Pegasystems Inc Q3 FY2022 Earnings Call

Good day, and welcome to the Pegasystems Third Quarter 2022 Earnings Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ken Stillwell, COO and CFO. Please go ahead.

Good evening, ladies and gentlemen, and welcome to Pegasystems Q3 2022 Earnings Call. Before we begin, I'd like to read our safe harbor statement. Certain statements contained in this presentation may be construed as forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. The words expects, anticipates, intends, plans, believes, will, could, should, estimates, may, targets, strategies, projects, forecasts, guidance, likely and usually or variations of such words and other similar expressions identify forward-looking statements, which speak only as of the date the statement was made and are based on current expectations and assumptions. Because such statements deal with future events, they are subject to various risks and uncertainties. Actual results for fiscal year 2022 and beyond could differ materially from the company's current expectations. Factors that could cause the company's results to differ materially from those expressed in forward-looking statements are contained in the company's press release announcing its Q3 2022 earnings and in the company's filings with the Securities and Exchange Commission, including its annual report on Form 10-K for the year ended December 31, 2021, and other recent filings with the SEC. Investors are cautioned not to place undue reliance on such forward-looking statements, and there are no assurances that the matters contained in such statements will be achieved. Although subsequent events may cause our view to change, except as required by applicable law, we do not undertake and specifically disclaim any obligation to publicly update or revise these forward-looking statements whether as a result of new information, future events or otherwise. And with that, I'll turn the call over to Alan Trefler, Founder and CEO of Pegasystems.

Thank you, Ken, and thank you to everyone who has joined today's call. I am pleased with this quarter's results. In fact, this is by far the best quarter we've had this year. As we discussed last quarter, we've become very focused on how we manage our business with a goal of balancing growth and profit to be a Rule of 40 company as we exit 2024. We reassessed our business outlook in July, and Q3 is a positive indicator that we are making progress. We continue to make operational efficiency a priority, limiting increases to our cost structure until we're confident of tangible benefits. And you can see evidence of progress in our results. On a non-GAAP basis, year-over-year operating expense increased less than 3% in Q3. The slowest year-over-year growth in operating expenses we've seen for years despite a high inflation environment. Ken will talk in more detail about the numbers in a few minutes. At the same time that we've been working across our business, we've been doing a special focus with regard to how we go to market and our client focus. We've realigned the organization to really focus on the largest global clients, where we believe we have the most upside for profitable growth. We know there is significant opportunity to increase our presence with these clients who know us, trust us and have often already experienced success using our software. Take the government area for instance. We have a robust heritage of success working with many of the largest government agencies around the world to help them achieve modernization goals and transform the digital experience for their staff and constituents. And we continue to increase our presence. For example, in Q3, we expanded in the footprint in the U.S. Department of Justice and Veteran Affairs, as well as the State of California, who are using our intelligent automation capabilities to improve efficiency, ultimately providing better experiences for their constituents. Also, last quarter, we expanded our work with a U.K. shared services program out of the cabinet office. They provide workflow automation services, across ministries and are expanding their use of Pega's workflow automation to deliver pay and pension services to the Ministry of Defense. We've been conducting events like a Pegathon at one of the largest U.S. federal agencies. It started with low-code workshops that were attended by over 300 of our clients' employees to learn about Pega and get hands-on experience with it and have culminated with hundreds of participants in a live build event to showcase their innovations. I was thrilled because I was able to spend nearly half of the quarter meeting with key clients and partners, including a run through Asia Pacific, India, Singapore, Australia, and then on to the U.K. and Europe, after 2.5 years of being unable to visit clients, it was really energizing to get back on the road in a significant way. I met with some of our most strategic and longest-standing financial services clients at Sibos, a premier financial community conference that had over 8,000 attendees. And I had a chance to spend time with our two very first clients who have been with us funding our software since 1984 through multiple generations of technology, and obviously, a rapidly changing and extensively changed technical and business landscape. At this event, we had more than 90 significant meetings with clients. I met personally with about 45 clients and partners. It was great to hear their confidence in our ability to help them solve their pressing business challenges. I am gratified to hear that Pega continues to be seen as a critical strategic partner in digital transformation efforts, and many of them talked about their intentions to further invest in Pega. Back at home, we've been very busy hosting clients and partners at our Cambridge headquarters, at our new Edge Center for Innovation. In Q3, we held more than 20 meetings with clients like Ford and Siemens, giving me more opportunities to connect in person with some of the key people. I've heard a few consistent themes. One is our clients continue to face multiple issues like we talked about last quarter, from labor shortages to rising inflation, to supply chain interruptions, and many are bracing for a recession. They want help in tackling short-term challenges while supporting their long-term strategic goals. As I said, I believe that Pega is uniquely suited to help enterprises manage through such uncertainty while building for the future. 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, save money, and adapt quickly. At times like these, we also know that many organizations prefer to do business with partners they know and who inspire confidence because their products have worked and are providing strategic value even as economic environments change. Now part of that confidence, I think, comes from our continued focus on innovation, to deliver the industry's best technology platform for our clients. Since we last spoke, we've continued to enhance our software to make it easier for our clients to be productive and to address their employees and their customers' needs. I'm really excited about the latest addition of Pega Infinity, which we announced last week. This newest release helps transform how organizations quickly deploy apps, create smarter workflows, and deliver better experiences for their employees and customers with enhancements throughout our software suite. New features empower brands with enterprise-wide pragmatic AI that works behind the scenes to increase efficiency, speed innovation, and improve customer interactions. This improves end-user experiences and helps deliver better apps. Combining AI with automation in a well-architected platform helps employees with their productivity, lets them make better decisions, and lets them improve business performance. We also continue to receive recognition from leading analyst firms and other third parties. Earlier this month, Pega was named a leader in Know Your Customer (KYC) solutions by Charters Research, a leading risk technology analyst firm that focuses on this important sector. Know Your Customer standards are designed to protect financial institutions against fraud, corruption and money laundering, terrorist financing and are increasingly important for international banks, and we see tremendous interest in this area. The report evaluated the 32 most significant KYC providers across 4 criteria, and Pega received the highest possible scores in three of those categories. In September, we were recognized by Gartner as the highest-ranked vendor out of 14 in its 2022 Critical Capabilities for Salesforce Automation. The report states, Pegasystems offers exceptional automation and process management within its CRM. Pegasystems' vision is one of autonomous CRM, where automation offloads repetitive work and AI assist users, increasing their efficiency and improving the delivered customer experience. Now you likely know by now, little makes me happier than clients who are willing to go on public record with their success stories. We just posted two new videos on pega.com that you might want to take a look at. QBE, a global insurer, with policyholders in 140 countries, recently completed a video testimonial. They leveraged Pega Intelligent Automation to free up over 50,000 employee hours a year. W&W, a leading German financial services group, also completed a video describing their use of how Pega supports their customer engagement and how they've gone about creating a Pega Center of Excellence to support and guide their transformation initiatives. Now regarding our company culture, I continue to be proud during these difficult post-pandemic times of our resilient and passionate team. Their commitment to our clients, partners, the communities they serve and to each other, looking to create a vibrant, diverse and equitable culture. I'm happy to see how our people are adopting a Rule of 40 mindset across the company to bring the sort of value to our constituencies. There are people who are getting back together in person; I'm seeing teams combining meetings with volunteer or fundraising activities for the causes they believe in. This is fostering terrific collaboration and providing support for causes that matter to our clients as well. I continue to be inspired by the generosity and kindness of our people towards each other, as well as towards those in need. So in summary, I'm pleased with our results this quarter that show progress towards adopting the Rule of 40 vision, making that happen. I believe the discipline and focus we're driving in our go-to-market strategy is absolutely the right approach. I'm excited about the direction it's heading and what we're seeing. Though we continue to operate in an environment of significant volatility, we believe that our software is uniquely suited to address these times and that we have appropriately changed how we are going to market to make that clearer to our clients and prospects. To provide more color on the financial results, let me now turn it over again to Ken Stillwell. Ken?

Thanks, Alan. Our team executed very well in Q3 in what was, as Alan mentioned, very uncertain times. I'm really happy with the way we finished the quarter given the economic environment that all of us are facing. In fact, it was the strongest quarter of the year for us. We had more $1 million-plus purchases by clients in Q3 than any other quarter this year, and our business was particularly strong in financial services and had some nice contributions from our public sector. As we continue our multiyear subscription transition, growth in annual contract value, or ACV, continues to be the most important metric to measure the success of our business. In Q3, total ACV grew 16% in constant currency year-over-year. Our ACV growth was powered by Pega Cloud ACV growth of 39% in constant currency year-over-year, which reached $416 million. Pega Cloud ACV reached 40% of our total ACV for the first time, and it continues to be our fastest-growing ACV component. We've clearly made some good progress in improving our go-to-market execution in Q3. And I want to remind you that Q3 2021 was a strong ACV growth quarter. So Q3 2022 faced a relatively tough compare. The second most important metric to measure the success of our business during our subscription transition is growth in remaining performance obligation (RPO), or backlog. Total backlog grew 18% in constant currency year-over-year. Pega Cloud bookings were the largest contributor to backlog growth in the quarter. Pega Cloud backlog grew at a very high pace at constant currency year-over-year of over 30%. Volatile foreign currency exchange rates continue to reduce our reported results, which is why we're focusing on being very clear with our constant currency performance. We are primarily exposed to changes in the currency values associated with the U.S. dollar, the euro, the British pound, and the Australian dollar. For example, the persistent strengthening of the U.S. dollar negatively impacted ACV growth. When normalizing exchange rates from Q3 2021 to Q3 2022, total ACV was reduced by $58 million year-over-year. We've included charts in our earnings release to illustrate the currency impact on both ACV and on backlog. Moving to the status of our subscription transition, we're in the final phase of our multiyear subscription transition, and we expect to wrap it up in mid-2023, as previously communicated. In this final phase, we expect profitability and cash flow to normalize, positioning Pega to achieve the Rule of 40 as we exit 2024. As a reminder, we define Rule of 40 as a combination of ACV growth and free cash flow margin. Given our best-in-class enterprise solutions and robust renewal rates, we think there is tremendous untapped earnings power in our company. We are already seeing tangible results from the efforts to refocus our go-to-market motion. Our sales productivity has begun to improve in Q3 and was better than the first half sales productivity, an indication that our strategy to refocus our sales team on organizations with the highest propensity to purchase is working. Our go-to-market strategy focuses our sales teams on deeper client relationship engagement to tackle the considerable additional opportunities they have to expand their relationship with Pega by deploying new applications, expanding volume and capacity on existing solutions, and embracing the digital business era. We measure sales productivity by comparing net new ACV added in the period relative to sales and marketing spend. We plan to continue driving strong expansion purchase activity going forward to drive ACV and backlog growth. Improving Pega Cloud gross margins and increasing sales and marketing operating leverage are two key drivers of our plan to achieve Rule of 40 as we exit 2024. It was encouraging to see improvement on both of these levers in Q3. Moving to our outlook for the rest of the year, through the first 3 quarters of 2022, Pega Cloud represented just under 70% of our new client commitments, which is higher than the 50% we expected when we set our plan for the year. Just to remind you, a higher Pega Cloud mix negatively impacts reported revenue in the current period. In Q2 2022, we communicated our intention to implement cost-saving initiatives to reduce the impact of the previously announced revenue shortfall on our profitability. I'm happy to share that we've made great progress against those cost-saving initiatives, and you're already seeing the impact of that work flow through our financial results. In Q3 2022, Pega Cloud gross margin improved 400 basis points, increasing from 67% in Q3 2021 to 71% in Q3 2022. On a trailing 12-month basis, after several quarters of growth, the quarter-over-quarter growth in sales and marketing expense has been flat for the last two quarters. As we continue to navigate a very uncertain economic environment, especially in Europe, we plan to do what Pega does best: deliver best-in-class mission-critical solutions to the world's largest clients. Pega has successfully grown revenue through difficult economic times in the past by focusing on large enterprise clients who have the highest propensity to purchase Pega and receive value from the solutions that we offer. We are fortunate to have so many marquee customers in our installed base with tremendous additional opportunity that we have not yet tapped. This installed base is led by firms that will be able to most successfully weather, and even prosper during difficult economic times. In our experience, many large enterprise clients consolidate vendors during times like these, which is one of the reasons why we're currently focusing less on capturing new logos as we believe, given high inflation and economic uncertain outlook, enterprises will focus even more on automation and digital transformation for efficiency gains, a demand catalyst for our intelligent automation product portfolio. In conclusion, I'm really pleased with our Q3 2022 results and really proud of our team. Given that we have some distractions in the first half of the year, it's great to see this positive Q3 performance and the business heading in the right direction. This is by far the best quarter we've had this year given the combination of growth in ACV, Pega Cloud, and backlog, while at the same time, we're making progress managing the business with much more of a focus on operational discipline and profitable growth as we progress on our journey to achieve the Rule of 40 as we exit 2024. Seeing us finish with a strong Q3 gives me confidence in our ability to finish the year well. I'm looking forward to seeing many of you as I hit the road for face-to-face investor meetings in November and December. I also want to encourage all of you to mark your calendars for our Investor Day on Monday, June 12, which will be held live and in person at PegaWorld in Las Vegas, Nevada at the MGM Grand. That's right, PegaWorld is live in '23, and we are excited.

Our first question comes from Kevin Kumar with Goldman Sachs.

Alan, I kind of wanted to touch on the public sector. I think you made a comment there on seeing relative strength there. I know Pega recently created a new entity of service to the government customer base. So maybe a little bit on the rationale for the creation of that entity and what you're seeing from a demand perspective in the government sector relative to some of the other verticals would be helpful.

Sure. Well, it's interesting because we're seeing good interest in the government sector, not just in the U.S., where I mentioned the work with the Department of Justice and Veteran Affairs. We also have, as we've done for a long time, continue to work with many other departments from the IRS to Marshalls, etc. But we're seeing some very strong interest from foreign governments as well. When I went through Australia, Canberra, which is the capital, there is a lot of work that we're doing there. In the U.K., I met with some of the people where we are actually delivering the recruitment system for the U.K. Navy and Air Force. As you think about what's happening here, the programs in many cases that were rolled out during the pandemic had a lot of 'bailing wire' in them. People have had to and have wanted to go back and see if they can ensure that they are more stable and more secure. And there is still a strong need for efficiencies in government that our software is being very well regarded for. So I think the rationale for liking the government space is that they tend to have lots of workflows. The workflows can be complex, and they often can get big, which is something we do unusually well.

That's helpful. And then I wanted to touch on some of the cost rationalization and improvement on efficiency. I guess, maybe touch on free cash flow conversion, Ken. I know there's some volatility on a quarterly basis, but I'm curious if cash flow margin is trending in line with your expectations. Should we expect that to track ahead of other metrics like operating income and net income as we kind of near the end of the model transition?

Sure. There are a couple of parts to that, Kevin, that I'll touch on. First off, our operating cash flow for 2022 does have some nonrecurring headwind because of the legal expenses that we've added back to our non-GAAP EPS related to some of the legal discussions that you're aware of. So there's that to highlight as a starting point. But yes, our operating cash flow, our working capital is staying relatively consistent as we scale. We've been doing a very good job on our DSO and accounts receivables, so certainly nothing in that area is happening. And we know that cash flow is never a straight line for a company like Pega that has a lot of client engagements that typically occur at the end of the year in Q4. Our billings are not linear through the year, not unlike other enterprise software companies. But we believe that when we finish the year, we will have positive operating cash flow as we expected, even given some of the headwinds that I mentioned. When we get to next year, we’ll be that next step toward Rule of 40. In 2024, we'll be a Rule of 40 company. So the cash flow is trending as expected. It is still negative in this part of the year because, like I said, the billings are not as heavy in Q2 and Q3.

Our next question comes from Steve Enders with Citi.

I just want to ask about the strong sales execution that happened in the quarter here. I guess, how much of that was driven by some of these delayed deals in some of the past activities that we saw in the first half versus some opportunities coming in? How should we think about for the year, you talked about 16% ACV growth last quarter, the target for the year. I actually wanted to get an upside of execution here.

Sure. We don't give guidance to our assessments because we made major changes to the way the go-to-market organization was structured. I would tell you that the improvements in Q3 were, in my view, almost entirely as a result of the changes. It's not like deals slipped and suddenly came in; that wasn't it at all. A big part of what we did is we reoriented ourselves to say, look, we have many hundreds of customers who are writing us checks every month or quarter. We need to spend time on them. We need to make them successful like us. In reality, the upside in those organizations is significant and ample for our sales goals, frankly, for the next couple of years. So we're not issuing a new name but basically saying we're going to stop chasing them, which I think had been pretty materially the way we were going to market a while ago. I think the results of our change in focus drove the better results in Q3. It wasn't a whale or two or a big slip deal; as Ken said, it was very balanced. That makes me feel good that the things we're doing are right, even as the economy is obviously seen as tough.

I'll add one additional thought on there. Alan mentioned a couple of things. One, the breadth of the performance means the contribution from lots of clients was really healthy. Sometimes you hit a quarter with just one big deal or two big deals; that wasn't our Q3. That's really promising. Probably the most optimistic thing in the quarter is that breadth of engagement with so many different clients. The second point is, we experienced distraction in Q2, and that even carried into July, part of Q3 also had some level of distraction, and we still executed well. I think the reason why that may be is, selling to existing logos is much more productive in general. For Pegasystems, it's always more efficient to sell to an existing client than a new logo. So naturally, that helps with our Rule of 40.

Okay. Great. That's very helpful context. I guess, broadly, just thinking about the macro, and I know it is a challenging time right now. How are you viewing the pipeline and the opportunities looking toward 4Q? Has there been any change in either deal dynamics, things slowing down or deals potentially coming in a little bit smaller than expected? How should we think about what you're seeing in the current environment?

The style of engagement we’ve been doing in the last several months, since we reoriented here, is different. It's not a lead-response style where you worry about deals slowing down conversion during different parts of the funnel. This is a full engagement style, understanding the client strategy and demonstrating how we fit into that. I actually think those deals are much more reliable and more influenced and controlled by us because it's not a mass or a market motion. This is especially true for organizations where we are already doing things that they're building on. As Ken said in his examples, they decide they're going to put new workloads on, move to a different department, or do an analogous function, building on the success they’ve seen. The idea of the app factory, which we've talked about, is really taking hold. We've taken steps to encourage customers to do that and make it easier for them to get started on projects, which I think will lead to greater reliability even in this difficult economic environment.

Thanks for taking the questions.

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

Our next question comes from Pinjalim Bora with JPMorgan.

This is Noah Herman on for Pinjalim. First, any major changes you've seen in the demand environment, specifically in the U.K. and APAC? For the full year, are there any changes to the revenue guidance that you laid out last quarter in terms of some of the impacts?

Let me take that second part of the question, Alan, and then maybe you can give your perspective on APAC and EMEA. As Alan mentioned earlier, we're not in the business of guiding quarterly. What I would tell you is where we said we were going to be 16% constant currency ACV. We were 16% constant currency ACV for Q3. That's a confirming indication that Q3 was kind of a step on that journey. The factor that is not related to us guiding but just to keep this in mind is the dollar's performance in Q3, which is a big wild card. In terms of the fundamentals of our business, we anticipated that the economic environment was going to be deteriorating through '22 and likely into '23, but I think we're executing well in that area. However, currency is definitely a prolonged and significant headwind for a company like Pega that reports in U.S. dollars. Alan, maybe on EMEA and APJ in terms of the demand environment, your perspective?

Sure. Since we’re selling in local currencies, just about always because customers expect that, the sale can get impacted by what the dollar is doing. I've been in both APAC and the U.K., as well as in Continental Europe in just the last seven to eight weeks, and I would tell you that the demand environment is not pushing things off. It's not hard to get meetings; people are interested in how they are going to transform to become more efficient. There’s more interest around cost savings and retention rather than boosting revenue. This is not true for every business or environment, but generally speaking, we see this historically when there are recessionary or inflationary pressures. I felt good coming off those trips, and it's good; I’m going to do another one in 2.5 weeks because there’s a lot of demand.

Our next question comes from Joe Meares with Truist.

I apologize for the background noise. I'm curious, last quarter, you mentioned that in the second half, you were expecting sales cycles to elongate. I'm curious if in Q3, they elongated more or less than you expected coming into the quarter.

I think that they were probably a little more worried than what actually happened. When you're in the early bits, it's not uncommon for things to elongate because people will put extra levels of controls on spending. It's anecdotal, it's not statistical, but I didn't really see any meaningful elongation happening. Yes, I would say that was probably a smidge better than I might have been afraid of going into the quarter. I think part of what's happening is some scrutiny is occurring earlier in the process, so customers who are not willing to do something are more likely to not engage as opposed to scrutiny coming later in the process, where Ken, as CFO or COO tries to stop something from happening. That actually bodes well for the level of attention we're getting.

I would add one other thing, Joe. In this environment, I think the biggest headwind in the sales cycle is related to new logos. Companies that don't know the vendor end up going through a prolonged process which affects onboarding. Selling and deepening engagement with existing logos avoids those objections. In tough economic times, that headwind tends to be more pronounced; however, our focus area counters this trend, which is key.

Super helpful color from both of you guys. Just as a follow-up, I think last quarter you mentioned you were expecting to get somewhere over $100 million in OpEx savings to offset that revenue headwind you were anticipating. I'm curious how far along you are in that process.

Yes. The great news is we've achieved that mitigation as we sit here in October. We're looking at how much more progress we can make through the rest of this year and in '23 to prepare ourselves for our Rule of 40 targets in 2024. We're really happy. The team at Pega made a lot of progress in Q3. This isn't something that we're done with, but we want to run a good business as we’re far from the Rule of 40 right now and we need to get there. This was a really positive step in 2022.

Our next question comes from Steve Koenig with SMBC Nikko.

One for Ken; that's kind of a multipart about the numbers, and then a question for Alan. Ken, just trying to understand the numbers and what they say about the nature of bookings. Cloud ACV was up $12 million, which was nice, but cloud bookings were up a whopping $139 million. So that did a huge bookings number that didn't translate as much ACV. Can you clarify that? Were there a lot of renewals in there? Was it a big renewal quarter for cloud? On maintenance, RPO has been down year-on-year for two quarters now. Is that a beginning of a trend? What should we expect? Is that a function of clients migrating from term to cloud?

There are a few factors involved here, Steve. First, the currency has an impact on every number. We perform a reasonable amount of Pega Cloud outside and maintenance outside the U.S., so currency is a factor. Yes, there were more renewals in Q3 than in Q2, which is why Q2 RPO showed slower growth. Q3 was more of a normal renewal quarter. Sometimes, Pega Cloud bookings might not start an ACV in the quarter they get booked. Meaning the effective date could be the next quarter which means a percentage of ACV won’t reflect the booking in that timeframe. On maintenance, some clients are moving to Pega Cloud and modern contracts which does impact maintenance growth, but currency is also a factor.

That’s super helpful. And my follow-up for Alan. You made some commentary about the culture and employee morale during these post-pandemic times. I'm wondering if you could comment on kind of, I guess, one of the elephants in the room that was distracting in Q2 was the lawsuit. How does that play into the kind of motivation and alignment within Pega and the questions you may be getting about that from employees?

The staff has a lot of confidence that we write our own software. They know how Pega is differentiated from other companies. I don’t think the staff is giving much credibility to the assertions made. There are also people who were with us during these time periods, and their understanding differs from some of what has been claimed. The staff is holding up quite well. It’s not the easiest time to be an employee in high-tech business right now. But those who've been around a long time are able to talk to the newer employees. We are pretty scrappy. Some anxieties might arise with companies that haven't weathered storms. Good communication and our heritage have kept our company together despite the difficulties.

One thing that really engages our employees and gets them fired up is their interactions and the solutions we provide to our clients. Our client engagement is at really all-time highs. That shows just by the broad performance in Q3, highlighting how crucial it is that we're deeply engaged with our clients.

Our next question comes from Vinod Srinivasaraghavan with Barclays.

I know you had said you weren't updating your guidance. But can you talk a little about your overall guidance philosophy? Did you build a buffer into guidance? Should we expect you to hit what you laid out?

Over the last 3-4 years, it was tough to peg specific revenue and EPS numbers due to the shift to Pega Cloud and that variability. In 2022 and going forward, that's less impactful compared to what we saw in 2018 when revenue changes were more pronounced. We have more certainty now; however, there is some variability with the timing of renewals and bookings. We aim to provide a reasonably accurate number based on our cost savings and believe we've made significant progress there. We weren't building a cushion into a beat-and-raise model since we're not guiding each quarter, but we aimed for accuracy.

That's helpful. One more for me. It was good to see the Rule of 40 expectation reiterated. But I wanted to discuss the weighting between growth and margins, given the demand headwinds. Do you have any changes to the weighting of the factors? Ideally, what would you like to see?

The beauty of building a Rule of 40 model is if your growth expectations are reasonable, your margin can match; if you outperform on growth, it helps twice. We aim for a growth number that is achievable while ensuring a margin profile provides Rule of 40 probability based on reasonable growth targets. That said, we want to grow faster. We won't push costs to achieve higher growth; we want to be thoughtful and profitable in our growth strategy. This is different from previous years where there were longer payoff periods and we were more aggressive.

That's on target. We're investing in growth and want to be a company that grows well. We've previously stated a capability for 20% ACV growth, which is a lot better than past performance. However, we will not aim for 35% growth while spending aggressively. We want balance, and I think the message has gotten through to the company, and the staff is buying into it.

Next question comes from Joey Marincek with JMP Securities.

First, Alan, can you talk more about Pega 8.8? Which capabilities are you most excited about? How do you think about your overall development strategy?

There's a lot in 8.8 that I think is exciting. The additions to the app factory capabilities, which we're already seeing some excellent adoption of, make it easier for organizations to implement automation on a platform that has enterprise-scale capabilities. Some alternative low-code solutions risk becoming like a reincarnation of Lotus Notes, so our structured approach can keep organizations agile. We’re also focused on processed AI to enhance our existing solutions, along with improving user experience with a flexible digital experience API. We're providing clients with the option to use either the Pega experience or their own interfaces.

Can you give us a quick update on the Everflow acquisition? What has been the feedback and demand from customers on those new process line capabilities?

We’re demonstrating them, and there's a lot of interest around process mining. The purpose of mining processes is to automate them for better operations. This aligns perfectly with our product line, making the Everflow acquisition a strategic fit for us. I saw a demo yesterday with a client who seemed quite impressed, and I believe it's going to result in great outcomes.

Our next question comes from Fred Havemeyer with Macquarie.

I wanted to check on a different part of the lawsuit. Has that come up in conversations with customers? Is it shaping any of your customer conversations at all?

Of course, it comes up with customers. If they don't bring it up, we'll bring it up. We don't want that to hang out there. Our conversations with customers show a lot of respect for the longevity and independence of Pega. Customers have been tremendous in listening to and reading what we put on our website that helps provide color. We will not discuss specifics that will become visible as our appeal moves forward, but customers have continued to focus on what they need from us.

When you have a significant announcement like that, clients need to understand what happened and we’ve been clear to point that out. We've kept communication transparent and provided details on our website, which has generally received a positive reception from clients. The most prominent indicator is the increase in the number of $1 million deals in Q3 with our clients, so I believe they’re comfortable with our engagement.

As one client said, they get sued all the time, so it's not a foreign concept. While it's not enjoyable, it's not anything new for a large bank or insurance company.

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

Thank you, everyone, for dialing in and listening. The Pega team has been working very hard. We’re invigorated by the new software we’ve put out, and we're excited about being able to engage more directly with clients as the pandemic period has ended. There is a lot of enthusiasm for becoming a better-run, more efficient company while bringing those benefits to our stakeholders. I like the feel of it, and the energy is great. We're going back to work for you soon. Talk to you later, everyone. Thanks.

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