Pegasystems Inc (PEGA) 2018 Q2 法說會逐字稿

Good day, and welcome to the Pegasystems Second Quarter 2018 Earnings Results Call.

Today's conference is being recorded.

At this time, I'd like to turn the conference over to Ken Stillwell, Chief Financial Officer, Chief Administrative Officer and Senior Vice President.

Please go ahead, sir.

Thank you.

Good evening, ladies and gentlemen, and welcome to Pegasystems Q2 2018 Earnings Call.

Before we begin, I'd like to read our safe harbor statements.

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, could, should, estimates, may, targets, strategies, intends to, projects, forecasts, guidance, likely and usually or variations of such words or 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 2018 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 the forward-looking statements are contained in the company's press release announcing its Q2 2018 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, 2017, 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.

In terms of sort of a couple of highlights for the quarter and first half of the year, we are continuing to make progress on our strategic plan, and the movement to the cloud is very encouraging.

At the same time, we now and are building up the business to pursue a much bigger opportunity in front of us that we're focused on capturing.

As I've often said, it's important to look at our results in context, especially as we're now reporting under the new ASC 606 accounting standards.

These new rules have the potential to further exacerbate lumpiness in our quarters associated with term licenses and may result in some comparisons looking odd.

Our year-to-date results are a good example of why context is important.

We continue to see acceleration in our move to the cloud and recurring arrangements.

In Q2, for the first time in our history, cloud represented more than 50% of all new business.

And it was 54% in Q2 and grew 37% year-over-year.

Now I think this is really terrific for our business long term.

It can make our performance in short-term periods harder to understand.

And it's important, we think therefore, to consider growth in ACV, what's called annual contract value, when evaluating how the business is doing.

In this quarter, the accelerated shift to the cloud adversely affected revenue growth and EPS, but you can see the incredibly positive impact on ACV in the ACV chart.

We saw year-over-year growth of 20% in our total annual contract value, which does include maintenance recurring revenue.

And we saw strong growth in our term license and cloud ACV of 31% year-over-year.

For context, compare this to our full year ACV growth in 2017 of only 20%.

Now Ken has been showing the ACV number since the beginning of 2017.

So those of you who've been with the company for a while will find this quite familiar.

Ken will be providing additional financial details momentarily.

Now in terms of what happened in Q2.

Q2, in many ways at Pega, was dominated by PegaWorld and our largest ever product announcement, what we call, Pega Infinity.

I know many of you may have been able to attend and experience the excitement firsthand.

For those of you who didn't, I encourage you to watch the replays, which are available on pega.com.

The events and the product launch reflected our strategy and focus on delivering the best solutions for digital transformation, which we believe requires both effective customer engagement and digital process automation.

More than 70 customers discussed their use of Pega Live, reflecting our unique competitive differentiators.

The 6 core differentiators, which we called out, include: first, what we refer to as real-time omni-channel artificial intelligence that is self-optimizing and can embed itself seamlessly and work across channels to deliver the right action at every customer touch and optimize those interactions for both experience and value.

End-to-end robotic automation that includes robots, process automation, case management and natural language e-mail bots to drive inside optimization and productivity.

Importantly, we are the only CRM with robotic automation included.

What we refer to as journey-centric rapid delivery that allows our clients to attack their customer engagement initiatives one journey at a time, rapidly letting them get value and work effectively across channels, starting with what makes the most sense for them and their clients.

What we refer to as the Situational Layer Cake, which is the unique architecture that allows organizations to quickly specialize, differentiate and reuse their applications across products, regions and channels.

And all of this is based on our unique model-driven development approach.

Sometimes, people are talking about Low Code.

We like to think of ours as no code that lets business and IT design applications together and then have the system generate, tune and ultimately document the software that it creates.

This empowers the sixth aspect, which we refer to as Cloud Choice.

We're the only vendor in our space that allows our clients to decide where and how they want to run their applications without being locked into a single vendor platform.

They can run it on Pega Cloud, our cloud, a private cloud, a partner's cloud or a hybrid cloud and move between as needed.

We think, and we've heard from customers, this is a tremendous advantage.

The PegaWorld presentations included customers like JPMorgan Chase, who described using Pega and its digital transformation initiatives with scalable, secure and agile application development to really impact the customer experience.

Aflac, who outlined using Pega also in a major transformation initiative that changed the internal perception of IT from being an order taker to a consultative business partner, really simplifying and streamlining processes, making it possible to work differently and engage with the business and engage with customers very, very differently.

And Google, our new client, who described its use of Pega's Dynamic Case Management to automate network maintenance to sustain and ramp up capacity to support its global enterprise customers.

In addition to seeing these differentiators highlighted on stage at PegaWorld, these unique capabilities continue to drive new business.

We continue to see a good mix of business across our core verticals platform, applications and geographies.

For example, we drove new business in this quarter with a new client, Liberty Global, one of the world's largest international TV and broadband companies with over 22 million customers.

They chose Pega as part of their global digital transformation, an initiative they call [Atlas], which is designed to provide an always-on approach to engaging customers and provide a context-led experience to let them really react to changing needs and market threats.

Liberty Global's vision is to be incredibly strategic in the way that it engages with its customers.

FedEx selected Pega as the company's enterprise "Case as a Service" platform to support digital automation of a whole variety of processes and aspects of customer engagement and customer satisfaction.

This new platform will replace a 20-year-old mission-critical set of applications that are used across the global enterprise and rationalize more than a dozen additional case management systems, a part of their customer service, global trade networks, variety of applications.

And Mitsubishi UFJ Trust, one of the -- part of one of the world's largest financial services groups by assets, the bank expanded its work with Pega to support also a multiyear digital transformation to help fulfill their Trust Drives Our Future corporate branding.

To achieve that vision, Pega is helping improve the customer experience, loyalty and trust by supporting the bank's strategies about how to engage with customers.

And this quarter, we celebrated go-lives with clients such as Credit One Bank using Pega to support their rapidly growing customer base through an integrated customer service initiative.

Cox Communications, which is using Pega in a new business unit designed to help roll out new network capabilities; and Vodafone, which continues to roll out Pega globally.

This quarter, Vodafone Spain went live with the new marketing application that brings together decision-making from a customer perspective and ensures relevant touches, while reducing churn and increasing satisfaction.

Now from a technology and ecosystem point of view, as I mentioned, we announced our biggest product launch ever at PegaWorld.

What we refer to as Pega Infinity provides the industry's best, in our view, digital transformation architecture, something that really holds things together from end-to-end.

We refer to it as the Pega DX, Digital Transformation architecture, and it does a terrific job of bringing together those 6 core elements I described earlier, each of which we see as meaningfully differentiating us from competitors and customer alternatives.

Now highlights of this architecture include the AI, the robotic automation, DevOps capabilities that allow our clients to improve customer engagement, truly automate from end-to-end and more easily build for change, which, of course, is our very motto.

Since our last call, we also announced a number of advancements to expand our ecosystem, enhance our offerings and make our software more available to new and additional organizations.

We have a new independent software vendor program to bring our solutions to clients with more specific market needs added by partners, a new Pega Community to empower people at all experience levels to build software with our coding and understand how to use our products.

We've extended the free use of our Pega Academy, which is having tremendous success at bringing new partners, new customers into the mix.

We introduced the Pega Blockchain Innovation Kit that enables banks to see how Ethereum can really be used in our Know Your Customer and Client Lifecycle Management applications, a real, I think, bonafide and genuine use of this technology.

And a partnership with LinkedIn to integrate our offerings and help power engagement strategies across sales and marketing.

And, of course, it was a pleasure to be able to help Google on stage talking about Pega on the Google Cloud, now a part of our Cloud Choice offerings.

We also continue to receive awards and recognition from the leading industry analysts like Gartner, Forrester.

And this past week, Ovum, a noted analyst, named us the #1 Customer Engagement Platform out of 11 solutions evaluated.

And these included companies like Salesforce.com, Adobe, Oracle.

And they recognized our Customer Decision Hub as best for its ability to predict the next best action at the next best moment as well as having an underlying architecture [in order] to fulfill and execute.

So we are continuing to grow the company.

We are continuing to bring on new talent.

And one of the things I'm really pleased about is we just announced the appointment of Adriana Bokel Herde as Chief People Officer, succeeding Jeff Yanagi, whose taking a well-deserved retirement after doing a great job with us for over a decade.

Adriana brings more than 20 years of leadership experience in fast growing companies and is recognized as an innovative, high-performing leader with the ability to architect, execute and drive business growth.

We really are excited to have Adriana continue our focus on bringing high-caliber talent into the organization so that we can meet our goals and work to accelerate our growth.

So in summary, we had a solid first half in 2018.

We continue to see good progress in areas important to the execution of our strategy.

The move to cloud and recurring revenue streams, increased engagement with our key clients and prospects, continued enhancement to the key differentiators in our product capabilities and the broadening of our sales force along with improved onboarding and training to try to bring them up to speed faster.

We have a strong differentiated offering at the intersection of major growth areas and client needs, and we continue to be very positive about how our software is being adopted and the long-term growth opportunities.

To provide some more color, let me turn this over to you, Ken.

Thanks, Alan.

The first half of 2018 has resulted in very positive movements in the business.

For the first half of 2018, we experienced a solid increase in new license and cloud commitments, continued acceleration of ACV growth and a noticeable shift toward cloud arrangements.

As we've discussed in the past, our strategy is to accelerate growth with much higher mix of recurring client arrangements.

Over time, we can leverage this movement to recurring contracts to expand margin.

If one just looks at our reported revenue for the first half, it would lead to an incorrect conclusion.

Our year-over-year term and cloud ACV growth exceeded 30%, and it's a very important headline and is much more reflective of our overall business momentum.

Also the significant amount of year-to-date client commitments that were cloud exceeded 50% for the first time in our history.

The associated revenue trade-off that occurs with a massive movement to the cloud is normal and expected.

In addition, I'll remind everyone that we also had a very large terminal of $35 million that occurred in the first half of 2017, which can add to making a year-over-year revenue comparison an incomplete good measure of our progress against our strategy.

Let me talk a little bit more about the details.

Our new license and cloud commitments grew by over 25% year-over-year.

In the first half of 2018, our mix of new commitments was over 86% term in cloud, but most notably, cloud was over 50% of new commitments.

To provide a comparison, cloud, as a percentage of new commitments, was approximately 20% in the first half of 2017 and approximately 22% for the full year of 2017.

We had an anticipated cloud increasing to approximately 30% of our new commitments.

So this acceleration to over 50, well, it's a pretty significant shift.

Conversely, perpetual deals dropped from 57% of new commitments in the first half of 2017 to just 14% in the first half of 2018.

The short-term revenue impact of this significant shift is obvious if you look at the top line revenue.

However, there are much more meaningful learnings when you look at the individual revenue elements.

If we adjust it for the $35 million term renewal in the first quarter of 2017 and adjusted for our bookings mix that we had modeled for 2018 of approximately 30% cloud, our revenue would've increased approximately 20% year-over-year.

If you adjust for the extraordinary $35 million term renewal, term revenue would've increased by 30% year-over-year.

Maintenance revenue continues to grow by approximately 10% annually.

Our consulting revenue year-over-year only grew by 8%, which is much more in line with our long-term targeted growth rate and our build of our ecosystem so that more of our services work can be done through our partners.

Cloud grew by an amazing 56% year-over-year.

So when you look at the individual revenue elements, you can see our move to recurring, and specifically cloud, playing out well, though it does require some examination to come to that conclusion.

Our full year guidance was developed using an estimate for cloud at 30%, as I mentioned earlier, versus the first half actual of more than 50%.

Although it's still early, cloud momentum has been accelerating.

This is driven by market demand as well as improvements to our financial incentives for the cloud.

As we've said in the past, each 1% shift toward cloud has the potential to reduce full year 2018 revenue.

We estimate that to be approximately $3 million per year, as the economic value is reflected in ACV, but is not reflected in current period revenue when we book cloud.

We began disclosing annual contract value, as Alan mentioned, about 6 quarters ago.

With the impact of implementing a new revenue standard, we believe annual recurring contract value is highly correlated to recurring and predictable cash flows.

Our term and cloud ACV grew by 31% year-over-year, which highlights the growth in predictable future cash flows from term, and increasingly, cloud.

Our year-over-year ACV growth of 20% is the highest that we have reported to date.

We have over $0.5 billion total ACV, which is up almost 40% over the past 2 years.

We have consciously continued our strategic investments in go-to-market capacity, noticing this significant shift to the cloud.

We are confident in the market opportunity, our ability to capture our fair share.

And then ACV acceleration we are seeing supports the long-term value stream that we're creating here at Pega.

Of course, there is a lead time in achieving full productivity from these investments -- these go-to-market investments.

So much of this will be used to drive our continued growth in 2019.

On a year-to-date basis, our non-GAAP fully diluted net income and earnings per share have been materially impacted by the sharp shift to cloud and the lack of near-term revenue associated with a shift like this.

Although optically the results look confusing during such a transition, we're fully committed to continue to drive to more recurring and specifically cloud.

We're also confident that we are not the first company to transition to the cloud and manage through the associated revenue trough that comes with that.

We are disclosing $477 million of commitments from customers that have not been taken to revenue as of June 3, 2018, including perpetual, term, cloud, maintenance and consulting.

We've increased the level of transparency related to this disclosure to include all commitments.

Let me help provide some context around how to use this metric when thinking about future cash commitments from our clients.

If you start with our unbilled receivables and contract assets that are on the balance sheet of approximately $325 million and add to it this $477 million of customer commitments not taken to revenue and then subtract our deferred revenue of approximately $170 million to avoid double counting, you arrive at a balance of $632 million.

This is the total committed future billings from our clients, where we have recorded the commitment as revenue already or will recognize the commitment as revenue in the future.

So this is not an apples-to-apples comparison to our pre-606 measure of backlog.

This is a measure that can be compared period-to-period and is an important operating metric that reflects business growth.

From a cash flow perspective, we produced $75 million of operating cash flow for the first half compared to $86 million for the first half of 2017.

We finished the period with total cash and marketable securities of over $244 million.

You can see that operating cash flow is not highly correlated to net income in times where there is a large shift to the cloud.

Naturally, cash is king and the reason that we focus so much on ACV, especially when going through this type of shift.

In the first half of 2018, we returned over $46 million to shareholders through dividends, net settlements of equity and share buybacks.

In summary, we are very pleased with our midyear execution against our strategy and focused on finishing 2018 strong and continuing that momentum into 2019.

And with that, operator, we will open the call to questions.

(Operator Instructions) Our first question will come from Rishi Jaluria with D.A. Davidson.

I appreciate the color on the cloud business, I mean, interest being significantly ahead of expectation.

Can I -- in your prepared remarks, you mentioned that it's a combination of increased demand and financial incentives.

Can you expand a little bit on what sort of financial incentives there are that are driving customers towards cloud?

Any changes organizationally that may be need to be made to meet that demand?

And then, obviously, there's a -- it's hard to predict the future, but how should we be thinking about that metric in terms of cloud as a percentage of new bookings or new business going forward for the rest of the year?

And then I have a follow-up.

Yes, I'm glad to clarify.

When I say about financial incentives to customers, we changed -- when we went into this year, for the first year, we flipped our entire commission structure in the company to ACV, to annual contract value.

And historically, we had different rates for cloud versus other types of licenses.

Now we're basically treating everything as if it is recurring and as if it is cloud.

And that actually gives the salespeople a little more of a financial incentive.

If they sell -- if they end up selling a term license without it running on the cloud, they just don't get comped for the additional revenue that they would get if it ran on the cloud, so they have an additional incentive.

Having said that, I think a lot of it is that customers are interested, and that ultimately is what drives what people buy.

Got it.

That's helpful.

No, that absolutely does.

So how we should be thinking about where that directionally is going from here based on your existing pipeline today?

So let me make 2 points on that.

So there -- so I want to talk about recurring versus nonrecurring, and then we can talk about cloud for a second.

So the first thing is, if you look back a handful of years, we had a fairly reasonable amount of perpetual bookings and revenue in each year.

And if you look at the first half of this year, I mean, we have $35 million, I believe, of revenue perpetual for the first half of the year versus if you go back into the 2015 timeframe, that number was approaching $200 million, right?

So that -- the first point is we are seeing a pretty significant shift that customers like to buy recurring, right?

They are interested in recurring models and so that's completely aligned with our strategy and our compensation structure that we have with our field teams.

The second point is cloud.

We are Cloud Choice.

We believe in that.

We believe in giving customers the option of dealing with whether they want it inside of their private clouds or whether they want Pega to manage it in our cloud.

And the important opportunity there is that customers can have flexibility and they also have flexibility if they decide that their needs have changed in the future.

That said, we are seeing customers embrace our cloud at an accelerated rate.

We can't predict if that will continue in the future.

But normally, when you look at -- the market moving in that direction, cloud adoption tends to continue.

And so we're hoping that this is a trend that continues.

Okay, got it.

And then last question on the cloud and I'll jump off.

But Ken, you mentioned just associated headwind.

Just want to make sure I fully understand it.

So is that a -- each 1% increase in cloud as a percentage of new commitments that leads to a $3 million headwind?

And just kind of putting that together, if that metric stays at 50% for the full year relative to the 30% when you initially guided, that would be roughly a $60 million top line headwind on a full year basis, assuming no changes.

Is that a fair statement?

That's -- so that is a fair calculation.

The reason why the $3 million is not a science, because it naturally depends on when that cloud deal was booked in the year, and I'm sure you realize that.

But -- so that's a factor to consider.

But there could be -- if our cloud stayed at 50%, you could see that kind of impact [to shook to] revenue.

Now naturally, you would see ACV growth being very stellar for the year if that happened, of course.

Our next question will come from Steve Koenig with Wedbush Securities.

I'll do -- I'll dig into the financials with Ken.

And then, Alan, I've got a follow-up for you.

So Ken, I think the -- people might be struggling in the aftermarket a little bit with Pega, because it is complicated.

But you guys have posted stellar ACV, stellar cloud mix, and in terms of triangulating on what the growth rate of new business is, there's obviously several ways to do it.

But Alan mentioned that the TCV grew 20%.

You mentioned new license and cloud commitments grew by over 25%.

And then on top of that, I know that you guys don't manage sales to TCV anymore and it's not -- you don't quite manage it to ACV.

But kind of it's still a little bit of a combination.

Can I jump in?

I might have -- Steve, I might have bumbled.

I meant to say -- I've stopped talking about TCV percentages entirely, because we've got -- we've worked to get our company off of it.

So read my TCV comment, if I did make it, as an ACV comment.

Total -- to clarify, total ACV, Steve.

So Alan's 20% was total ACV, which is license, cloud and maintenance.

We don't measure TCV anymore in that way.

So that's an important clarification.

But sorry to interrupt you.

Okay.

No problem.

No problem.

So you said new license and cloud commitments grew by over 25%.

And now we know perpetuals were down, and I can see that from the Q, and that's understandable.

How do you think about the growth of your new business?

And in particular, I'm thinking about in terms of the ways that you [quoted] your salespeople.

It looks like it was a pretty stellar quarter.

How do we get our arms around that?

And I guess, a related question would be, that new disclosure looks really helpful.

Do you have a sequential compare for that, a Q1 compare possibly?

So let's -- I'll take those in order.

So a question that is an easy one to answer, that actually touches on your first one is that you might say, were your -- would your commission payments to our sales team, which is an indicator of kind of that bookings question that you asked, would they have increased by the 25%?

And the answer would be yes.

There is a correlation there with the amount of business activity and how we've motivated our sales team.

So it's not a precise number that, because of the way that we comp our team, we get -- we don't give a direct ACV.

We also encourage a small bonus for multiyears for additional years.

But yes, there is a correlation to our business activity growth being in kind of that 25% range.

So that was your first question.

The second question, sorry, repeat the second question again.

I was just wondering if you had a sequential compare possibly for that new disclosure, which looks very helpful?

Sorry, yes.

So I -- so we don't, and the reason being is that when we first did the disclosure at Q1, we did it with -- which was the -- was only deals more than 365 days, if you remember.

And when we got the feedback with that -- although that is technically permissible, that really wasn't useful.

And so we improved the robustness of the disclosure in Q2, but we didn't have the ability to go back and recreate that.

But going forward, you'll get it.

Yes, you'll get it going forward though every quarter.

Okay, great.

And if I may, one follow-up for Alan here.

Alan, you spoke about the fact that the reps now have a slight incentive to tilt towards cloud.

Clearly, clearly, the market is favoring cloud as the migration to cloud in terms of new apps for sure.

But your mix shift has changed radically, and clearly, there was a demand for your cloud solutions.

Is it simply a matter that Pega unlocked the keys to selling cloud for the sales force?

Or also are there factors related to anything you've done with your product or building customer references or greater use of cloud in production environments as opposed to just dev test?

What's driving the mix shift this year beyond the sales methodology?

Yes, I think we've become in the last, I would say, 12, 18 months, much more focused on developing and maturing and growing our ability to talk cloud at state-of-the-art levels.

We've hired and are continuing to build out a very, very robust cloud-skilled and cloud-knowledgeable people.

And frankly, that's helped a lot as well.

Before we were not as aggressively in that business as we are today.

We're going to continue, we're going to stay, we've got a lot of customers interested, signing up, et cetera.

So I don't think it's just been a change to the comp plan in any stretch of the imagination.

And we didn't do anything diseconomic, like I know some companies have done.

We just don't do that stuff.

But we have greatly deepened our skill set.

We announced -- on a previous call, we announced we brought a fellow named Frank Guerrera, who is a really well-noted leader, and at this point, a little over a year ago.

And I think he has and is continuing to really deepen our bench there.

So I'm excited about that.

Next we'll go to Greg McDowell from JMP Securities.

One for Alan and one for Ken.

First, Alan, I was at your user conference, had a great time once again.

And I'd love to ask about Infinity and how you think your investors should track the progress of Infinity?

I mean, ultimately, I know it's not necessarily a separate SKU.

But do you think in the medium term or long term, Infinity will lead to sort of higher ASPs on a per user basis or a per case basis and will it allow you to just basically extract more value from your customer base?

How should we track it?

How should we think about it?

Yes, I think it will.

I think that it will both let us get more value and also compete more effectively in lots of settings.

Some of the things I mentioned, which you would've seen at the conference and I think are really highly distinguished, is that we enable -- because we have this real commitment to architecture, we enable things like robotics, which is trendy these days, though frankly a lot of it doesn't work that well.

Robots that can get data out of systems, robots that can do natural language processing of e-mails.

Those are seamlessly put together in Infinity with the rest of the insight we offer and the customer engagement, et cetera.

And the reality is a lot of the other products out there are really very much pieced together, collections of clouds that have been renamed.

We think Infinity has really this future-looking architecture, gives us just a lot of additional juice in both directions.

I also think that frankly, irrelevant to whether this is a stellar quarter or not, I think we can do a lot better and I think we should be doing a lot better.

And that's what this year and next year are going to be all about, being able to realize some of the return on investment on our technology by actually putting it in customers' hands and having them be more successful.

Great.

And Ken, one for you.

I mean, you pretty materially beat my ACV estimates, and so kudos on that.

I know the headline numbers often are -- don't accurately reflect what's going on in the business.

But I guess, my question is, I really want to just steal your words, improve the robustness of my modeling for the second half of the year.

So how can you sort of help us improve that term license, perpetual license breakdown?

And how we should think about maybe seasonality for the back half of the year?

I mean, it was very helpful to see the recast for 606 on a quarterly basis for last year.

So I guess I'm asking, what are the landmines -- potentially the modeling landmines in the back half of the year we got to watch out for, whether it's 7-digit or 8-digit renewals in term or just anything we should be super careful of?

Okay.

So I'll kind of use this as maybe to reiterate something that we talked a little bit about at Investor Day.

So Q4 is always a larger -- has always been a larger new business activity quarter.

So -- you know that, right?

So just keep that in mind.

Q3 and Q2 tend to be about the same level of business activity in our space.

Now naturally, sometimes there is a variance there and sometimes Q2 is stronger than Q3.

But if you see the kind of business activity that we saw in Q2 and you see the kind of cloud percentage that we saw -- that Q2s and Q3s don't look dramatically different.

I think the question and the wildcard for you to model and for us to model, quite frankly, is the percentage of cloud.

Because that is just not -- we are not at a point where we're able to say that, that will be 40 or 50 or 30 or 60.

It's just -- it's challenging because customers have choice and they make decisions right up until the last part of the sales cycle around their decisions.

In terms of unusually large renewals that might sneak up on you, right, because that -- which is another factor that you mentioned, 2018 is not a large renewal year as scheduled.

Now we could have a large amount of term deals that might translate into revenue in the back half of the year, that will depend on our business activity, of course, but this isn't a year where we have a disproportionate amount of renewals.

I would say, '18 is pretty much a typical year in terms of renewals, whereas in '17, we had that very large renewal that was -- that made '17 a little bit unusual.

So I don't know how much that will answer your question, but it's kind of -- I'm trying to help connect what we talked about a little bit at Investor Day and now.

I think the biggest wildcard is the percentage of cloud and how much that can change the revenue.

And I think that's why it's important for us to show you ACV, talk about the percentage of cloud for new, give you a directional impact to revenue when there is a 1% shift.

And I'll continue to give as much of that information so that you can kind of make sense of what that revenue variance might be based on the cloud mix percentage.

Our next question will come from Mark Schappel with Benchmark.

Just following on the theme of shifting to the cloud.

Ken, your September quarter is usually a strong quarter for your growing up-and-coming federal business and -- federal government business.

And the government historically has been slower adopters of the cloud.

I was just curious if you could foresee your 3Q cloud commitments kind of reverting back to the 30% range as a result of that?

That's a very good question, Mark.

I would take the public sector out of this answer, because I don't think the public sector makes a difference in this discussion.

I see cloud interest from our customers and clients and our sales team and the market in general as being very robust.

So I would think that cloud would be very interesting for us to sell and for our clients to buy going forward.

Whether 50% from what we achieved in the first half is still achievable in the back half, well, that's to be determined.

But I don't believe that the movement to cloud in the first half is just a onetime thing, and we're going to immediately go back to everything being on premise.

Yes, it's pretty clear that the 30% number that we modeled at the beginning of the year, so more than it was for '17, was just unduly conservative.

That I would agree with.

The federal government space, we're working and investing a lot to get approval for what's called the FedRAMP offering to the federal government.

And to the extent that the federal government has run on the cloud historically, and they have, they bought a license from Pega and then just chose to put it up on one of their private or AWS-type clouds.

When we have FedRAMP, I think we will see receptivity of the government, and we're working very, very hard to try to get that.

Great.

And then Alan, could you just discuss a little bit of a contribution from your channel partners this quarter?

And more specifically, are your channel partners -- are they -- are those deals that they're signing or helping sign, are those shifting to the cloud much more so than the direct deals?

I would say there's not a big difference.

We do have partners attached to 80% or more of the deals that we do.

More often than not, they're not reselling, because typically -- I mean, typically, our customers want to end up having a direct -- we're doing mission-critical stuff, so they want to end up having a direct relationship with us, so that the amount of resale business, I would say, is typically in the sort of single digits.

That, I think, is going to go up on an absolute basis as we go forward with some of our strategies, but I don't think it's going to be radically change.

I think it will just continue to grow with the business growing in general.

If you're doing a digital transformation, we're squarely in that space, and it's a wonderful space to be in.

They want to be able to call up the company if there is something that's going on to really partner with the company.

And so we will continue to see, I think, a strong bias towards direct, even if a partner is very involved in helping us sell it, which a number of them are.

That does conclude our question-and-answer session at this time.

I'd like to turn the conference back over to management for any additional or closing remarks.

Yes, this is Alan.

I'd like to thank you all.

And you should all know we're working very hard.

I do appreciate that the modeling question is just hard to come up with a satisfactory answer for.

I want you to know that we're going to continue to try to improve our disclosures and give the transparency that would let people see what's really going on in the business.

So obviously, it does require a stronger look than it might for some other companies.

I think that if you do take that look, you'll like a lot of what you see.

So thank you very much, and look forward to seeing you all soon.

That does conclude our conference for today.

Thank you for your participation.