Ladies and gentlemen, thank you for your patience. My name is Krista, and I will be your conference operator today. I would like to welcome you to the Pegasystems Third Quarter 2025 Earnings Conference Call. I would now like to turn the conference over to Peter Welburn, Vice President of Investor Relations and Corporate Development. Peter, please go ahead.

Thanks, Krista. Good morning, everyone, and welcome to Pegasystems' Q3 2025 Earnings Call. Before we start, I would like to share our safe harbor statement. Some statements in this presentation may be seen as forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Terms like expects, anticipates, intends, plans, believes, will, could, should, estimates, may, forecasts, and guidance, or variations of these words, indicate forward-looking statements that reflect our current expectations and assumptions as of the statement date. Because these statements pertain to future events, they are subject to various risks and uncertainties. Actual results for fiscal year 2025 and beyond may differ significantly from our current expectations. Factors that could cause such variations are detailed in our press release announcing our Q3 2025 results and in our filings with the Securities and Exchange Commission, including our annual report on Form 10-K for the year ended December 31, 2024, along with other recent SEC filings. We advise investors not to place undue reliance on these forward-looking statements, and there are no guarantees that the matters indicated in these statements will be realized. While future events may lead to changes in our views, except as required by law, we do not commit to publicly update or revise these forward-looking statements based on new information or future events. Our non-GAAP financial measures discussed in this call should be considered alongside our consolidated financial statements prepared in accordance with GAAP and are not a replacement for financial measures prepared under U.S. GAAP. Constant currency measures are derived by applying the September 30, 2024, foreign exchange rates to all periods shown. You can find reconciliations of GAAP and non-GAAP measures in our press release about Q3 2025. Now, I will turn the call over to Alan Trefler, Founder and CEO of Pegasystems.

Thank you, Peter, and to all who are joining today's call. I'm really excited to see the continued strong results through Q3. And as we've seen for the last number of quarters, our team is really focused, executing well and our differentiated AI strategy continues to resonate with clients, prospects and partners. We've been saying for some time that we believe we have a competitive advantage in today's AI world, one that's built on a unique architecture and a special approach to AI and agents. I believe that the results we've seen over the past few quarters reflect those advantages and will continue to serve us, our clients and partners well for the foreseeable future. Ken will walk you through the financial highlights in a few minutes, but I want to talk a bit about what I'm seeing in the market. AI continues to dominate the tech conversation. And candidly, not always for the right reasons. The buzz is overwhelming. There are new tools, new terms, lots of hype. And we've all seen headlines with 95% of enterprise pilots failing and predictions that generative AI will actually, in some ways, eliminate the software industry. I think all of that misses the point. First, most of the failures aren't about bad tech. They're about misapplication. And this is an industry problem stemming from our competitors' approach to use large language models to orchestrate and control workflows while an application is running live in production. In other words, at runtime. Using a large language model to orchestrate and control workflows at runtime runs the risk of mixing the appropriate context and guardrails and results in what we consider to be an inadequate level of accuracy and reliability. The unpredictability of this approach is a nonstarter for regulated industries like banking, healthcare and insurance, where even minor inconsistencies can trigger major consequences. And that's exactly why our competitors' approaches are falling short. Pega's revolutionary idea is to really harness the power of the large language model to design the application and then use the power of Pega's patented world-class workflow engine to create appropriate context and guardrails prior to putting the application into production. And we think this unique combination is our advantage, and it's a structural advantage. It's about the structure of how we operate. And I don't think our competitors can readily replicate this because they don't have this world-class workflow engine that's the core of driving consistency. And they don't have anything like Pega Blueprint to ideate and design clients' workflows. As a result, they've taken this prompt-driven approach. But as I said, there are fundamental challenges with depending on prompts alone for critical work and decisions. Small changes in wording or in the data can produce wildly different results. And large language models evolve constantly. So the same prompt can yield different answers over time. The suggestion of using prompt-driven AI to make decisions in real time is akin to hiring somebody and saying, 'Hey, you process claims how you think is best.' What organization would do that? A much better approach is to give them defined processes to follow so that every claim is handled the same way. Similarly, we would not let a customer service representative freestyle responses to sensitive questions. You train them, guide them, ensure they escalate when needed. We think the same logic applies to AI and is why you need to design this thoroughly and get the right sort of approvals before you begin. Prompts can be great for brainstorming and creativity, but not for making critical decisions in the moment based on variables that can be unpredictable, especially in those critical regulated industries. Enterprises should use generative AI to innovate and to get the workflows right. But once they're agreed upon, the agents must follow them. So it operates the right way every time. So once again, our approach with Blueprint is to leverage the power of large language models at design time with the power of a robust workflow engine at runtime, delivering the best of AI plus the best of reliability. It's an optimal approach for building a sustainable, scalable agentic framework even in complex enterprise environments. Now last quarter, I continued to spend significant time with senior leaders around the world. And these conversations reinforce how some of them are really seeing the strength of the approach I described. Our architecture and AI strategy are built for real-world impact, helping customers move faster with greater confidence and control. Our goal is to be the workflow automation and AI orchestration platform of choice for the enterprise. And I believe we have the right architecture, solutions and approach to make that happen. And we're seeing strong momentum as clients shift from experimentation to execution, embracing Pega Blueprint to drive meaningful transformation across their enterprises and critical systems. Blueprint is more than a tack-on feature. It's an entirely new way to drive enterprise transformation built on the concepts and architecture we have developed over decades of automating enterprise processes. It breaks down silos between businesses and IT. It helps organizations reimagine how to get work done. And it helps clients and partners move from ideas to execution faster than ever. Blueprint has changed how we engage with our clients, replacing weeks of discovery and demo building with near real-time examples of what's possible with Pegasystems. It's been a game changer. And it enables us to target a broader group of organizations because it makes things easier and faster to understand and more reliably applicable to implement Pega. So we're seeing Blueprint shorten sales cycles, especially the early stage parts of this conversation. And we're also starting to see the time from design to production truly accelerated as we build additional functionality to Blueprint and key parts of the development cycle are jump started. This allows companies to get to production faster. And we see more projects going live faster than has been the historical norm. So though it's early days, we're really excited to see this happening. For example, a global food and beverage company launched a marketing spend management application, a large U.S. bank deployed a consolidated tax return solution. A consumer goods company went live with a pricing approval automation solution, a telecommunications provider launched a network issue resolution workflow application. And one of our large automotive clients, which presented at a Pega event a few weeks ago, described how they leverage Blueprint to transform an old Lotus Notes collection of finance applications into a modern cloud-based Pegasystems. And all of these went live in under 100 days. But it's much more than speed because Blueprint enhances the way that business and IT collaborate and uses AI to reimagine outdated ways of working. It means our clients get better apps that deliver more value. And when clients can get that much value that quickly, we think they're much more likely to invest in Pega. As a reminder, you can try that Blueprint for yourself at pega.com/blueprint. But what I like when I'm talking to senior execs is it's not just clients that are excited about our approach. Partners are also leading it. In June, we introduced Powered by Blueprint, which allows select partners to make Blueprint their own by embedding their best practices into the tool and branding it with their name and logo when they use it. It's sparking new momentum and becoming a rallying cry for our ecosystem. And it's going to help partners differentiate, deliver faster and scale smarter. It's a signal that the clients are getting a modern AI-native approach to transformation, now not just from Pega, but from the whole ecosystem. And it's a big deal because real enterprises aren't one size fits all. They are complex, messy and diverse. Pega and Blueprint are built for that. Last month, I sat down with Ravi Kumar, the CEO of Cognizant for a fireside chat about the role of AI in enterprises and the power of Blueprint. Ravi said he was 'blown away' by Blueprint and excited to take it to his clients. You can find the interview on YouTube. Just search Trefler Kumar. And I hope you watch it because you'll get to see the kinds of conversations and reactions we're seeing from our global partners. Now we continue to innovate across the Pega Infinity Suite, most recently with the availability of Pega Infinity '25, which we believe is the industry's first agentic enterprise transformation platform. Enhancements across the suite, including Blueprint, provide improved capabilities for enterprise transformation, and they deliver trustworthy predictable AI agents that operate as an orchestration fabric across the enterprise, including the ability to leverage Pega as well as non-Pega agents. This makes it easier for organizations to capture and reimagine legacy systems, automate work and boost productivity. As I noted a few minutes ago, our goal is to be the workflow automation and AI orchestration platform of choice. Now work in this world is done by a combination of people, automation technologies and AI. In addition to our belief that we have what's needed to claim a top spot here, we're also receiving outside validation from top industry analyst firms like Forrester and Gartner as leaders in the key categories in which we play. These include decision management, AI decisioning platforms, real-time interaction management, CRM software, process mining platforms and enterprise low-code application platforms. Recently, in August, we were named a leader in the digital process automation platforms by Forrester, receiving the highest scores among 14 evaluated vendors in both common offering and strategy categories. The report stated that Pegasystems 'best suits enterprises with sophisticated transformation goals, particularly if they want to focus on customer-facing AI agents.' And just last week, out of 20 vendors, we placed as a strong leader in Gartner's inaugural Magic Quadrant for Business Orchestration and Automation Technologies, or what they call BOAT. I think this is going to be a big area in the future. I think business orchestration and automation is an area where we are beautifully suited, and it's nice to get that sort of recognition. And we also earned number one scores in the adjacent critical capabilities evaluation for case management and enterprise task and process automation. Now these industry recognitions are, we think, important, and they give us some insight. But what we really love is how we're starting to have different and I think the right conversations about Blueprint, about AI agents, about the Agentic Process Fabric concept. And those, coupled with a strong partner strategy and our vertical understanding, I think, puts Pega in a really good position. So we're thrilled by the new clients. We're thrilled by the whole way that the analysts are responding to what we're doing. And we're really pleased that the ability to work with partners is being massively increased by some of the new technology and some of the new positioning and approach we're taking. So I'm pretty optimistic about our future. I think Pega is built for this moment. The distinctive architecture, the unrivaled Blueprint solution, it makes us uniquely capable of handling the volatility and complexity of modern enterprise environments. And I'm confident that our approach to AI will continue to resonate with prospects, clients, and partners. And I think if you take a few minutes to think about it, this idea of really doing the creativity at design time and ensuring reliability at runtime just makes a lot of sense. Now to provide more color on our financial results, Ken, your turn.

Thanks, Alan. We delivered record results in Q3 2025 with Pega Cloud ACV, revenue, and free cash flow, all reaching new highs and showing continued acceleration. These results reflect the demand for Pega and our ability to both execute on and monetize our differentiated AI strategy. At the same time, we've demonstrated our strong commitment to return capital to shareholders by completing our largest share repurchase quarter ever. Annual contract value grew 14% year-over-year. Through the first 9 months of 2025, we added over $147 million in net new ACV in constant currency, and that exceeded the total net new ACV we added in the entire year of 2024. Once again, the standout performer was Pega Cloud, which grew 27% year-over-year and represented the fastest-growing component of Pega's total ACV. This accelerating growth trajectory highlights not only the scalability of our platform but also the increasing client focus on cloud-native architectures and solutions for the adoption of AI. Several factors drove our ACV growth. First, our global sales organization continued to execute well across all major geographies. Several years ago, we made a strategic decision to reorganize and refocus our go-to-market model, aligning teams more closely to our clients. That transformation has clearly been paying off through deeper client engagement and a far more efficient sales motion. Second, Pega Cloud remains a major growth driver. As more clients migrate to Pega Cloud, we're experiencing accelerated growth and momentum, and the economics of our cloud migration strategy are compelling as well. Pega Cloud margins continue to expand, approaching 80% in Q3. With the vast majority of our net new ACV coming from Pega Cloud, we continue to realize the benefits of a more scalable business model that drives significant customer value. Third, our unique approach of utilizing AI in the design phase, as Alan mentioned, while leveraging predictable workflows at runtime is fundamentally unique and continues to differentiate us in the market. Clients are using Pega GenAI Blueprint to design sophisticated workflows that streamline operations and improve customer service. This new innovation is generating enormous enthusiasm, and we're seeing examples of deals closing faster as clients recognize and take advantage of the numerous tangible benefits of our AI-powered architecture. For example, we sourced and closed a new logo via a non-Pega partner within Q3, a powerful example of speed, precision and alignment across teams. Keep in mind, this is someone who never knew Pega but found Blueprint and saw its power. This rapid win highlights how Pega's cutting-edge technology and delivering methodologies are transforming the way clients envision and implement intelligent automation. By leveraging Pega GenAI Blueprint, the client was able to instantly visualize their use case, dramatically accelerating stakeholder alignment and simplifying the decision-making process, which can typically take months was reduced to days. About a month after the first Blueprint was created with the Pega sales team, the deal was signed, demonstrating the power of AI-driven co-creation and agile execution. Implementation will be powered by Blueprint Delivered, Pega's new AI-powered delivery methodology. This approach ensures rapid time to value, reduced delivery risk and a smoother path to deployment, helping clients realize benefits sooner and with greater confidence. In addition, the deal also features Pega's usage-based model. This creates a scalable foundation for future growth as the client leverages the platform to get more work done, Pega subscription revenue scales alongside it. It's a true partnership. When the solution goes live, Pega will be compensated based on the real work processed, reinforcing the partnership and outcomes as well. This win showcases the impact Blueprint can have with new Pega partners and clients. Moving on to cash flow. We generated $347 million of operating cash flow and $338 million of free cash flow through the first 9 months of 2025, representing an increase of 38% growth year-over-year for both metrics. This robust cash flow reflects our strong ACV growth, disciplined management and the continued benefits of our recurring financial model. Our healthy cash generation and our solid balance sheet also enabled us to invest in innovation and return capital to shareholders. As a result, we have purchased $393 million of Pega stock or approximately 8.7 million shares, demonstrating our confidence in the long-term value of our business and our commitment to returning value to our shareholders. As of September 30, we had $350 million in cash and marketable securities on our balance sheet. And as a reminder, since repaying our convertible senior notes in March 2025, we remain debt-free. I've received some feedback over the years that it's helpful when I share comments on modeling our business, so I'm going to continue to offer some perspectives on the fourth quarter of 2025. As more and more client workloads migrate to Pega Cloud, this trend reinforces the long-term strength of our subscription model, even while putting some near-term pressure on maintenance and term license ACV. Over 85% of our ACV growth this year has been generated by Pega Cloud, a clear indicator of how rapidly clients are embracing and adopting our modern scalable cloud platform. This momentum highlights the growing reliance of Pega Cloud as the foundation of our clients' most mission-critical workloads, even as it naturally reduces term license and maintenance activity over time. As you model Pega Cloud revenue, it's important to keep in mind that based on contract effective dates and typical client go-live schedules, there's often a delay of a few quarters before reported Pega Cloud ACV becomes Pega Cloud revenue. As a reminder, we provide annual guidance at the start of each fiscal year and do not typically update it. In conclusion, we're confident in our business, our strategy and the opportunity ahead. We're focused, obviously, on closing the year out strong and continuing the momentum that we've seen through 2025. We look forward to seeing many of you in person at numerous upcoming investment banking conferences across the United States. At this point, operator, please open the line for questions.

Your first question comes from Steven Enders with Citi.

This is Palak for Steve Enders from Citi. So my first question is, you touched on this a bit, is what drove the much better ACV and acceleration versus your expectation of it slowing down on a much tougher comp? And how should we think about ACV for Q4 and FY '25 as a whole?

So thank you for your question. So I think when we guided at the beginning of the year, we were pretty clear that we said we were not going to factor a direct impact from Pega Blueprint into our results. And I think what you're seeing is through the first 3 quarters, Pega Blueprint has begun to impact our business in a positive way. It's the exclusive way that we go to market with our clients and our partners are now adopting it at an accelerated pace. So I think the performance is certainly connected to the impact of Blueprint on our business, and we would see that continuing.

Perfect. And I have a follow-up on what you were seeing on the federal side of the business and what the deal environment looks like?

I mean the federal space, I think, obviously has been through a lot of change in 2025. And with the current situation of the government not being open right now, certainly, there's an impact to our clients. That said, our projects with our clients are long term and very strategic and tend to go across not just weeks and months, but tend to go across years in terms of the changes we're helping them drive. And so we've been through shutdowns before and our clients have certainly continued to move forward with their initiatives. So we don't expect that to be different now.

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

Great to hear that Blueprint continues to resonate with customers. Just on some of the newer predictable AI agents you recently launched, can you talk about the early feedback you're getting for those solutions? And just what's different about those agents versus what some of your competitors are doing?

Yes. I think it's actually great seeing that the understanding of the difference is starting to resonate with customers because there's so much noise and hype in this space. It's just you can't wait. It's pretty crazy. The way all of our competitors build agents is they give you a prompt studio. You go into a studio and you begin writing prompts, and now they're trying to put additional controls in because they realize those prompts haven't necessarily always resulted in the right outcomes. So they introduced Salesforce's agent script to be able to sort of add controls. The problem with that approach is relying on the large language model at runtime is inherently unpredictable to a degree. And when you're in a business where you really, really want predictability, you want to be 2 customers the same way based on law, based on policy, it's really important to have codified that in advance. So by using the large language model to foster the creativity, to foster the discipline at design time, and being able to take this library of workflows and execute it at runtime, is really quite remarkably more predictable and it's structural. The other thing that I'll tell you, and this is interesting as well, a lot of people talk about how large language models are driving waste in the electric grid. And candidly, when we run at design time, the large language models we're using are exactly the same. But a workflow is thousands of times less consumptive of natural resources than a large language model and they run on an ordinary CPU. They don't need the fancy CPU to be able to run. Being able to do this has an interesting additional environmental effect. So as far as I'm concerned, the predictability is the most absolutely compelling part of it.

Very helpful. And then it's pretty clear the acceleration that Blueprint is driving within the existing base. But now that you've started to invest more in new logos over the past few quarters, can you talk about the doors that Blueprint is opening on that front and just how that overall push has gone thus far?

Well, I think, Jake, I'll start just real quick and then let Alan chime in. I think there are 2 aspects of new logo acquisition. The first is how you initially engage with them and what the experience is. And I think the Blueprint is a completely different kind of nontechnical, very user-friendly experience where you don't need to know Pega or actually have someone that is an expert in Pega to start that engagement. The second thing is it speeds up the business development kind of solutioning time in the campaign. So I view those as 2 really great accelerators, and we're seeing the ability to actually be more targeted with more new logos to be able to accelerate that, which previously was hard to do because of the time that it took to actually get through kind of getting something into the pipeline.

Yes. I think that the ability to show a customer what we do has gone from something that took months and lots of meetings to something that when people see Blueprint and spend an hour, if you haven't done it already, Peter, I'm sure, would be glad to walk you through a Blueprint demo, any of you, be happy to do that. When you see it, you go, 'Oh, I get it,' and the thing I'm really excited about is it's not just speed. We've been able to take a lot of our design principles and a lot of the ways that we've thought about workflows and process automation for all these decades. And we've been able to build those into Blueprint as a critical part of the intellectual property. What that does is it's not just faster; I think even more important than speed is it's way better. And I think it's also much more reliable from an implementation point of view because it guides you to get it right. So it's a fundamental change, particularly with new logos and others who don't know Pega because they just get it. I'll tell you the truth, it actually made our own internal training of all of our staff easier and better, too, because people really, really understand Pega at a different level after having just even done one.

Your next question comes from the line of Raimo Lenschow with Barclays.

Perfect. Congrats from me as well. Ken, one for you. Like I was trying to understand your comments a little bit better when you talked about the impact of more cloud and how it does have an effect on term and license, and you said you wanted to help us a little bit with Q4. So should we kind of think about that deceleration or like that we saw on that cloud line of the business should continue probably maybe a little bit more in Q4 as you gain momentum there? Just kind of trying to translate your words into numbers.

Yes, that's a great question. I wanted to emphasize that in some past quarters, revenue from term licenses was higher due to a greater mix of deals in that category compared to Pega Cloud. Since we are experiencing 85% of our growth in Annual Contract Value from Pega Cloud, the impact from term licenses will be less significant. You can expect to see a decline in term license revenue over time. I've mentioned before that the decline hasn't occurred as quickly as I anticipated, likely due to some anomalies related to duration. However, with 85% of our business in Pega Cloud, it's reasonable to expect a reduced impact from term license revenue. While I'm not suggesting a large difference, you should anticipate the decline. That's the point I wanted to make.

Yes. And let's think a lot of the confusion that can come in is because of what I would consider an accounting anomaly where if you have a piece of business that's a $20,000 a month piece of business and it's term, if it goes on for extra years, you end up having a present value. And look, we would much rather not do that, but it's just the way the accounting rules work. I think you're seeing the powerful move of our business towards Pega Cloud, which is a real validation of the quality of cloud. I see with my customers that are switching that they tell us that they get better reliability running on Pega Cloud than they do when they were running it themselves. We're able, I think, to do a better job from a performance point of view with them because we've got so much automation, and we've really, really built in just a whole support system for them that we can do when it's running on the cloud. And so you're seeing our business sort of inexorably shift to be, I don't know, an 85% cloud business over time. There's always going to be some customers who, for one reason or another, really want to run it on-prem. And we like being able to offer that choice to our customers. But it's becoming really a cloud business. And at that point, once you realize that, yes, we really are a bona fide cloud business, you then I think, really want to look at ACV. ACV is what tells you about the momentum of the business. It tells you about the durability of the business, and it doesn't fluctuate the way that particularly the term license line does. And I think what Ken is saying the term license line is going to fluctuate a bit just because of things that don't actually relate to the strength or weakness of the business. So I'd just also direct from a quality point of view, you think about Pega has clearly made the transition to cloud compared to where we were years ago. When we started this, we were a very small percentage, and look at it now. And we have strong ACV growth. That's pretty exciting.

Yes. No, makes total sense. It's really, really good to see. And then hopefully that translates into guidance as well. The other question I had, Alan, is the other big area around AI that should be really interesting for you is application modernization because there's so much that can be done there. Can you speak a little bit about where we are on that journey?

Yes. So we are seeing a lot of energy around that and particularly around the new features that we've introduced in the last 60, 90 days, which you can see if you go to Blueprint and you go to the place where you can upload assets, we've made it so that if you have an old mainframe system without any documentation, you can actually hook up and take a video of somebody using it. And they can go through and explain what they're doing and what the system will generate off of a 20-minute video in terms of creating not just a cloud-native replacement for some old legacy thing but actually modernizing it and innovating. And if you have 2 or 3 systems you want to group together when they're modernized, you just grab the assets from all of them and upload it, and Blueprint will work to help you reconcile them. So we think this is just enormously exciting, and you're going to see us continue to put a lot of work into making this better and better because it's a terrific area. A number of those 100-day implementations that we talked about fall into that legacy modernization category.

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

Congratulations, everyone. Let's discuss how pricing is evolving in this industry. I know you mentioned it, but I'd appreciate a deeper exploration. There was a comment about pricing based on real work processes. Additionally, Bret Taylor, CEO of Sierra, spoke extensively about outcome-based pricing and its impact on the competitive landscape. Any insights you have on the evolution of pricing would be very interesting.

Yes. My thought is we're about a decade ahead of all these other guys. So...

Yes, I know. We are in the right place, yes.

Yes, we recognized years ago that when we would sell a large number of licenses to a customer, they would often become more efficient but then question the need for those licenses at renewal time. It didn't seem fair, especially since the volume of transactions was increasing, not decreasing. We realized we were approaching it incorrectly by focusing on just the number of licenses. Thus, we shifted to a work-based pricing model where we charge based on the amount of work the system performs. Our system is designed to facilitate easy tracking and charging for workflows and output. I believe companies using seat-based pricing face systemic issues because this method doesn't align vendor and customer incentives. Both parties should aim to enhance business efficiency, but seat-based pricing penalizes efficiency improvements, whereas we have strong motivation to encourage it. I anticipate that pricing in our industry will need to change significantly, and we feel we are well ahead of that trend.

That's right. As a follow-up, Alan, are you seeing any new players in the space? Are you seeing Sierra or Decagon or anyone else like that?

We notice these companies on the outskirts. They engage with many of the same clients as us, and we often receive inquiries about them. The main issue with chatbot agent systems is what I've referred to before, Pat, as the concept of center-out. This means you need a system that can function across all channels, ensuring that the rules and processes can operate whether someone interacts through a chat, sends an email, or accesses a back-office system. It's essential to maintain a truly omnichannel approach. We've been discussing this center-out strategy for nearly eight years. Many of the companies out there are creating solutions that are confined to a specific channel. When you are limited to one channel, it becomes challenging to visualize how to effectively serve clients and staff across various platforms. I believe the center-out framework is ideal for agents as it allows for both agent-driven interaction and the involvement of a person when necessary. Historically, companies have entered this space with systems like IVRs and robots. Relying on peripheral operations with business logic doesn't seem as effective as having a centralized structure that operates effectively across all channels.

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

Nice job on the quarter, guys. A couple of questions around the legacy transformation opportunity. Alan, starting with you, the newest Blueprint release introduces AI agents that essentially analyze legacy apps and automatically design workflows. Regarding that transformation opportunity, are you seeing customers actually integrate this capability into production today? Or are they just still in the planning stages for that matter?

Our blueprint has been the driving force behind every new implementation we've completed in the last six months, with many of these actually in production. The workflow engine is what operates in production. One advantage is that we can enhance Blueprint every week or two since it functions as a SaaS application on pega.com that connects to Pegasystems. Recently, we've introduced localization features, allowing Blueprints for Pega Cloud customers to have their uploaded information stored in their specific Pega Cloud region. This means data can be stored in compliance with local data residency regulations, which has now been streamlined. When we execute it, the Pega system that we have developed over many years, with ongoing enhancements, is what operates, distinct from Blueprint itself. This is where some confusion arises; Blueprint represents a new approach to using Pega that influences the entire design environment, rather than being a separate product. I can confidently say that every customer I've encountered has begun using the Blueprint for several months now. Interestingly, one customer at one of our sessions held a sign stating their motto: "No sprint without a Blueprint," indicating that they always start their building process that way. There's a lot of enthusiasm surrounding it.

Okay. And then as a follow-up, Ken, if I recall correctly, the legacy transformation opportunity was supposed to add about 1 point of growth to ACV this year. Is it still tracking to that? Or do you see the legacy opportunity kind of outperforming that expectation?

I would say that any acceleration beyond what we guided can be largely attributed to Blueprint and legacy transformation opportunities. If we experience growth acceleration, it will be driven by Blueprint and most of our efforts are related to some form of digital legacy transformation or application modernization, regardless of the industry's terminology.

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

Nice quarter guys. I just wanted to delve into verticals just a little bit. You touched on federal. Maybe just to dig into that a bit more. What sort of are you seeing there from a claims volume perspective? I'm not sure what percentage of the government base is on cloud versus on-prem, so if it makes that much of a difference? And are you changing your go-to-market activity there right now? And just maybe a little more color around what you guys see happening in federal.

Yes. So a couple of things. One, we feel a little fortunate that some of the agencies that really were targeted happened not to be the ones that we do a lot of work with. But having said that, when the offices are closed, progress on projects is slowed down. The services projects, they don't necessarily come to a halt, but they massively, massively reduce. And so if this goes on, this will obviously affect how those projects roll out. But as Ken said, these tend to be very long-term agreements, and they're not going anywhere. So we'll pick them up when things come back. We have accelerated the move to the cloud in the federal government. So we've actually had quite a few successes with our Pega Cloud for government offering, which is designed specifically for the FedRAMP federal environment. We actually have other customers in other governments like some state governments, etc., that are interested in Pega Cloud for government. And so that's, I think, a good offering. So the cloud, I think, is strong. Projects are, as you would expect, in some turmoil with work stoppages when the workers don't come in. And we're hopeful that sooner than later, this will get unlocked.

I want to highlight the government's focus on IT modernization. Over the past few months, Alan and I have had numerous meetings with various agencies and lawmakers to gain insight into how Congress is prioritizing spending initiatives. IT modernization has emerged as a bipartisan focus. There is considerable momentum around addressing the legacy issues these agencies face in IT, with efforts to reallocate funds to support these initiatives. It’s clear that regardless of who you speak with, IT modernization is a top priority for the government.

And there are lots of workflows in government, and they really need to be done predictably. So I think it just plays perfectly in what we're doing.

Your next question comes from the line of Devin Au with KeyBanc Capital Markets.

Could you maybe talk a little bit more on the partner-branded Blueprints? I know you said it previously, but have you seen that kind of unlock a whole host of use cases that Pega and maybe broader partner systems have not seen before? And maybe give us some flavors on what the new use cases that you've seen stemming from them? And kind of how has that influenced sales pipeline and velocity thus far from the launch of that?

It's going to be quite important. It's very new, having been announced in June. We have five partners who have established their private knowledge stores, which we operate on Pega Cloud. When Blueprint runs for one of these partners, if a staff member logs into the system, they will see Blueprint with that partner's name at the top. Only they, if logged in with that ID, can access this information. It will automatically be integrated into the analysis that Blueprint conducts. This development serves a couple of significant purposes for us. First, it enables partners to utilize their experience in conjunction with ours, which is a great application of AI. What excites me is that historically, all of these partners had Pega practices that focused on implementing the Pega system. However, for the larger partners, these practices represented only a small fraction of their total workforce. With Power Blueprints, we aim to allow partner staff outside of the Pega practice to engage with their prospects and customers, not to sell Pega, but to promote their own intellectual property and offerings in increasingly competitive environments. As we expand this next year, I believe it holds great potential.

Great. That's helpful context. And then for my follow-up for Ken, again, a really strong cloud ACV growth in the quarter and also noticed that license ACV declined sequentially quarter-over-quarter. I'm assuming that's a function of the strength you've seen from the strong migration activity. Could you maybe in any way kind of help put some numbers around how much has migration from licenses contributed to cloud ACV growth this quarter or maybe thus far this year?

Sure, Devin. Migrations are a key part of our strategy to migrate clients to Pega Cloud. However, migrations alone have not significantly influenced total ACV or its acceleration. That growth is primarily due to clients increasing their usage of Pega. Nevertheless, migrations will eventually lead to a decrease in term ACV and related term revenue. While you haven't seen this impact yet, this year, term license revenue will increase year-over-year due to the substantial revenue we recorded in Q1. However, we expect to see term revenue decline in Q3 and Q4 when comparing year-over-year. This is indicative of the transition to Pega Cloud. Overall, our growth is mainly driven by increased spending from our clients.

Your next question comes from Rishi Jaluria with RBC Capital Markets.

Nice to see continued strength in the business. I wanted to start by maybe thinking a little bit conceptually about Pega's role in this new AI ecosystem, broadly speaking. Alan, I know we've talked about this concept before, right? But as every kind of vendor and stack is building agents, one thing that we really haven't seen anyone truly crack the code on is the ability for someone to be kind of a neutral middleman and handle the agent orchestration layer, right, and allow a lot of these agents to work with one another and especially at a time where MCP is still in its nascency and A2A probably even more so. Can you talk about maybe what potential role Pega can play in that in kind of assisting all these agents across so many different stacks? And then I've got a quick follow-up.

Sure. When we think about orchestration, there are a couple of key aspects to consider. One is the technical connectivity between agents, such as how one agent communicates with another. Tools like MCP and A2A are already quite effective in facilitating this communication. We utilize this capability routinely in our operations. However, orchestration also involves logic; it's about accomplishing tasks effectively, not just making connections. Ensuring tasks are completed in the correct order and linked to the appropriate elements is crucial, which is where workflows come into play. When we evaluate our approach compared to others like Microsoft, Salesforce, and ServiceNow, they enable agents to orchestrate or utilize their frameworks with large language models for control. The challenge arises when agents interact, as the data can vary subtly, leading large language models to follow different paths. Our recommendation is to clearly define the orchestration for various types of work and not rely on large language models for reasoning during execution. Instead, we advocate for establishing a dependable workflow for orchestration. This distinction is particularly significant for use cases where predictability is essential, and we see it as a fundamental difference in our strategy rather than just being slightly ahead or behind competitors. The approach we have taken will offer a much clearer framework for orchestration and ensure reliable execution. It's important for us to communicate this clearly, and we're finding that customers respond positively to this message.

Yes, I understand. That's helpful. When we consider the growth drivers for ACV moving forward, a significant portion has come from your existing customer base, with Blueprint being a potential contributor to upside. However, with Blueprint lowering barriers to entry, there appears to be a real opportunity for acquiring new customers to significantly drive growth in the coming years. Conceptually, how should we view the composition of that mix over time? Could new customers become a more substantial factor in future ACV growth?

Yes, I think you're going to see new logos be a more meaningful driver if our partner strategy is successful because by recruiting partners to have their own powered Blueprints that let them bring their IP to their customers their way, it opens the aperture on who we would be talking to a lot. And it does it without us having to do all the heavy lifting of doing it ourselves. So I think that we're on the cusp of a huge set of changes here. But I think these changes as you think about next year and you think about where this is going, we're really pretty jazzed that we've got a lot of the stuff in the right group.

I believe a way to approach this is by acknowledging that if we aim to grow new customers through a direct account executive model, we face limitations due to the logistics involved in expanding that team. Hiring people and signing contracts are necessary steps, and while they can enhance our capacity to acquire new clients, Alan's point highlights that achieving significant growth relies on leveraging the 100,000-plus sellers already engaging with those organizations in our partner ecosystem. These two approaches are complementary; however, one has the potential to drive growth much more rapidly, while the other is constrained by the operational logistics of scaling.

And that's why we have to do a great job for our partners to let them capture their IP and let them bring their story to a prospect here. And if we can be successful on that, it's, I think, extremely exciting. Hopefully, that makes sense. And I think we are at time. So with this, I'm going to thank everybody for attending. I want folks to know we're working real hard for you, and I look forward to talking to you after we wrap the year. Thanks.

Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation, and you may now disconnect.