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Pegasystems Inc (NASDAQ:PEGA)
Q2 2020 Earnings Call
Jul 28, 2020, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day ladies and gentlemen, and welcome to the Pegasystems' Second Quarter 2020 Earnings Conference Call. [Operator Instructions]

At this time, I would like to turn the conference over to Ken Stillwell. Please go ahead.

Kenneth R. Stillwell -- Senior Vice President, Chief Administrative Officer and Chief Financial Officer

Thank you. Good evening ladies and gentlemen and welcome to Pegasystems' Q2 2020 earnings call.

Before we begin, I would like to read our Safe Harbor statement. Certain statements contained in this presentation may be construed as forward-looking statement as defined in the Private Securities Litigation Reform Act of 1995. The words expect, anticipate, intend, plan, believe, will, could, should, estimate, may, target, strategy, intends to, 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 is 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 2020 and beyond could differ materially from the company's current expectations. Factors that could cause the company's results to differ materially from those expressed in forward-looking statements are contained in the company's press release announcing its Q2 2020 earnings and in the company's filing with the Securities and Exchange Commission, including its Annual Report on Form 10-K for the year ended December 31, 2019 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 will turn the call over to Alan Trefler, Founder and CEO of Pegasystems.

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

Thank you, Ken. Let me say that I'm pleased with our results for the first half, especially given the global pandemic. We are operating at a time of uncertainty and anxiety, and I'm deeply respectful of how our team and our clients are engaging constructively and optimistically, despite the many tensions.

All results reaffirm what we said last quarter, about how we thought the pandemic was likely to affect us and our clients in the near term. Our expectation that digital transformation would remain front and center, even during COVID has held true in Q2. Our business remains robust and we're helped by several major factors.

An increasing percentage of our revenue is predictable and recurring. In the first half, our total ACV, annual contract value, which we consider the best indicator of our improving cash flows and underlying business growth, increased by 21% year-over-year and over 90% of our new client arrangements are recurring. Our Pega Cloud business continues to grow above 50% year-over-year.

We are fortunate that digital transformation is more important than ever. And our strategy is resonating with our clients' prospects. Most of our clients are in industries that are less adversely affected by the pandemic, or ones like financial services insurance, healthcare, government, telecom, instead of more heavily hit areas like hospitality, travel and consumer products. Our clients tend to be large organizations that can withstand the short-term financial pressures of today's market. We have little exposure comparatively to smaller organizations that are unfortunately struggling the worst right now. And we have a very strong cash position with more than $0.5 billion in liquidity to help us weather this storm and continue to invest, where it makes sense for long-term growth.

We have a strong and resilient team that is committed to the success of our clients and to Pega. And as I said, last year, we've navigated through many challenging times in our history. And we've always come out stronger on the other end. Now, in terms of our response to the pandemic, based on what we see today, digital transformation is on everyone's mind. Whether modernizing the customer experience or building the automated connective tissue through the operations of the business. Though we've seen some opportunities put on hold or postponed, other projects have accelerated and some new ones have been initiated. The types of challenges our clients faced a few months ago continued in some cases are accelerate.

For example, meeting like managing avalanches of customer service inquiries, supporting remote workforces or or adjusting to new government driven policies, all are well supported by our technology. While we hope them in the immediate term, we also see their desire to build stronger businesses for the new future. Then new solution we introduced early in the pandemic has been well received and continue to open doors for us. And we continue to improve our software and its core to make it easier for clients to enhance their customer engagement, boost their employee satisfaction, improve their efficiency and reduce cost.

For example, since we last spoke, we launched a number of interesting new things. The first was an Ethical Bias Check, a new capability in the Pega Customer Decision Hub that helps eliminate biases hidden in the artificial intelligence driving customer engagement. We talked about the Pega Process Fabric, a new cloud-based software architecture designed to radically streamline how organizations to drive work across distributed enterprises, breaking down technology silos to unify work across an enterprise and help improve user experience.

We introduced the Pega Customer Service Unified Messaging Edition, a new SaaS based application that helps customer service teams respond faster and more efficiently to customer who's flooding across different channels and do it through a single unified dashboard. And most recently, we introduced a really cool capability called X-ray Vision, the industry's first self healing, robotic process automation capability, able to detect and fix broken box without human intervention that help provide clients with faster and more durable and easier to deploy robotic process automation.

Our products continue to receive strong industry analyst attention. Since we last spoke, Gartner recognized us to be a Magic Quadrant to the CRM Customer Engagement Center and the Magic Quadrant for multi-channel marketing hubs.

Moving to new business, our new business this quarter was particularly strong in our traditional areas of financial services, government, healthcare, insurance and via the industries that Pega really grew up on. I indicated that we expected these to be more resilient during the pandemic and that's what it's turned out to be.

For example, in healthcare one of the largest US healthcare payer organizations recently merged with the leading pharmacy benefit manager. They're using Pega to bridge their multiple customer service environments and to drive service standards at a corporate level. They expect to significantly reduce operational costs, while magnifying the value of the merged operation through their customer base.

In financial services, a large institution serving a customer based in the tens and billions, it expanding its use of Pega, leveraging our AI-based customer decision hub. Building it in the cloud provide customers with a one-to-one personalized experience across the entire enterprise and across multiple channels. The goal is to transform currently disconnected experiences into one-to-one personalized conversation to improve consistently, accelerate speed to market and provide ongoing learnings, all about creating exceptional customer service.

We're also seeing a lot of traction in the governments throughout the world. For example, Her Majesty's Revenue and Customs kind of like their IRS, expanded their use of Pega to transformed the desktop experience for their 30,000 telephone advisors who are expected to handle about 45 million calls this year. Running on Pega Cloud, we're moving from a legacy of inefficient multiple desktop application to an efficient solution that reduces handling time and post-call wrap up and will lead to a better experience without employees and the taxpayer constituents. All while driving huge savings for the UK taxpayer. The new app is already live and being rolled out across the organization to terrific reviews.

Now the IRS, the US analog to the HMRC, was one that I mentioned that we had just won in the last quarter, but we were very excited when this quarter, they announced actually just last week, a new enterprise digitalization and case management office. This new organization was created to spearhead their efforts to empower both taxpayers and IRS employees to rapidly resolve issues in a simplified digital environment.

In the IRS press release, they outlined their goal to stand up a consolidated case management system to overcome the challenges of having casework done on 60 plus ageing systems, most of which I have talked to each other right now. They also noted that the first release with Pega is already well under way.

And last quarter I'm mentioned the state of Bavaria in Germany chose Pega to help them provide faster relief to the small and medium sized businesses impacted by COVID. This was a great example of how we're able to sell, develop and launch apps in record time, even when working remotely. Based on the success of that initiative, our software last quarter was chosen for a much larger project by the German Federal Government to support a new bridging aid program that will replace previous government programs. The new application will be used across all 16 states in the country. These projects are great examples of how flexible our technology is. We can both deliver hyper quickly and be used in serious large scale transformation.

Now, as I mentioned last quarter, we pivoted quickly to function as nearly 100% remote workforce and have been operating effectively this way since March. As you can see from our results, this new working situation has not had a material negative impact on our ability to sell or service our client. In many cases, we're seeing unprecedented access to senior client executives and finally, we can coordinate meetings much faster versus the old days when we had to get everyone in the same place, traveling is such a hassle. We've shown we can effectively onboard new employees even while being completely remote, so we continue to hire more selectively and strategically.

And since we last spoke, we held PegaWorld virtually. And this was the first for and and involved a complete reimagination of the event. We weren't quite sure what to expect. And we're frankly blown away by the results. We have more than 42,000 people register. Now, this compared to a little over 6000, we might have gotten in the in person events. And more than 26,000 attendance, those are outstanding numbers for free virtual events where the industry standard is about 25% conversion rate, we were over 60%. We also know the event drove engagement. As we set a record for page views on pega.com in April, May and June and answered more than 1300 questions through live Q&A during the event. We continue to draw large audiences to our archived presentation.

And we received lots of positive feedback on the format and content that does make it clear that we made the right decision to create an event that was tailored to digital experience, rather than try to move an in-person event online, like a big webinar. In the case you didn't attend, we'd love to hear your feedback and it's all available online and we're converting all of our second half events to virtual and are deep in the process of working through what those look like incorporating what we learn in the first half.

Now, we continue to believe that for us, our partners and our clients, there will be no going back to business as usual. We see in our work with clients and prospects that digital transformation initiatives are of enormous importance. And I personally believe we've got some time to go before we reach any kind of news somewhat predictable normal. But in the meantime, we're well positioned to help our clients adjust to uncertainty while planning for their long-term successes. We're confident we will do much more than just survive this current crisis, we will come out stronger company in the long-term. We're deeply gratified that the continued support of our staff, clients and partners has been at a very high level. It's truly at times like this, that we can see strong character in those we work with. And we are committed to continue to support the greater Pega community and those around us and face very real challenges as a result of this crisis.

So in summary, I'm pleased with our first half results, especially in light of global crisis. And to provide more color on the financial results, I'm turning you over to our CFO, Ken Stillwell. Ken, it's yours.

Kenneth R. Stillwell -- Senior Vice President, Chief Administrative Officer and Chief Financial Officer

Thanks, Alan. I want to express my best wishes for everyone's safety and well being during this unprecedented time. I'm going to start my remarks today by sharing some insights on Pega's response to COVID-19 and a few observations on the impact of the pandemic on our clients, our employees and our industry.

Starting with our customers. To-date, the overwhelming majority of our clients and prospects digital transformation buying behavior has been largely unaffected by the pandemic, while our business has not been negatively impacted in a significant way, we did see a couple of projects delayed or cancelled due to shifting priorities of some client organization.

We also saw a small number of our clients request additional flexibility with extended payment terms to help them work their way through this downturn. Most of our clients and prospects are acting with a new sense of urgency and rethinking what they should do differently in the short-term and in the long-term to build a robust modern business architecture.

As a result, in many cases, our sales teams are getting more access to senior level executives than they ever have in the past. And they are having very effective discussions with dozens and dozens of executives that -- frankly very difficult to coordinate those meetings with travel schedules and the historical bias toward face-to-face in office meeting with senior executives. The good news for us is that, the increased level of executive engagement and solid execution by our sales and marketing teams resulted in a strong Q2, especially given the environment that we're in, these results are exciting to see.

Clearly, many leaders are prioritizing digital transformation projects in a new way, given the structural changes in the way that people are working remotely from home, interacting through digital channels. We continue to be very optimistic about our ability to accelerate our growth based on our increased -- based on increased urgency of digital transformation.

Our employees have done an incredible job transitioning to working remotely. They have been working diligently with our partners and clients, and continuing to execute our strategy. It's been somewhat amazing to see how well our employees worldwide have transitioned to this new way of working. And as Alan mentioned, I don't think that things will ever be the way they were. And there is a lot of positive in that. Our field teams have been engaging and closing deals with customers virtually and digitally. Only time will tell, but what we saw in Q2 may represent the spark of a new way of enterprise software selling. Even after this there is long behind us, we will continue to see a mix of virtual, as well as on-site sales activity.

Lastly, regarding our employees, we are focused on supporting our employees to be as productive as possible when they are working remotely. And we're thinking about the most safe, efficient and effective way that our employees can have access to physical office -- offices when that's appropriate.

Next, I'm going to share a few thoughts on the impact of the pandemic on our industry. The enterprise software industry is going through yet another major disruption. For the last decade, the rise of subscription software has reshaped the enterprise software industry. And in the first half of 2020, we saw clear indications that the pandemic will accelerate the footprint of subscription software given the growth of working remotely and the increased pace of digital transformation.

During our last earnings call, I explained about how our business is resilient and I remain confident in our ability to deliver on our long-term strategy to be the leader in digital transformation. Let me remind you why I feel that way. First, we've been transitioning our business from a largely perpetual software license model to a recurring license model for several years. In the first half, more than 90% of our software revenue was recurring, which is supported by our very high net retention rates. As the growth rate of our subscription revenue accelerated in Q2, and we continue to move away from professional services as a key revenue contributor, as we engage more and more of our partners to support our clients implementing and driving value from our solution.

This shift to recurring revenue is especially important in times like these. The shift means our quarterly revenue and billings should be much less vulnerable to short-term disruptions from situations like the one we're seeing now. That's because the business with a higher proportion of recurring revenue and a lower rate of customer churn like Pega is less resilient -- excuse me, less reliant on new business bookings to achieve its quarterly revenue and billings plan.

Second, the key verticals that we serve; financial services, insurance, healthcare, telecommunications, manufacturing, government are less exposed to the direct impact of the pandemic than other industries, such as airlines, hotels, restaurants and retail. Many of these clients -- and given some of the more challenged industries now see the need for digital transformation like never before. In Q2, we saw solid demand from clients in many industries. In fact, financial services, insurance and healthcare and government made up approximately 80% of our new license bookings for the quarter.

Also, our existing and target clients are the world's largest customers and brands. Many of the globe -- many of these global 3,000 enterprises are better equipped to weather a downturn than small and medium-sized businesses. Small, medium-sized businesses are often the ones that unfortunately struggle most when compared to large enterprises that have strong balance sheet to withstand these short-term economic shocks.

Simply stated, the underlying strength of our large enterprise customer base is a core attribute of our business, that helped us not only weather difficult economic times in the past, but it also helped us grow revenue through those periods. Our large clients, especially in North America were major contributors to our growth in Q2.

Third, we have the liquidity necessary to weather the crisis. Earlier this year, we raised more than $500 million through a convertible debt offering. And as I've said before, whether we were lucky or it was just really good timing and smart planning, February was the perfect time to raise this capital. The available liquidity provides us with the financial strength and flexibility to successfully navigate the market for digital transformation solutions and make the right long-term decision.

Finally, our digital transformation solutions continue to be mission critical to our customers. Our customer engagements suite helps our clients retain their customers. Our Intelligent Automation suite, which includes our industry-leading Business Process Management software helps companies reduce costs by improving efficiency and effectiveness. Our digital transformation solution are even more relevant during times like these, because businesses with robust digital infrastructures quickly adapt -- adapted operations to remote -- to support remote workforces and remote operation.

So now, let's turn to our financial results for the first half of 2020. Especially for those who are new to Pega, I'll start by providing a little more context regarding the evolution of our business model. During our cloud transition, the two most important metrics that we use to track the progress of our strategic execution are annual contract value or ACV and remaining performance obligation or RPO which is also known as backlog.

I'm going to start with ACV. Total ACV is the sum of recurring Pega Cloud and Client Cloud commitments, representing the annualized spend from our clients for cloud, term license and maintenance. Increasing ACV is critical, because it's the best leading indicator for our future revenue growth.

I'm happy to report that ACV increased year-over-year by 21% on a constant currency basis. At the end of Q2, our total ACV was $738 million, up from $611 million at the end of Q2 2019, an increase of an impressive $127 million. The majority of our ACV increase was driven by Pega Cloud, which increased by 56% from $135 million a year ago to $211 million in Q2 of this year in constant currency.

It's exciting to see that Pega Cloud portion of our business received $200 million in ACV for the first time in our history, nearly doubling in size in about 18 months. Client Cloud increased by 11% from June 30, 2019. ACV continues to be our most important metric, reflecting the successful execution of our strategy and while 21% increase is strong ACV growth, we believe there is an opportunity to continue to accelerate our ACV growth in the future. We're investing in go-to-market resources to capture increasing share of our client spend for digital transformation.

Let's turn to remaining performance obligation, or also called backlog, which is another important metric. Backlog reflects the client commitments not recorded as revenue as of the period reported, providing visibility into where a significant portion of our future revenue and billings will come from. A robust backlog is another benefit of our cloud transition. Historically, some of our bookings were taken as revenue in the current period, which caused variability in our quarterly results. These days, the largest portion of our bookings are cloud, most of which goes into backlog, creating a more predictable revenue and cash flow stream in the future.

Pega Cloud backlog increased 26% from $362 million as of June 30, 2019 to $457 million as of June 30, 2020. And total backlog increased by 30% from $628 million on last June 2019, to $817 million as of the end of Q2 2020. This increase is especially impressive because our backlog tends to grow at a slower pace during the middle part of our financial year due to the higher concentration of business activity specifically occurs in the fourth quarter of the year for software -- for enterprise software companies.

Turning to revenue. Total revenue for the first half of 2020 was $493 million, an increase of 18% from total revenue in the first half of 2019. And that was driven by 55% increase in Pega Cloud. As we were in a cloud transition, the impact of the cloud shift on revenue growth is really important to understand. We've been moving away from perpetual license bookings, replacing large upfront cash and revenue with cash and revenue that will be received and recognized over many years.

During the first half of our cloud transition, revenue growth was a lagging indicator because subscription revenue was recognized over time versus perpetual license revenue, which is recognized upfront. Given that since 2017 we focused on ACV growth, which is that leading indicator of successfully executing our strategy. Now that we've passed the midpoint of our cloud transition, revenue in ACV growth have started to converge. And we continue to do so during -- and we'll continue to do so during the remaining two years of our transition.

In the first half, our success in closing new and expansion Pega Cloud and Client Cloud deals drove our growth in term license, cloud and maintenance revenue, which make up our recurring revenue sources. Total subscription revenue for the first half of 2020 increased by 38% year-over-year, soaring from $270 million to $373 million, a leap of $103 million.

Professional services revenue declined about 6% or just under $7 million for the first half of 2019 compared to the first half of 2020. It's important to note that more than half of this decrease or nearly all of the decrease for the quarter was due to the reduction in reimbursable billable expenses for travel, as our service teams are executing project work at our client location. Additionally, a few of our professional services engagement were not able to be done remotely, which has impacted our professional services revenue. In the first half of 2020, Pega Cloud mix was about half of our new client commitments consistent with our expectation.

In total, over 90% of our new client commitments were either Pega Cloud or Client Cloud, with the remaining being perpetual license arrangements. For the three months ended June 30, 2020, we reported both GAAP and non-GAAP results. And a full reconciliation of all GAAP to non-GAAP measures are provided in the financial tables in the press release that we issued earlier today. And those numbers are also available on the Investor Relations section of our website.

Non-GAAP net loss was $0.28 per share, compared to a net loss of $0.30 per share a year ago. Much like revenue, net income will be less impacted as we exit the cloud transition over the next couple of years. We remain very confident that the long-term benefits of recurring business model, including a more predictable future revenue and cash flow stream far outweigh the skewed short-term optics around reported revenue and the impact of near-term cash flow and reported EPS.

So, let's turn to a few other details. You may recall that we had a successful convertible offering in the first quarter. Pega finished the period -- the second quarter with total cash and marketable securities of $512 million on June 30, 2020, compared to $538 million at the end of the first quarter.

During the first quarter, we returned -- during the first half, excuse me, we returned about $48 million to shareholders, comprised of dividend, buyback and net settlements and equity. We ended the quarter with just over 5,500 employees worldwide, an increase of about 13% from one year ago.

We are very disappointed that we couldn't provide a strategy update during PegaWorld, but we have decided to hold a Virtual Investor briefing on Tuesday, August 25th. As you can probably imagine, this will be virtual and it will be an update on the progress of our transition to be an as a service business. If you're interested in joining that session, please email Pega Investor Relations at pega.com.

In conclusion, at the mid point of the year, we're very pleased with the way our business is performing. As we look ahead, we acknowledge that there's increased uncertainty in the current environment for all businesses and we are certain to face obstacles of our own. However, we believe that Pega remains unusually well positioned to continue delivering on the strategy to be the leader in digital transformation.

And with that, operator, we're ready to take questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] We'll take our first question from Rishi Jaluria with D.A. Davidson. Please go ahead.

Rishi Jaluria -- D.A. Davidson -- Analyst

Hey, guys. Thanks so much for taking my questions, and nice to see some continued strength in the business. Wanted to start out with -- maybe, if you had any update on some of the hiring plans, especially when it comes to new sales reps? And alongside the sales rep side, you have been hiring over the past year, two years. Just how are you feeling now in terms of sales coverage and [Indecipherable] those sales reps?

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

Well, I can answer that. You blanked out a little bit, but I understand your correction. You're asking how we're feeling about the sales reps and tenure and who we are hiring? I think that the increased sales force has been able to do two things. One, I think it's given us greater reliability, which proved really to be extremely helpful during this pandemic, because you have a lot more, what I would describe as sort of a account engagement than sort of trying to bounce off customers if you don't have enough reps to fully cover them. And on top of that, I think we've demonstrated that we've been able to grow as a result of hiring new sales reps.

So the thing I'm pleased about is that I believe our on-boarding and our education have really moved extremely effectively to this remote environment, both for our sales teams and for the other folks that we are hiring. So I think we're going to continue to be able to develop productivity, effectiveness as we grow the sales force. And also looking to make the sales force we have more effective to do.

Rishi Jaluria -- D.A. Davidson -- Analyst

Okay. Great. That's helpful. And then, wanted to get a sense of, as we look at the strong ACV growth that you've been putting up so far this year. I'm just trying to get a sense of -- is there anything from customers that indicates that there has been some pulling forward of projects or IT budget in the back half of this year, into the first half? Or is it just been kind of tracked relative to plan and the pipeline growth for the back half of the year looks so strong [Indecipherable] so far this year.

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

I haven't seen a lot of evidence that people are going to sacrifice their second half for their first half. I actually see more -- the people canceled things that they didn't think were critical just throughout the year, so that they could maintain their focus on things that aren't critical. Thankfully, the digital transformation stuff we do, I think tends to fall more into critical bucket. Both the immediate stuff that we can do to get something off the ground, but also the fact that we can offer people a path to a well-architected long-term effective solution. So, I've no basis to evaluate and start to see the second half problem like you might hypothesize.

Rishi Jaluria -- D.A. Davidson -- Analyst

Great. That's helpful. And last one from me and I'll jump off. But Ken, in your prepared remarks, i.e., you did mention that there were some services projects that can't be done remotely. Can you give us a little bit more color on what is preventing that from happening? And then, maybe some color around that, what does that mean, right? Does that mean that this is for deals that were already closed? And it's just the time until the customer goes live, shift out? And does that mean revrec for all the closed deals? Maybe just a little bit more color around, that's ling of helpful. Thanks.

Kenneth R. Stillwell -- Senior Vice President, Chief Administrative Officer and Chief Financial Officer

Sure, Rishi. So, I would say that, just to clarify, it is very rare that we will see a client not be able to support a remote professional services work. I mean, it does happen. I mentioned that because in full disclosure, it will happen now and again. But it is not something that is common and it is certainly is not happening in any big way. But I would even tell you that I actually am surprised that how well people are able to work remotely. So, I would say, in general, I think the environment is quite frankly better in terms of kind of effectiveness that I would have anticipated back in March.

But that said, some clients are not as comfortable, don't have the technical infrastructure. Culturally, may not be as effective at working remotely. And quite frankly, those are many time the clients that actually are the most that need for digital transformation. So, I do think it does happen. And I feel like just in the interest of full disclosure, we should mention that it can happen, but it's certainly not something that's happening often.

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

So, I think that's a good point. I mean, it's not just us that need to be able to work remotely, which I think we've demonstrated we can do at scale. The client participants in those projects also need to be able -- they need to be comfortable working remotely. But as Ken said, this is not a material part of the business.

Rishi Jaluria -- D.A. Davidson -- Analyst

Wonderful. That's helpful. Thanks, Alan and Ken.

Operator

We'll take our next question from Chris Merwin with Goldman Sachs. Please go ahead.

Chris Merwin -- Goldman Sachs -- Analyst

Okay. Great. Thanks so much for taking my questions. I wanted to ask a bit about the use cases for new product. Of the deals you're winning or even those that are in the pipeline, are you starting to see some different use cases for the low-code platform, particularly in light of how many customers seemingly are looking to digitally transform key systems [Indecipherable] impetus might not have been in place before. So, just curious if there's been any evolution there that you've seen more recently.

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

Well, I think the evolution has been that -- which, I view as encouraging is that a number of organizations have realized that even the things that they didn't think were problems actually are problem. And so you're able to have more engaged conversations with senior people about how they actually create a digital transformation strategy, whereas a lot of times I think before, there was a little less of the strategic focus. So being able to both do the low code, high-speed deliveries, but also have those strategic conversations, I think puts us in a pretty advantaged position.

As you think about how we describe, what we do, we do basically customer engagement, that's work involving expert systems and artificial intelligence that generally help make good decisions. We provide process automation to drive that work to done. And then we provide an environment that makes that work across channels and across different back end systems. That is a recipe that is strongly beneficial for any organization trying to do a transformation.

Chris Merwin -- Goldman Sachs -- Analyst

Okay. That's great. And just one other question if I could. Ken, it looks like the backlog actually accelerated from 20% growth last quarter. So, I think 30% growth this quarter. Can you talk a bit about what caused that big step up? And any other color you could share about the cadence in bookings as you move through the second quarter and even into the month of July so far?

Kenneth R. Stillwell -- Senior Vice President, Chief Administrative Officer and Chief Financial Officer

Yeah. So Chris, couple of things that are interesting. The first thing that's interesting is that, as we hire more accounting executives and actually get into a stronger cadence with our clients around faster deal cycles and really getting started with Pega Cloud and accelerating off of that, kind of that minimum level of product, as you might call it, to be able to not -- and reduced the kind of the deployment cycle of our clients as they are in cloud. What you see is, you see more business activity moving throughout the year. Meaning, everything isn't just Q4 deal that's really large as a whale that's kind of long-tail at the end of the year. So that's one promising thing around this Q2. This was by far the strongest Q2 that we've ever had. Now, you would expect that as we're growing and it was a very solid Q2, especially given COVID.

Second thing is, it's a demonstration of our duration of contract lengths holding up, which is really a sign that clients are continuing to think about their investments in Pega on a very long-term basis. Now, we are not -- we actually are not encouraging our sales teams to extend the life of contracts. But I think there was some -- there's always some focus around when you sell fast, when you sell cloud the duration compressed and therefore, cause a less efficient selling cycle, if you're selling one-year versus, say, three years. But I think what you're seeing is that, not only is the business activity up, but the durations are holding very steady and specifically around Pega Cloud. So it's just a really great sign of our retention rates, the continued investment and the momentum of Pega Cloud.

Chris Merwin -- Goldman Sachs -- Analyst

Great. Thanks very much.

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

Thanks, Chris.

Operator

We'll take our next question from Steve Enders with KeyBanc.

Steve Enders -- KeyBanc -- Analyst

Hi. Great. Thanks for taking my question, guys. I just wanted to check on, I think it was last quarter that pipeline was up really strong year-over-year. I'm just wondering where pipeline stands today and how the top of funnel performed as you moved through the quarter.

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

Yeah. Pipeline is still strong. The pipeline we have doesn't move around that much during the quarter, if you think about it. But we still -- we still see plenty of opportunities. Primarily with customers, we've had some contacts with. They look at their large customers, small customers because this environment here makes it much harder because we are aiming into lots of small businesses, but we have lots and lots of runway at our -- our top 10 customers have enormous amount of additional ACV opportunity as we continue to perform well for them. So the pipeline is not a concern at all.

Steve Enders -- KeyBanc -- Analyst

Okay. Got you. That's helpful. And just want to check, we've been hearing from some other vendors have reported so far about incumbency being a real differentiator in the quarter and ability to get deals. Just wondering how you're seeing the environment today to either capture new customers or to take incremental opportunities within your current customer base?

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

So, I think incumbency is helpful. And incumbency in very large organizations that are well suited to what we do is doubly helpful. I think if you're selling a product, if you are selling an HR system or something where they can only buy one, obviously incumbency can be a limitation. There's so many ways that these organizations can continue to apply what we do.

That -- we are having and I'd actually say the strategic conversations accelerated in the last four, five months in terms of where we want to go together with our partnership. So incumbency definitely helps. And as sometimes we worried that we were to sell out the world's biggest companies that we're in. And the answer to that is, not remotely. There's is so much upside, because we've never been a company to sell these stupid enterprise licenses to a lot of clients without it being reasonable. That's just never been in our DNA. So, we have real upside as we continue to perform [Indecipherable] us to do that.

Kenneth R. Stillwell -- Senior Vice President, Chief Administrative Officer and Chief Financial Officer

I would add another piece of color on that, Steve. As we think about, Pega's business traditionally, about two-thirds to 75% of our bookings each and every year come from our existing clients. So certainly, incumbency has led to lots of Pega growth over time, but it's really important to have a balanced view. You have to really cover those incumbent organization, so Pega can continue to further penetrate to Alan's point.

But that said, we generated a lot of new logo growth as well in the first half. And so, I don't think that all of the business was just going to be incumbent. So, I do think that that is -- certainly, it would skew incumbency in a time of any economic pressure or stress. But I do think our opportunity to both continue to enrich the relationships that we have with our existing clients, but also gather very large and significant logos as we actually build kind of new fertile ground to continue to expand. I think the opportunity for digital transformation really provides that. So, we've always been dependent on continuing to sell to our clients. But I think that we've also generated lots of new relationships in the first half as well.

Steve Enders -- KeyBanc -- Analyst

All right. Great. That's very helpful. I will pass it on.

Operator

We'll take our next question from Mohit Gogia with Barclays. Please go ahead.

Mohit Gogia -- Barclays -- Analyst

Hey, guys. Thanks for taking my question and I'll offer my congratulations on the solid quarter despite the pandemic. The first question is for Alan. I wanted to dig more into the federal vertical. So, you guys have previously discussed that being your fastest vertical last year and obviously, some impressive wins you have outlined through the first half. So wanted to see what is working well there, right? I mean it tends to be a competitive landscape, not just in the software for BPM, but also in the broader enterprise software with a lot of red tape, right? So, just wanted to dig in as to what is working there and whether you can use that table for maybe sort of like increase your penetration and increase your growth rate in some of the other [Indecipherable]. And then I have a follow-up question.

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

Let me make sure I understood, which vertical you were asking about because you are sort of cut out. If you just...

Mohit Gogia -- Barclays -- Analyst

The Federal vertical.

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

The Federal vertical. Yeah. So look, we were not very deep in Federal, if you go back five years and it's been absolutely terrific. And it's to my mind, only getting better. It was not just the recently announced big IRS, where you can imagine the sort of competitive environment around some of that is key. But if you think about all the other parts of the government that we're working with, from defense to being the system that the US Marshals chose to modernize. the desire to try, to try to to create efficiency, that's huge and we're seeing it not just in the government of the US, but we're also seeing it in places like Australia, as I mentioned. And we talked earlier about the UK.

So, that is an excellent vertical for us and we are doubling down on it. It's a great place to be able to put additional selling resources and also to build the right partnership, because those are so important when selling to government. So we're thrilled. And even in places -- I mentioned the German Government, for example, another example of a new logo for us. And also worked with the government of France. So, we're seeing a lot of stuff in a lot of place.

Mohit Gogia -- Barclays -- Analyst

Thank you. So the follow-up question for Ken. So, you alluded to that, obviously, 21% ACV growth, I mean, despite the pandemic is pretty strong when some of the other vendors are feeling some of the hit from COVID-19. But you also alluded to that there is an opportunity going forward to maybe accelerate that ACV growth, right? So I was wondering if you can dig into some of the vectors that you think are maybe in the near to mid-term are more important when it comes to opportunity to accelerate that?

I think you mentioned that two-third of the ACV growth were out of new bookings from existing clients. So, how was the expansion rates and upward trajectory for expansion rates maybe it's one vector. But just wondering if you can drill into the business vectors, please. Thanks, guys.

Kenneth R. Stillwell -- Senior Vice President, Chief Administrative Officer and Chief Financial Officer

Yeah. Sure. So, I'll mention a couple of things that I think are interesting. The first thing is, if you look at our net retention rate, if you kind of reverse engineer our net retention rate with the 21% ACV growth, our net retention rate is somewhere in the 1.13% to 1.16% kind of range. So if you just think about that as a 113% to 116% net retention or net expansion on year-over-year for our existing clients. If you take that percentage and you think about the impact of digital transformation and the fact that we, even in our largest clients, we're not even 10% or 20% penetrated on what we could sell them, that really ties to our strategy around density of hiring account executives and really further creating relationship kind of equity around the largest organization, making sure that we're covering the different buyers of the different business units and further penetrating. That's a tremendous opportunity.

Another example of an opportunity is that, you just asked about early, the Federal space. Even just looking at US Federal state, that vertical is so relevant for Pega, they're going through digital transformation, the government is looking a cloud first, which is that much more relevant for Pega now with our strategy over the last few years of really pushing as cloud being our primary go-to-market. That vertical is one of the emerging and fastest growing, but still not 10% of Pega's business yet.

So if you think about that as an opportunity and ignore new logos and all of the other opportunities across the business, we could accelerate our ACV just on those two dimensions noticeably. So, I think that's what exciting as we have so much opportunity with our existing installed base, our existing client base and then we have these verticals like a Federal vertical, that's just one country. It's just one buyer really within that country. And I think there's just a tremendous amount of opportunity. Our wins at defenses, our wins at IRS, really just demonstrating how credible we are in that space, even with being relatively -- that being a relatively less mature vertical in terms of the growth rate.

So, I think that there is just opportunity like that in all the countries and other verticals. But I'm just giving you a sense of why we believe that we can accelerate our growth rate and we want to continue to invest in that.

Mohit Gogia -- Barclays -- Analyst

Okay. Thanks, guys.

Operator

We'll take our next question from Yun Kim with Rosenblatt. Please go ahead.

Yun Kim -- Rosenblatt Securities -- Analyst

Thank you. Hi, Alan and Ken. Congrats on a very solid quarter. Obviously, Pega Cloud had a spectacular quarter. Sequentially, ACV for that business, I believe was up record amount. Just want to talk more about the trends that you're seeing in that particular business. And what are the trends around the deal size? Are customers making bigger commitments or was the strength driven by higher deal volume? Any trend that you're seeing between new and existing customers for the Pega Cloud business? Thank you.

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

Ken, I'll let you answer statistically. But this really -- the business is coming across the entire continuum. So it wasn't driven by a couple of monster deals. This was exactly like you wanted. But Ken, do you have more specific?

Kenneth R. Stillwell -- Senior Vice President, Chief Administrative Officer and Chief Financial Officer

Yeah. Well, I can give you one measure that will answer your question, Yun. It's the average deal size of Pega Cloud versus the average deal size of Client Cloud was largely the same for the first half of the year. So that might -- that's probably -- that metric probably answers your question. We're not doing lots and lots of small clients. And we are not doing just a small number of very large ones. It's really down the middle Pega Cloud.

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

And remember, that between Pega Cloud and Client Cloud, that's over 90% of our revenue. So, that's really -- that's the business, the leftover business perpetual from whole contract aren't -- as they shouldn't, aren't driving our business and you can see that in the percentage of revenue of perpetual going down, which is what we like as that happened and the recurring revenue and recurring commitments going up.

Mohit Gogia -- Barclays -- Analyst

That makes sense. And Alan, obviously, the digital transformation secular trend is definitely resonating with your business. Can you update us on traction with the large global system integrators? Obviously, of the -- do they also embrace digital transformation initiatives out there?

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

Yeah. I think they're definitely extremely interested. We are engaging with them and sell them the relationships have really deepened. I will point out that in just the last three, four months, we've actually brought in a new head of Pega Ecosystem, a very experienced woman who brings tremendous background in terms of being able to build those relationships with those -- particularly the large SIs. And the new leader of our go-to-market, which we announced just started June 1, Hayden Stafford, also has a tremendous background working with both Salesforce and Microsoft Dynamic CRM and building extremely material relationships with partner organizations. So we are committed to the partners. I think you're going to see that being an increasing area of emphasis. And I think there's a lot of leverage to come up on that as well.

Yun Kim -- Rosenblatt Securities -- Analyst

Okay, great. Good to hear. For you Ken, in terms of the current model transition, we are seeing Pega Cloud accelerate versus the Client Cloud. Would that affect margin at least in the near term? And also, how should we think about margin benefit coming from the total revenue now that, that line is going to start growing faster given that the model transition has passed the midpoint?

Kenneth R. Stillwell -- Senior Vice President, Chief Administrative Officer and Chief Financial Officer

So the Pega Cloud -- as Pega Cloud continues to accelerate, you do have some variable costs with Pega Cloud, but you get a much bigger operating leverage or operating lever as Pega Cloud gets larger. So net-net of that change, the combination of those two factors, I think, will not impact our margins positively or negatively as Pega Cloud. A little bit more variable cost, but also better operating leverage and operating scale efficiency.

Well to your second part of your question, which is, what should happen over the next couple of years? Look, when you get through a cloud transition, you wash away all your perpetual revenue at the beginning, and it takes you a series of years to build that back in the business. And so normally when you start a cloud transition and you end the cloud transition or start a recurring transition, end it, your margin profile look similar when you start and you end, because once you end it, that's when the operating leverage could really be exhibited on the business model. And so we will exit this transition in 2022. So between now and 2022 and beyond, you'll see improvement in our operating margin each and every year. So we kind of get some more of that timeless model, which will still be out in like, say, the 2023 time period. So you should see operating margin improvement and operating cash flow improvement, it gets kind of better each year that you go through it now that we're past the hardest point.

Yun Kim -- Rosenblatt Securities -- Analyst

Great. Thank you so much.

Operator

We'll take our next -- I'm sorry. Go ahead. Okay. Sorry about that. We'll take our next question from Mark Schappel with Benchmark. Please go ahead.

Mark Schappel -- Benchmark -- Analyst

Hi, good afternoon. Thank you for taking my question. And nice job on the quarter, very nice job. So Alan, starting with you, in your prepared remarks you touched on your new messaging solution and the RPA X-ray business solution, I believe. I was wondering if you could just go into a little more details on those two products and how they differ from other solutions in the marketplace?

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

Sure. I didn't hear the first one. Once again, my line is a little choppy. What was the first of the two you asked?

Yun Kim -- Rosenblatt Securities -- Analyst

So in your prepared remarks, you touched on your new solutions. One was a new messaging solution. And another was, I think, it was called RP X-ray Vision. I was wondering if you just go into a little bit more detail.

Kenneth R. Stillwell -- Senior Vice President, Chief Administrative Officer and Chief Financial Officer

No, I got it. I got it. Thank you. I just wanted to make sure I heard properly. So we selectively acquire companies and bring them into the mix and weave them in to what will be a cogent solution for our clients. And both -- so last year, we bought a company called In The Chat, which brought very, very sophisticated messaging technology and also actually brought a great leader who is the GM, general manager, now of our customer service business into the company. And this represents the rolling out of that technology as part of the platform. And it really is a perfect example of where communications technology and process automation technology really go hand-in-hand together. And it demos beautifully, and there's a lovely augmentation to the system.

You may remember several years ago, we bought a robotics player, a company called OpenSpan. And we've integrated robotics into what Pega offers, in frankly, a completely different way than the robot-first type people, who I think is -- it's interesting Gartner put robotics into the truck of disillusionment a couple of months ago because robotics projects turned out to be incredibly fragile, particularly when people start putting lots of business logic in the robots. But what we're able to do with our solution is to be able to make them way less fragile by keeping the business logic where it belongs on the robotic channel, but in an omnichannel sort of position in the center of their business. And then just using the robot when you have to go the last bit if there's not an automated interface.

And this X-ray capability actually takes that architecture, which we already established, and makes it tremendously less fragile, tremendously more able to self-heal even if the back-end systems change, it doesn't break the robots. The robots actually understand how to find the right data and do the right thing. And I just think it's another example of bringing great technology to the outside, but making it even better by leaving it in to a service background and AI background. Does that make sense?

Mark Schappel -- Benchmark -- Analyst

It does. Great. Thank you. Helpful.

Operator

And we'll take our final question from Steve Cowing [Phonetic] with SMBC Nikko.

Steve Cowing -- SMBC Nikko -- Analyst

Great. Hey, thanks for squeezing me in. And I'll add my congratulations on the quarter. Just one financial question then one follow-up. Ken, maybe can you just help connect the dots on how the numbers, trying to get on looking at the cloud percentage of new commitments was 50% for the first half in total, I think it ran maybe a little high in Q1, so maybe a little lower in Q2, but cloud ACV accelerated sharply. So just maybe help me understand that. And then I got one more specific question for you guys.

Kenneth R. Stillwell -- Senior Vice President, Chief Administrative Officer and Chief Financial Officer

Yeah. So the cloud ACV did not accelerate because of a mix shift, which is you're right -- I see where you're going with the question. So you're right. It was just that the bookings were strong in Q2, which actually -- and the percentage of Pega Cloud was high enough such that it led to an acceleration.

Steve Koenig -- SMBC Nikko -- Analyst

Okay. That's helpful, Ken. And then just my last question. I'm curious, maybe just on your initiatives that you embarked on a couple of years ago now to improve deal velocity. And Alan, you made a reference to some of the low-code deals earlier. How is that coming? I hear you that the arrangement is steady, and that's a good thing, but wondering about deal velocity. And then I'll just add as well, any color on any major competitive bake-offs in the quarter as well? And that's it for me.

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

Sure. So look, we're working in a highly competitive world. So every piece of business we're winning, somebody else is losing. So that's just the way it goes. And we show very well competitively, particularly in the sweet spots, which I think our view on low-code goes all the way back to our original vision of being a model-driven platform. The places where we just, I say, pretty solidly win is when the company does not want to adopt low code as a series of little stand-alone islands, little department things. But they'd like to give those department and the business users the power to be able to drive change, while at the same time, having something that can scale to the enterprise and really support the right sort of standards of security and other sorts of things.

You might remember years ago, Lotus Notes, with kind of the low-code system of its day. All of those systems are either long dead or considered just dreadful technical dead. That's what we -- when somebody remembers those stories or knows about those stories, that's when we consistently, I think, are highly, highly successful. So my view of the low-code app factory for a business. So there's not a bunch of tiny little systems hanging around, but it's really a way to think about the enterprise, that's when we are enormously advantaged. And frankly, I think more and more enterprises are used to that. So I understand that was the last question?

Steve Cowing -- SMBC Nikko -- Analyst

[Speech Overlap]

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

So with that, I know that we've gone beyone one hour. Let me just wrap up by saying thank you to all the investors that have been interested in us and stood by us as we've gone through these incredibly hard times. The Pega team is working extremely diligently. I think we're working well with our clients. I think we all need to have a level of care and patience to make sure we're getting through all of this. And I'm thrilled that this has, I think, tested our team and made -- and shown it to be extremely strong. And whatever happens in the future, we need to continue to build on that strength. And we'll be working hard on your behalf. So with that, let me say thank you, and have a great evening.

Operator

[Operator Closing Remarks]

Duration: 62 minutes

Call participants:

Kenneth R. Stillwell -- Senior Vice President, Chief Administrative Officer and Chief Financial Officer

Alan Trefler -- Founder, Chief Executive Officer and Chairman.

Rishi Jaluria -- D.A. Davidson -- Analyst

Chris Merwin -- Goldman Sachs -- Analyst

Steve Enders -- KeyBanc -- Analyst

Mohit Gogia -- Barclays -- Analyst

Yun Kim -- Rosenblatt Securities -- Analyst

Mark Schappel -- Benchmark -- Analyst

Steve Cowing -- SMBC Nikko -- Analyst

Steve Koenig -- SMBC Nikko -- Analyst

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