client, Lloyds Banking Group, won a Digital Transformation of the Year award for the work that they're doing with Pega. It really gives their employees and their customers the best experience at key moments of truth. I'm very proud of the work that we're doing together. Additionally, the government sector continues to drive significant business, and we increased our presence in government clients in every region around the world. Government leaders know that the next few years are gonna be challenging, and that the flood of service and program needs that we have experienced over the past year and a half will continue. They know they have to deliver a wide portfolio of critical services, and yet outdated systems, inefficient processes, and disconnected channels can slow down that service and make it hard to keep pace with needs and changes.
We help government clients go live quickly and drive amazing outcomes, whether it's starting with one small critical application like we rolled out for the state of Bavaria, which by the way, has led to new opportunities across EMEA, or at massive scale, like at the U.S. Census. We've been wildly successful with our government clients over recent years who find the platform is built for change, sophistication, and scale. By the way, our outstanding work for the Census is now documented in a recent video available on pega.com, highlighting success. As Michael Thieme, the Assistant Director for Decennial Census Programs, Systems and Contracts, U.S. Census Bureau, said, quote, "Everything worked as it was supposed to. It was smooth. I would almost call it historically smooth." Not just in this continent.
In Australia, our software is being used by the Department of Home Affairs to develop what they call their permissions capability platform as part of an overhaul of their visa processing system. They wanted an integrated enterprise scale workflow system capable of being used across the government. They expect to roll out new digital incoming passenger cards, which will include vaccination status to airports around the country by the end of the year, paving the way for border reopening. In the U.K., our software is being used by the Royal Navy and Royal Air Force to develop new end-to-end recruiting platforms. The goal is to provide a better digital experience for the 180,000 annual potential candidates and help reduce recruitment cycles.
Now, as we emerge from the pandemic, we are gauging our clients' and partners' comfort level in meeting in person, and we're gradually bringing back in-person events and getting our selling teams back on the road where we can. We continue to raise our visibility among our key clients and prospects with targeted selling and marketing approaches. For example, you may have seen that we sponsored the Ryder Cup this year, a new initiative for us to increase our visibility, and it provided an excellent opportunity to connect with some of our most senior and strategic clients and partners. We just held our inaugural Executive Partner Advisory Council meeting with senior contacts from some of our most strategic partner organizations who have broad and deep established relationships with many of our clients. We're excited to be able to hold this meeting in person.
Our new streamlined partner program that was rolled out this summer is being well-received, and we will continue to focus on deepening these relationships to make it easier for partners to engage with us in joint solution development, co-selling, and client referrals. As a result, we're seeing increases in partner engagement and partner source business, and we have plenty of opportunity to fully leverage, we think, a strong and growing partner network and feel very positive about the overall direction of momentum. In summary, I'm pleased with how we're executing on our strategy and how it's reflected in our results through Q3. We continue to make excellent progress on our transition to a recurring revenue model. Our clients recognize the need for digital transformation solutions that can solve both their short-term challenges and long-term strategic needs.
We feel we are uniquely available and able to help them. We continue to focus our strategic investments to leverage this great opportunity while thoughtfully managing margins. To provide more color on these results, I'll now turn it over to Stillwell. Take it away, Ken.
Thanks, Alan. Q3 was another strong quarter following on the heels of what was a very strong Q2. When it comes to our most important metric that we measure as our business success, ACV continues to be the most important metric, and that's the growth in our annual contract value. In fact, if you look at the combined Q2 and Q3 of 2021, we added an impressive net new ACV gain of $95 million, an increase of 45% year-over-year. What's really nice is to see such strong momentum through what is traditionally a slower ACV growth period for Pega, which is the middle of the year, the Q2 and the Q3 time period.
As you know, in late 2017, we started a multiyear cloud transition, moving from a company that primarily sold perpetual licenses to a company whose go-to-market motion is focused on selling subscription. Today, almost all of our new client commitments are cloud choice. These clients are either subscribing to Pega Cloud, a cloud deployment that Pega manages or Client-managed cloud, a cloud deployment that our clients manage on the cloud of their choice. As a result, our total software revenue mix has shifted to SaaS to subscription. In fact, through the first nine- months of 2021, more than 97% of our software revenue is in fact subscription. Pega remade itself as a subscription software company over the last few years, a significant achievement that we're very proud of at Pega.
During our transition to the subscription model, there are two metrics that properly measure our success. The first and most important metric is growth in ACV, as I mentioned earlier, which represents the annualized value of our active client contracts as of the measurement date. In Q3, ACV grew 22% as reported and 21% in constant currency from a year ago. Since ACV growth had dipped below 20% constant currency earlier in 2021, I'm really excited to see total constant currency ACV growth accelerate back above 20% in Q3. One thing to clarify with our ACV growth is that it came about a little differently this quarter with a higher Client-managed cloud mix than in recent quarters.
We're not entirely surprised by this mix, as we've seen our clients become increasingly sophisticated in adopting and managing their own cloud environments for their most mission-critical, tightly integrated applications. We believe increasing adoption of Client-managed cloud reflects this dynamic. Going forward, we continue to believe that Pega Cloud will be the faster-growing component of ACV, but it's awesome to see our clients truly embracing cloud choice. An interesting note is that almost half of our clients who have ACV greater than $1 million per year leverage both Pega Cloud and Client-managed cloud. We view this as a validation of our cloud choice strategy. In our view, total ACV growth is what ultimately matters for our strategy. Let me explain why. First, unlike other enterprise software companies, the Pega Cloud and Client-managed cloud are in fact the same underlying technology.
The only difference between the two offerings is who manages the solution and where those solutions are managed. Second, we continue to view our strategy to provide customers with Cloud Choice. Reminder that the Cloud Choice is the choice to deploy with Pega Cloud or Client-managed cloud. It is a key differentiator for us. Oftentimes, our clients tell us that Cloud Choice is a key differentiator for us in the enterprise space. These clients have needs that are complex, therefore, clients require flexibility when deciding how and where to manage their enterprise solutions. Another important metric to measure our success during the cloud transition is our growth in remaining performance obligation, RPO, sometimes called backlog. Total backlog represents clients' contractual commitments that are expected to come into revenue in future periods.
Total backlog increased by 23% from Q3 2020 to Q3 2021, increasing from $838 million to just over $1 billion. It's tremendous to see total backlog increase by almost $200 million in 12 months. It's worth mentioning that maintenance backlog growth also accelerated through 2021. When a Client-managed cloud deal is booked, a portion of that transaction is recognized as term license subscription, and a portion goes into maintenance backlog to be recognized in future periods. The strong growth in maintenance backlog is a direct result of our strong Client-managed cloud bookings during the last 12- months. I've often advised investors not to get too hung up on the accounting of ASC 606, but instead to think about combining term ACV and maintenance ACV as those together represent Client-managed cloud ACV.
Turning to revenue, total revenue through the first three quarters of 2021 increased 25% year-over-year. This increase was driven by Pega Cloud revenue growth, which increased 49% over the same period. Subscription revenue jumped by 32%, reaching $708 million through the first three quarters of 2021. Over this period, subscription revenue made up just under 80% of total revenue, up from 75% of total revenue during the same period last year. Our success in closing new and expanded Pega Cloud and Client-managed cloud deals drove our growth in term license cloud and maintenance revenue, which makes up our subscription revenue sources. There are several factors powering the subscription revenue growth. We've clearly expanded our total addressable market because of the pandemic.
Companies are adopting modern software solutions to automate manual business processes across all of our key industries, financial services, insurance, telecommunications, healthcare, manufacturing, and the public sector. We are still in the early innings of digital transformation, which is accelerating across the globe, and Pegasystems is at the center of this opportunity. Our software is clearly becoming more important post-pandemic. Companies are embracing a hybrid workforce, and that means more digital engagement between clients and their customers as well as their team members. In conclusion, we delivered a great third quarter, highlighted by solid total ACV growth, and we're looking forward to closing out a record 2021. As always, Q4 is a critically important sales quarter, and we are laser focused on finishing the year strong and positioning our company to deliver the future. Operator, please open the line for questions.
Thank you. If you'd like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure that your mute function is turned off to allow your signal to reach our equipment. A voice prompt on your phone line will indicate once your line has been opened. Once again, that's star one if you'd like to ask a question. We'll take our first question from Steve Koenig with SMBC Nikko. Please go ahead.
Hi. Good afternoon. Thanks, Pega. I'll do one for Alan and one for Ken. Alan, could you give us an update on where you are in terms of the journey you launched with Pega Infinity? I think it was two years ago now. You know, COVID has my sense of time warped sometimes. Where are you with multi-tenancy, microservices and the IDE, all the interesting stuff you are adding to the platform. Then I've got one follow-up for Ken.
Yeah, you know, Steve, at the risk of really putting us all in a time warp, it was actually over three- years ago that we announced what we call Project Phoenix, which was a very carefully crafted strategic way to build additional capabilities into Infinity in a way that customers wouldn't have to wait till everything's done to take advantage of them. What I'll tell you is that with our 8.6 release, which has been in our customers' hands now for months, and our 8.5 release, we were actually able to put very important capabilities in.
For example, most recently, the ability to use what we call the DX API, the digital experience API, which is now being used by numerous production customers to give them a real cross-channel way of having the brains and the process from the center out architecture, you know, from the guts of their where they run their business, drive their front ends. We have numerous clients who are using it, and we're now actually able to use that also to generate state-of-the-art React-based desktops, which is available to clients on early adopter status in 8.6 and gonna be broadly available in 8.7. Very, very substantial functional and compelling improvements. From a microservices point of view, we have very substantially taken the Pega system and subdivided it into key microservices and into key recurring services.
Concepts like multi-tenancy are ones that are also being built-in in a variety of ways, but in very capable ways. We will continue to be able to offer certain clients the ability to run as their own set of tenants. Whereas, I would expect that, you know, looking at a year or a little more, you'll be able to see us offering software to perhaps new cadres of clients that, you know, is really the right way to enter certain sectors and segments of the market as we, you know, look ahead. Very pleased with the Project Phoenix progress, and you can see it in reality paying off today and arranging for us to pay off even more in the future.
Terrific. Thanks for that, Alan. Quickly for you, Ken. I think you mentioned that cloud was a really big part of new bookings. I think last quarter it might have been 60%. It sounds like it was even higher this quarter. Could you give us some color on that? Just to add to that, any color on how sales productivity is trending after all the hiring you've been doing, you know, and how it's been impacted by the go-to-market changes that Hayden has made? That's all I have. Thanks very much.
Sure, Steve. Yeah, let me clarify one thing. Our overall cloud choice is accelerating growth. For the year, Pega Cloud to Client-managed cloud was still for the year about 50/50 in terms of the percentage mix between the two of them, so nothing really noticeable there. Client-managed cloud was stronger in Q3 than Pega Cloud, just slightly. Whereas last quarter, they were close last quarter. I think Pega Cloud was maybe a little stronger. They've been pretty equivalent. We've seen good balance there. Just to clarify what you'll see in the financials.
On the sales productivity, what's interesting is, you know, because of the significant growth that we had in Q2 and Q3, the sales productivity for just Q2 and Q3 certainly has strengthened. Q1, I would say, was not as strong of a quarter, you know, in terms of overall ACV growth. Q2 and Q3, we've certainly been moving in the right direction.
Great. Thanks a lot.
Thank you. We'll now take our next question from Jack Andrews with Needham.
Oh, good afternoon. Thanks for taking my question. I was wondering if you could provide more details just on your partner progress. Is there a way to frame just what proportion of your opportunities are now influenced by partners these days?
I can talk to that. The significant majority of our opportunities have very meaningful partner engagement. You know, I would actually say it's north of 80% where a partner is meaningfully engaged. You know, this has been a key part of our strategy and something that Hayden has been advocating and we're very excited about. You know, there's a lot more opportunity here, frankly, as we continue to work going forward, but we believe our strategy needs to be extremely partner-friendly, and that will only continue.
Jack, I'll add.
Okay.
I'll add one other qualification onto what Alan said. Although partners, Alan is right, partners are very involved in many of our campaigns. I would still say there is a lot of upside in terms of the deals, so to speak, that partners are bringing us. We are still sourcing the deals in our traditional fashion, and partners are starting to refer more to us, but we're still in the early stages of that, if that's the other angle on that question.
Got it. That's helpful. Thank you. Maybe just as a quick follow-up, you know, Alan, you mentioned that you're most successful when you've got senior leadership engagement. I was wondering, is there a way to frame, you know. Has there been like a change in either the frequency or intensity of C-level conversations that you're having these days?
I think we've been able to meaningfully increase that. As we've added ourselves more senior people who are comfortable dealing at the, you know, COO, CXO, even CEO level, those conversations have increased. I would also tell you that bizarrely, in some ways, the pandemic has been helpful because you no longer have to struggle as much, frankly, to get schedules perfectly aligned. You know, people kind of are stuck, and so you just need to be able to find the right windows. Certainly, I'm on a pretty continuous basis involved with clients.
That's also true for a lot of the other senior people, Hayden, the executives who run our different regions, and the people who are responsible for both our products, the GMs of our one-to-one, our customer service and our intelligent automation, and also of our industries are all very involved with senior customer discussions.
Great. Congratulations on the results.
Thank you.
Thank you. We'll hear next from Steve Enders with KeyBank.
Okay, great. Thanks for taking the questions on my end. I just wanted to get a better sense, you know, I think we hear a lot in the news around, you know, great resignations and people worried about potential hiring out there. But I guess when you go back to your customers and your clients, and you have those conversations, is there an increased focus from them around investing in their own automation initiatives, given these potential challenges they're seeing within their own potential employee base?
I think that's a really good question. As we think about the next several years, we believe that our software writes software. You know, I think organizations who wanna be able to have a lot of control over their destiny, so they don't just wanna dump their systems in the hands of some off-the-shelf thing. They want that level of control, but they realize it's increasingly hard in this world where, frankly, the technology is complicated, security is an increasingly large issue, and the marketplaces were demanding agility.
You know, we think that our pretty unique ability to do this low-code implementation work with, you know, very sophisticated targets, customers who have multiple regions, multiple products, you know, multiple types of customers, that we think that actually strategically plays really well to our low-code strategy, but low code for sophisticated organizations and for organizations with complexity, which we can help them, you know, crush. They're really interested. A lot of them are much more open-minded about doing it somewhere differently because they realize how hard it is to build a team and keep it around. They need, frankly, new ways of doing it. I think that's gonna be increasingly important over the next 24-36 months.
Okay, perfect. No, that's great to hear. Then Ken, maybe just a housekeeping question. You know, good to see ACV growth come in, you know, at 22% again. Just wondering what the constant currency growth was there, if there's any FX impact in the quarter here.
Yeah. Constant currency was around 21, Steve. There wasn't as much of a currency tailwind in Q3. It's kind of the dollar starting to kinda get back to where it was toward the end of the year. We actually had in constant currency growth a pretty reasonable acceleration in Q3.
Okay, perfect. That's great to hear. Thanks for taking my questions.
Sure. Thank you.
Oh, great. Hey guys. Thanks for taking my question. Ken, the mix shift to Client-managed cloud versus Pega Cloud, I just wanted to double click on that. Is that impacted by more regulatory industries this quarter who wants to just manage their own infrastructure or any particular use cases that you're seeing that's kind of informing that basically to take in-house versus using Pega Cloud? And then on the other side, I mean, I think you said Pega Cloud growth should pick back up. Are you suggesting that we are kind of hitting a trough on the Pega Cloud growth at this point?
Can I jump in for a second?
Yeah.
Sure.
Go down.
You know, I think it's really important to understand how we're talking about cloud. You know, Ken mentioned it, and I'll just try to be a little, you know, more transparent. At the end of the day, actually at the start of the day, what we're interested in is cloud solutions. We're all in on cloud solutions. Whether that cloud is operated by a customer because they wanna put it in effect woven into their full backbone and the other 40 systems that they routinely hook us into, or whether they choose to have us be, you know, running on the Pega Cloud world where we're operating it, but those integrations need to go across, just like it would for anybody. They need to go across sort of standard, industry standard, you know, REST or other types of interfaces.
That's really an architectural choice that often reflects how the customer is thinking about its estate. The great news is that customers are thinking of us as an integral part of their technology architecture, their technology state. We do not draw a distinction in, you know, in how we compensate our salespeople, in how we, you know, think about it and judge ourselves internally about whether a dollar comes in from Pega Cloud or whether the dollar comes in from Client-managed cloud. Unfortunately, the accountants account for them differently, which I, you know, won't offer my personal opinion actually is that that's really suboptimal. You have to look at it from an accounting point of view. From our point of view, it's, you know, the same technology. It's really about what makes the most sense for this key strategic customer.
I just wanna be clear because a lot of other companies, and we're not one of them, have like completely different product lines from their cloud version versus their, you know, their client version. We don't. Think of it all as being about ACV, and you'll at least be looking at it more closely to how we think about cloud ACV, which we think about as more homogeneous, even if the accounting ends up being at least in the short term only, but in the short term, the accounting is a little weird. I think Ken works really hard to try to make that transparent. Does that make sense? 'Cause, you know, we do get this question 'cause other companies aren't like this.
No, yes. That definitely makes sense. One quick follow-up,
Pinjalim, can I answer the back part?
Sure.
Can I just take the back part of your question now? Everything that Alan just said, so if you think about it, who would be more likely to buy Client-managed cloud? Well, it's the use cases do play into it. But if you have larger organizations and using Pega centrally, kind of inside their tightly integrated mission-critical environments, some of them may want to manage that themselves, right? That would be Client-managed cloud. What I said in my script, which actually is the second part of your question that you mentioned, which is, it's not that. Don't think about an acceleration or deceleration. What I had mentioned was that Pega Cloud will still be the fastest growing from a percentage standpoint.
Because even if we end up with this scenario where it's 50/50, you know, 50% Client-managed cloud, 50% Pega Cloud, Pega Cloud will still be an accelerated grower for some period of time in terms of the percentage.
Understood. Thanks for the clarification, Ken.
Yep.
Ken, one more for you. In terms of the cash flow side, I think it seems like, well, just help us understand the timeframe on the normalization aspect of cash flow as we end this year and next year.
Think about operating cash flow connecting to what we call non-GAAP income, right? Just think about it that way, where non-GAAP income is very consistent with operating cash flow. The actual cash balance, of course, is impacted by other things like stock buybacks, etc., which we actually have a decent amount of stock buybacks that we do through the course of the year. Just think about non-GAAP EPS or non-GAAP income, which interestingly enough is a penny is kind of a million dollars if you kinda do the math quickly, or simply. That's kind of the way to think about non-GAAP EPS is a very close proxy to free cash flow to opt for. That's just kind of a simple way to think about it.
Got it. I get that. My question was more around the normalization of cash flow. I mean, consensus is modeling a big uptick in Q4 and next year. I think you're a little short on the cash flows side this quarter. I'm just trying to think, is that normalization timeframe pushed out?
Are we still?
No, we're still under the same timeframe. What we had is depending on the way the structure of the deal and when the billings come in, sometimes you do have some things shift between the quarters, but Q4 is typically Q4 and Q1 are kind of typically our stronger billing collection quarters, just as a general rule because of the amount of activity that happens in Q4, not just new deals, but also renewals, that happen. That tends to be the more kind of seasonally adjusted period.
Understood. Thank you so much.
Yep, sure.
Thank you. We'll now take our next question from Rishi Jaluria with RBC.
Hey, thanks. This is actually Philip Rigby on for Rishi. Thanks for taking the question. So nice to see a really nice acceleration in total ACV. I think you've all touched on this in prepared remarks, but wanna make sure I'm understanding this. The deceleration in cloud revenue is that really all just a mix to. Yeah, just trying to think through the disconnect between the deceleration cloud revenue and the acceleration total ACV. Yeah, any color there would be really helpful.
It's just a mix issue. Depending on the mix, I'll just answer your question on ACV 'cause ACV is a little bit more connected. Revenue has some kind of a little bit of weirdness around 606. But for ACV, if you actually have total ACV accelerating, but the mix shifts in ACV, naturally you'll have one accelerate and one decelerate, you know, in terms of the speed. You're absolutely right. We look at it as total ACV.
At the end of the day, although we see Pega Cloud being a critical part of our growth, at the end of the day, total ACV growth is really what matters, and we need that number to be accelerating and growing.
Got it. That makes a lot of sense. Any changes to what you're seeing in the new logo environment?
Alan, do you want the new logos?
Yeah, sure. You know, we are continuing to get new logos. You know, we love it, of course, when we get new customers. We're also getting, and I don't know if this counts in your mind as a logo or not, but we're seeing a lot of what I would describe, new businesses or for example, you know, new parts of the Australian government and, you know, parts of the German government and new agencies in the U.S. government that are coming on board based on our successes. They're, you know, in effect, each one tends to have its own logo, but they're really all part of a theme of continuing to do good work for some of these very, very large institutions and organizations and being able to continue to grow.
Frankly, I think that's a very reliable way for us to really build our footprint and, you know, build the extremely high retention rates that we have with our clients.
Got it. Thanks so much.
Thank you. We'll now take our next question from Fred Havemeyer with Macquarie.
Hey, thank you very much. I wanted to ask firstly, you know, how has Pega been progressing with the new go-to-market update vision and organizational changes that Hayden laid out at your Analyst Day? Are you kind of pleased with your progress and where that's standing or do you see areas where you think there's more work that could be done?
I'm very impressed by the talent that we found and been able to attract under Hayden's leadership in the last six-months and nine- months. I don't wanna offend anybody by picking an official timeframe. You can actually see who's coming on board. If you go on to LinkedIn and take a look, you'll see very, very impressive people with terrific backgrounds and experience who are joining us from, you know, competitors. There's a lot of appetite from people to take advantage of, I think, what's broadly perceived as a much better technology, which they can bring their selling skills and selling experience to. I'm extremely pleased by that. Having said that, you know, the team's all really new, and we're still in the process of pulling together, et cetera.
I think a really important event for us that we're all looking forward to is the beginning of January, our sales kickoff, when I believe we'll be able to take this team, which is, from my point of view, largely assembled, and really be able to launch them as a unit that we have been developing. I'm really excited as we think about going into next year, what we'll be able to accomplish. If you just take a look at the people, and this is public domain because you can find it on LinkedIn, it's a very impressive collection of talent.
Thank you for that. Well, Alan, I just added you on LinkedIn, and I'll start adding more people. We'll be following that talent progression there. Now
You should do it.
Ken, I'm not.
If you go to the company page, the Pega page, and you look under the Insights. There's a tab that says Insights. It actually will list for you know, recent senior hires and you know, it's. It'll speak for itself.
Absolutely. We've been tracking that part. You know, Ken, not to ignore you, but Alan, I have another question that I think might be more in your direction here. It's kind of architectural. We've been hearing more about the importance of event-driven architectures, you know, not just for building scalable infrastructure and enterprise IT environments, but
Even for workflow systems. I'd just like to ask, how would you consider Pega's capabilities to take advantage of more like event streaming technologies or essentially event-driven automation and workflows?
I think we're state-of-the-art. We've built in as part of Project Phoenix, one of the things that we did early on was make it so our system was amenable to events and made it completely natural, and events were a first-class citizen. We plugged into Kafka at numerous customers, consuming events and applying a combination of real-time decisioning, rules, process AI, and our workflows, which, of course, are our core. That plays enormously strongly. Frankly, a lot of the stuff that's out there isn't very good. I'm really proud of what our team has been able to build in that area as well.
Great. Thank you.
Thank you. We'll hear next from Mark Schappel with Loop Capital.
Hi. Thank you for taking my question. Alan, question for you. Historically, M&A has played somewhat of a modest role at the company. I was wondering, with the business model transition winding down, whether you see M&A playing a larger role.
We keep an open mind. The challenge, as we've discussed in the past, is when we go to market, and this is gonna be true, I believe, going forward, a critical element that we tell our clients is that we're not a Frankenstack, that we have bought things, but where we have, like we recently brought in the real-time speech and text analytics from a small technology company we bought called Qurious.io that's just absolutely brilliant and, you know, being released to early adopters actually this quarter. That sort of thing, we believe, needs to be woven into a consolidated architecture, not just something that looks good on the PowerPoint, but something that really is reflective of good what I would call technology.
That does mean that we're not expecting to be a company that like a lot of our, you know, frankly, competitors that have been financially quite successful. You know, they're basically buying revenue and buying revenue streams, but at the end of the day, their customers get, you know, what we, you know, sometimes refer to as a Frankenstack. We're so central to the architecture of our clients. I think that's gonna be increasing, that we would not wanna lose that technical integrity, though that doesn't mean we have to build everything ourselves. We're really open-minded about being able to find both technology and talent that we can bring in. As we complete the evolution, I would say in the next 12-24 months, we could become more amenable to M&A, but we're always looking.
If you know something that we should look at, we're glad to talk to them.
Great. Thanks. Ken, a question for you. You know, a few years ago, the company embraced the Rule of 40 as a guiding principle to balance ACV growth and cash flow margins. What is the right way that investors should be thinking about ACV growth versus profitability over time here?
I'll point back. I think this is where your question is kinda going, Mark. I think if you had to, if we had to look at a mix of Rule of 40 that would be more in line with the way that the investments that we've made in the business are trending, we've kinda said it would be kinda more in that 25% ACV growth, 15% margin. Now, naturally, we're not through the cloud, through the subscription transition completely, and we're not at 25% ACV growth right now. We're at, you know, we're kind of 22% now.
I think if you kinda think about that, I think that's the you know a way to think about the investments that we're making in the business and where you might see that you know if we were able to achieve Rule of 40, how it might look. We're not gonna be you know although I would wish we were, we're not likely to be a 40/10 or excuse me a 40/0 kinda mix, 40% growth, 0%. You know and we certainly don't you know we're not investing in the business in a way to think about ACV growth decelerating. So that's kind of the way I think about it.
Okay, great. Thanks.
Sure.
Thank you. We'll now take our next question from Vinod Srinivasaraghavan.
Hi. Thanks for taking my question. Just a quick housekeeping question first. Did you disclose the breakdown in cloud ACV this quarter?
Yeah, yes. The breakdown between Pega Cloud and Client-managed cloud?
I should have been more specific, sorry. The breakdown for Client-managed cloud between term and maintenance.
Yes. There is an ACV table if you wanna get the specifics. There's an ACV table. It's actually gonna be in our MD&A. I will verify where that is, but the ACV, we're trying to take a view of Client-managed cloud being both together in terms of ACV because the two numbers, as you can imagine, become confusing if you look at them individually. I will get back to you on where that is in the MD&A.
All right, great. Thank you. I just wanted to touch on the kinda the selling motion for Pega Cloud. You know, do you incentivize your sales force to sell it over Client-managed cloud? You know, do partners play a role in selling Pega Cloud as well?
Yeah, partners can be a source. We do have partners that actually bring us, you know, Pega Cloud deals. We generally, though not always, but almost always, the client ends up wanting to sign the contract with us, even if it's brought by a partner, just because they like having that sort of relationship with their cloud provider. But we have done some indirect as well, on Pega Cloud. We do not specifically extra incent one type of cloud versus another because we think the choice should be based on what the client needs. I do think we have to really get people oriented around the fact that, you know, Client-managed cloud is no less sticky than Pega Cloud.
Arguably, it's more sticky than Pega Cloud because typically people who are using Client-managed cloud are doing it because it's really deeply woven into their infrastructure, and they just have so many interfaces they wanna run it with the rest of their stuff. You know, I think that we are disadvantaged because lots of other software companies end up having very different software product lines, kind of their new stuff and their old stuff, and that's how they talk about cloud. That's just not us. You know, the Pega Cloud versus Client-managed cloud is sometimes a decision that gets made very late in the selling cycle based on strategic reasons. I don't think it would be appropriate, frankly, to extra incent one versus the other.
Got it. That's helpful. I guess the last question for me, can you just talk about how, I guess quantitatively some of the benefits of Project Phoenix, you know, specifically on kind of your longer-term gross margin profile?
I can talk to that a little bit. Project Phoenix has already brought us on to the Kubernetes platform for new customers. You know, we're running in production with what we sometimes internally call Cloud K, which is Client Cloud clients have been able to run on Kubernetes for a while. We're now running Pega Cloud on Kubernetes. That obviously gives us some additional savings. Other elements of Project Phoenix will give us, for certain use cases, the ability to do what you might describe as commingled multi-tenancy. Kubernetes gives you a form of multi-tenancy, but is not commingled between organizations. We will have the ability to do commingled multi-tenancy as this continues to develop over the next, I'd say, year or so.
You know, once again, we are thinking about how we commercialize that with our customers, because we also like a lot of what the sort of at least client-specific separations can provide. It really provides some very powerful options as it relates to things like encryption and other elements of how you do these things. Phoenix and this whole movement are definitely contributing, you know, to, you know, I think you're seeing margin improvements as we move along, and they're not done. We're continuing to build on it.
Adding one other piece of information to that. If you think about the best-in-class kind of multi-tenancy gross margins versus the best-in-class kind of single tenancy gross margins, the things that we're doing is trying to kind of you know, to have our margins kind of move in the direction of multi-tenancy by getting some of the efficiency by still having the flexibility of some of the benefits of some of the single-tenant benefits. That's kind of just think about it as we're trying to kind of you know, gravitate higher margin by almost simulating multi-tenancy with some of the things Alan mentioned, like Kubernetes, for example.
Got it. Thank you.
Thank you. We'll now take our next question from Patrick Walravens with JMP Securities.
Hey, guys. It's Joseph Marincek on for Pat. Thank you for taking the questions. A few quick ones for Ken here. You know, first, I wanted to talk about the 2023 update you laid out during the investor briefing in June. You know, how are you feeling about those targets? And then maybe how should we think about the trajectory and shape of getting to those targets? And then second, can you walk us through, you know, how you're thinking about the key levers to drive continued growth and possible acceleration in total ACV? Thank you.
Sure. So, the targets that we talked about in the Investor Day, probably the only one that is. You know, I still feel good about all of them, but there's the one that is kind of the unknown a little bit, is what's the mix of Client-managed cloud versus Pega Cloud. As we talked about earlier, from a business standpoint, I mean, we quite frankly really don't care that much because they're both valuable. We just really need to hit the growth number. But the mix of how they're booked, so to speak, the way the client buys that solution does impact some of the detailed lines that we talked about, like Pega Cloud ACV growth, Pega Cloud revenue, Client-managed cloud revenue, but it doesn't impact subscription, total subscription and total ACV.
I would say substantively nothing is we don't feel really any different than what we talked about back in the spring. It is the way the ACV and the revenue comes in is it's certainly, you know, we don't have a crystal ball on knowing whether it's gonna be Client-managed cloud versus Pega Cloud. Again, at the end of the day, we just need total ACV growth to continue to accelerate. I'm sorry, remind me on the second part of your question.
Yeah, just going off of that, you know, total ACV growth accelerating, how do you think about the key levers there in order to drive that?
ACV growth acceleration, I think, is. Look, we have plenty of addressable market. I don't think anybody would dispute that. We have a best-in-class solution set, and I don't think anybody would dispute that. We have marquee clients. I'm not sure anybody would dispute that. Really, the focus for us is to leverage those relationships that we have because we haven't even scratched the surface on the penetration that we can have with, you know, our largest and even some of our emerging clients. I think there's just a tremendous opportunity to accelerate ACV growth with, you know, the few hundred of the largest clients that we've built really good relationships, both in Pega Cloud and in Client-managed cloud, as I mentioned. I think that is gonna be the key lever for us to accelerate ACV growth.
It's to deepen those relationships, expand the use cases, like those clients want to do with companies like Pega.
That's super helpful. Thank you so much.
Sure.
Thank you. That does conclude today's question and answer session. I'd like to turn the conference back over to Mr. Trefler for any additional or closing remarks.
Thank you, and thank you to all of our investors and analysts. We are working hard on your behalf. I just want you all to know that. Please stay healthy, and I look forward to being able to see you all in person again at some point, hopefully in the near future. Be well, everybody. Talk to you again soon.
Thank you. That does conclude today's conference. We do thank you all for your participation. You may now disconnect.