Good afternoon, everyone. After lunch here, we have Pegasystems. We're lucky to have here the CFO and COO, Ken Stillwell.
Hey, Tom.
We have the Head of IR here in the front row, Peter, if anybody has any questions or wants to rush him here in the front here. So, you know, maybe just jumping right in, Ken, to you know, the most recent quarter, especially on the profitability side, it seems, you know, the $500 million annual free cash flow guide that you gave at the investor session in June 2023 seems to be approaching us. I don't want to intimate anything, but it when you're guiding to, was it $350 million?
Yep.
You know, we're approaching that a little maybe a little bit sooner than expected, but I'd like you maybe to just talk to that and what are you seeing in terms of the macro that's driving business here?
Sure. So if you, if you went back and looked at investor decks that we had from, like, 2017, right, when we first actually embarked on the subscription transition, you'll kind of see this kind of concept of how we wanted to move to Rule 40 and where we thought we might be able to land and the range. And you can kind of reverse engineer back in to see what kind of cash flow number that would be. Now, we thought we would be done with the transition when we started 2023. And the reality is we'll be done with the transition probably when we end 2024. So we were off by a year to two years. Some of that was some of that was just the natural risk of how you model. But some of it was that the, the transition kind of became a two-step transition.
It was a transition to subscription. And then kind of right when that started, it actually flipped to a transition to SaaS. And so that kind of did elongate it a little bit. But if you, you know, take the time out, take the timing element out, which was, you know, I think being within a year or two is probably still a pretty good forecast. But we wanted to be a kind of company that was generating kind of $300+ million of cash flow when we exited the transition. We're going to exit the transition. We're going to be generating $350 million. At least that's what we guided.
And now we're looking at the business and saying, "Listen, we think that, you know, $350 million cash flow"—by the way, that's not that's not EBITDA that's not like EBITDA minus CapEx. That's true cash flows. Like direct taxes are in there. One-time items are in there, etc. If you actually add those back, it's probably more like $400 million of free cash flow. And we, we had talked about in our Investor Day, you know, last year about, you know, can we be a $500 million free cash flow generator in a handful of years? So when you kind of, you know, you kind of read into what we said and look at where we are, that's we're talking about maybe 2026 or something like that in terms of and you're looking at a company that essentially is generating $400 million of EBITDA minus CapEx.
To think we could generate $500 million in the next couple of years is, at a company growing low double digits, I think, a reasonable assumption that we should be able to get a little bit more operating leverage. In a business that's, you know, got, you know, the basically every brand that, you know, you'd want as a client, very strong digital transformation spending durability and high retention rates and a lot of expansion with our existing clients. So those are all the dynamics that we feel like really fit well to this subscription transition. The last piece I would touch on, which is, you know, how's business kind of is the kind of that last part of your question is, there's no doubt that technology growth rates, I mean, just look at any chart.
You'll see the growth rate slowed in the last couple of years from where they were in the middle of the pandemic, as happened to us as well. The thing that is interesting is some of that could have just been demand pull forward. Some of that could have been just unusual spend that happened during the pandemic. But what is true, what we have seen, is that our clients are still not where they need to be from a digital transformation standpoint. And the durability of their investment in IT is still pretty strong. So I think the question really is about which projects they pick and where do they get the ROI. It's not about whether they have enough opportunity areas. The question about whether there's a lot of opportunity areas is undisputable. I mean, there is just, it's everywhere.
Question really is which ones do they go after? And I think that's, that's what we're focused on is supporting the clients on picking those helping them think through what's the best options.
Well, I'd love to dive a little deeper into, you know, what these clients are, at least have from and from your view at Pega in terms of what they need to work on. Before we get there.
Yep.
I think it's a segue as well. You got it to 11% ACV growth in 2024. I just wanted to maybe deconstruct that in terms of existing clients, which you're focusing on more, and, new logos. Just a question about visibility one year out.
Sure. We will if we hit our 11% growth, I predict we'll get about 10% of that from kind of NRR from existing clients and about 1% from new logos. The reason why the 1% is it might even be a little bit less than 1%. Just to clarify, even if we got a lot of new logos, we probably wouldn't generate a lot of bookings in that first year. Because the initial deals that we do with clients are typically not, you know, someone doesn't come in and buy a $10 million a year first time they ever did business with Pega. It typically starts more in the $500,000-$2 million. And then it expands over that. So by the time they buy the second one, they would then be in the existing client category.
So our NRR is going to be the driver. And even if we are adding lots of new logos, it's still going to be a big NRR business.
I think maybe in double-clicking on the visibility question.
Yep.
Dovetailing with your insightful comment about clients aren't where they need to be.
Yep.
You, you know, given Pega's expertise and been doing this for decades, what do you think are the top one or two kind of use cases that you think your clients need to be working on and maybe, you know, are even involved in setting bookings for 2024?
Well, I think there's one that they've been working on for a while. I think there's another one that's going to be accelerated from AI, right? So the one that's been the big digital transformation use case that we see is—I'm going to generalize it by calling it orchestration. What do I mean by orchestration? You've got an application landscape that does certain discrete tasks that many times are part of an end-to-end process. So if you think about a loan origination, for example, you've got maybe seven steps that are core steps that happen. You've got an application step. You've got an underwriting step. And these are not applications that are homogeneous. This isn't like an ERP system that the billing and the collections and the accounting all happen in the same system. They happen in different systems.
That needs to be coordinated. It needs to be coordinated from a compliance standpoint, from an intelligence standpoint. It's got to connect to systems. It's got to be real-time. It's got to be able to contain the case. You can do compliance and grouping and analysis later. So Pega really has thrived in the area of working well with other kind of customer-facing applications to be able to really do the heart of the management of the work in that, you know, that end-to-end workflow automation. That is something that clients want to increasingly do because they have disconnected systems. They're doing RPA to screen scrape between systems, which is just not scalable. They have lots of systems they can't build APIs to because they may be legacy systems. They got security issues.
Lots of reasons why you want to try to, you know, kind of contain the transaction flow. The thing, the other area that I think is really interesting with AI is everything around customer service. If you think about the way that clients want to manage customer interactions, they certainly don't want to do it by hiring more customer service representatives and building out processing centers and call centers and having the experience. It's not just the experience is poor because it's variable. Depending on if you get Ken or you get Tom, you're going to get a different experience when you actually interact with the company. That's one aspect. The other aspect is the efficiency play and the demand on resources, right?
Even in a digital post-COVID flex work environment, finding those resources and trying to coordinate where they are through one system, the experience being consistent, is going to be really hard. If you call AT&T and you call back five times, I can guarantee you the experience will be different every time that you actually call them. So we've got to actually our clients have to evolve to where the input comes in, whatever channel, voice, digital. The experience either uses Voice AI or some type of chatbot that actually synchronizes that experience. It uses AI and content libraries to be able to manage the communication, to be able to figure out what the Next-Best-Action , the Next-Best-Offer to process the transaction, to follow up. That all should be done without a person touching it, right?
And so that is where our clients kind of had that dream of getting there before kind of GenAI. But now I think they look at it and say, "What's preventing us from actually executing on that?" And to be honest with you, there isn't a lot that should prevent them. It's just a matter of deploying and managing the technology and, you know, compliance and, you know, customer experience, etc. So I think there's one is that orchestration. The other one is customer service tied to all of the advancements around AI, which is, that's probably the most exciting one that I see.
So these are two, obviously certainly needed, solutions. Pega's addressing these. In my modeling, it looks like the subscription business, the term license business, that you all have, it's about maybe just under 30% of the business.
Mm-hmm.
It is becoming more back-end loaded. As a CFO, how do you manage that? And instead of that generic question, or you can answer that if you like, but how does the customer manage that? Like, they must be these are big projects. They must have to get involved with them early. We're hearing from other customers that projects are in place. They're moving. But there's hesitancy to release the budget that's even there behind the project. A lot there.
Yeah. Well, so there's two different dynamics that you're touching on. One is a dynamic around some awkwardness that companies like Pega and Pega have within our business when you have term licenses versus SaaS and the accounting differences that happen there. So if you want to talk quickly about that side of it. So even though a client will pay us once a year at the beginning of a contract or quarterly in advance and commit for maybe multiple years, the accounting for SaaS is as you would expect it, right? It's ratable. And it's very predictable. The accounting for the maintenance stream is very predictable. The accounting for term license happens when a renewal event or a purchase event happens.
And because those typically happen in the fourth quarter, our fourth calendar quarter, it skews a lot of the revenue to that quarter, right? And because that revenue is, as you mentioned, call it 30% of our business, that's a pretty big shift of revenue that doesn't happen linearly through the year. Why Q4? Well, one is obvious. That's typically when buying patterns happen on expansion, either because we as a software industry have conditioned our sales teams that are pushing for accelerators at the end of the year. But also, it's the beginning and the end of a budgeting cycle for many companies. So they either have budget leftover or they're committing budget to the next year. So that December 15th to January 15th becomes a pretty active, buying act.
What happens then is when you have term licenses, not only the renewals hit there, but new, it skews the revenue there. One last point. We're moving to consumptive clauses in our contracts. What does that mean? Client commits to 1 million cases. That's a unit. A case is like a unit of activity. They commit to 1 million cases a year. We tell a client, "Go and build anything you want on Pega. And when you hit your renewal cycle, your annual cycle, you're going to your our system will tell you how much volume you have." And you have two options. You can pay for the variable usage. Or you can increase your commitment at that point, increase your ARR based on your volume. Most clients choose to increase their commitment because they know it's not variable. They know that they just rolled on some new applications.
The economics work better for them to commit to the annual spend. If they bought they pay variable, it's going to be more expensive for them. So it's just a logical way to kind of synchronize that selling process. That happens heavily in Q4. So that's kind of why the.
From a visibility perspective,
Yep.
One of the words you said right at the outset answering the question is it's a renewal.
Yes. It's typically tied. It's typically a renewal with an expansion. So the client may have two applications. And they may roll on a third. And so when that renews, they might have 2 million of cases. So they would then say, "Well, I'm going to have to commit to 2 million of cases." The negotiation is not really a new sale because you get kind of pricing economics, right? There's a discount curve, so to speak, that clients spend more, they get a better discount, so.
So, what is the company seeing in terms of that type of expansionary business? You get, you must see this stuff live, as it's working on your platform.
So we don't always have so, when it's our SaaS product, we have immediate visibility to all the volume, right? Because we can see it in our operations center. When it's on the client's, when the client is managing it, we actually do have the ability to see it but not real-time. So it's typically it lags. We might see it once a month. We might see it once a quarter. But we actually have a product that ties into their on-premise deployments that they use for diagnostic and kind of quality control. And we actually share that cloud environment with them. So our clients, we do have reasonable visibility. We don't always know when a client's going to start a project.
And to be honest with you, we're perfectly fine with that because that's a selling activity that just happened that we weren't selling, right? They were selling themselves. And so we actually love that model. And to be honest with you, I'm a little surprised how easy it's been for clients to buy into that because they love it too. Because they want, they don't want the hurdle of trying to go and put together business cases and figure out purchasing and budgeting and all these things to basically be able to try out a new, a new environment. They really and we, by the way, one caveat of that. We don't actually charge them for cases till they start production. So it's all, so they've got no risk in paying for the license. And quite frankly, we have no cost, right? Because they're not really running noticeable workloads.
It's really a marriage in terms of the outcome we both want.
So maybe shifting gears back to AI, thank you for that, Ken. You recently launched a product called Blueprint, which I.
Yep.
I got a demo from your CTO and the IR gentleman here, Peter. It was pretty impressive in terms of speeding up design of an application. Maybe just give a little bit more expanded definition of what Blueprint is. And do you expect that to impact revenue in fiscal, in calendar 2024 in terms of your guidance?
You know, Pega's been a software company. We've been around for over 40 years. We've been a public company for over 25 years. So we're not new to the technology space. And I've been in, you know, I've been in tech for, you know, God forbid, 30 years, right? But I would tell you that I've never had something in my career and certainly in Pega's history that could be as impactful as what Blueprint is. And I, I'm not, I don't say that lightly. What does it do? Okay. We're selling enterprise solutions. The biggest problem we have with getting a client to get started on a problem is the time it takes to assess the problem, to ideate, to figure out the architecture, to get all the people in the room, to whiteboard, back and forth, get an architecture document.
That might take three to six months. That's a selling process. So we've got solution consultants involved. We might have partners involved. The client might have 30 different projects that they want to work on. They might have the capacity to asses two . So they're going to have to pick the two, which might not even be the right two. That process is a lot of starts and stops, and many times does not end up resulting in a sale because the client might say, "I don't you know, I didn't get enough good information out of this." Or quite frankly, they just get fatigue actually going through that assessment. Blueprint is essentially a web-based application that you can go in and I'm going to simplify it.
You can type into a text box, "I want to create a customer service application in telecommunications to manage mobile users." That's all you have to say. You click return. It will pull up a document that says, "Here's all the steps, stages. Here's your workflow. Here's all your personas that you should have. Here's documentation." You can then communicate with the application to say, "We don't actually give refunds or credits. Or we don't actually have that. Or we may actually have a step that you didn't include there." At the end of that process, which at the longest it would take would maybe be an hour if you're communicating with a client, what you saw probably took about 30-60 seconds.
But you can actually come up with a PDF architectural document that you can hand to your engineer and say, "This is what we're actually designing." That document would not be done inside of 90 days in the traditional process with any enterprise software. Then what you can do, this can't—you can't do this yet. But this will be coming in like. There will be a button at the bottom that the client can say, "Implement." And it will actually build out the entire workflow in Pega. So you've got essentially Version 1 of an application, the entire design document, everything that's everything that you've told the application you want to build. What would that cost?
Does that.
It might be a year's worth of work.
Does that then be an existing client in terms of having all those first party engines and act?
It can. So when you do, it does not need to be an existing client. It could be new. If it's a use case that Pega knows well, what does that mean? Well, we have a whole library of all of our configurations. If you pick a use case that we know well, it's so much more robust. If you pick a use case that we know nothing about, like I did one where I just said, "I'm going to. I'm a. I own a mountain bike store. And I want to, you know, build out a customer, build out a CRM system." And it went through like, "I have nothing. I know nothing about mountain bikes or a mountain bike store." It basically told me, "There's a marketing. There's a selling. There's an inventory management. There's billing. There's returns. There's customer service.
Here's all your personas." Like, I learned more in reading that document about the way you would run a mountain bike store than probably people that run them. Where did that come from? It went and grabbed that from the Internet. So even in a use case that we know nothing about, it actually goes out and pulls it in. If we know a lot about it, it takes our library as well as the Internet and creates that. So it's tremendously powerful. The powerful part though is not just the actual ideation of the workflow. It's that next step of being able to implement it, which, you know, those two together, for those of you that have been around enterprise software, many times a document gets produced that says, "This is what we want to build." And what gets built is nothing like the document.
You probably have seen some of the little cartoons about like, you know, like the engineer built it this way. But the actual way that they built it was something different. So that to me is such a, you know, such a transformative way that people could build software. For us, the biggest hurdle is getting the client to pick the project, getting the ideation on the project, showing them how it would be implemented, give them the scope of what needs to be done, and getting them started. Now they can do all 30 of those projects in an afternoon versus doing one or two of them over three to six months.
In the next stage is the implementation, which.
And then you can implement that.
That doesn't exist today.
That doesn't exist today. But it'll be coming with it. This has been a fast moving. We just started this, you know, late last summer. And we've actually got something that we've run a few thousand of the projects through already. We've got partners. We're going to our partners. And our partners are going to start using Blueprint when they go talk to their clients about building out anything with any workflow, work automation. They're going to use that to help in the design process. And then we're going to hand it to our clients. It's not something we're going to charge. We think about this as like the Uber app on your phone. We don't want to charge for it. We want everyone to use it because we want to actually like sell the car, right? Yeah, right.
We want to actually sell the cases.
That makes sense. So this is the timing around that implementation is maybe this year, mid, you know, something like that.
We'll be rolling it out to our customers and field teams for sure before PegaWorld in June.
In driving business, this could be more of a 25.
I think realistically, it's going to accelerate pipe. It's going to bring new pipe in, probably give us an opportunity to get to new logos faster. But in my guide, I didn't include any of that. I'm assuming this is a 25 impact.
So.
But it could very well be faster.
So it's grinding gears on the 11% ACV growth that you guided for this year, the longer-term, three to five-year outlook that you gave at the June 2023 Analyst Day for the 13%-14% growth in ACV billings. Walk us through like any go-to-market changes that you've, you know, Pega's successfully gone through some iterations in terms of changing their go-to-market to focus on expansion at existing clients of late. What do you think is the CFO you need to do to kind of, you know, accelerate to that 13%-14% off of the current level?
So, I think we've, I think, on the margin side, we've made a pretty good swipe at getting ourselves to at least a respectable free cash flow. I think that, I think, we can go higher. There's no doubt we can go higher. And there are things we need to do there around sales efficiency and even expanding gross margin, that I think we have in our plan, you know, our long-range plan, our mid-range plan. In terms of growth, I think there's really kind of two levers, independent of Blueprint. So forget I even said anything about Blueprint. Act like it doesn't even exist. The two levers are because our sales model is anchored now.
We made a pretty big shift to move away from more of a territory selling model to a target organization model where we're focusing on being very selective with the organizations, very targeted. Our teams are completely aligned to sell to those orgs. And we have just started to hit the point where we're really starting to see the impact of that better coverage model with existing logos. So I think there's opportunity to have NRR expansion from that. And the second one is existing logo or sorry, new logos, which now that we actually have a pretty targeted way of and a prescriptive way of how we select logos, we can actually go after new logos.
Once again, we have to be very careful because we've done a lot of good work to build better efficiency in the model. We don't want to reverse from that. We have to be careful that we don't take on logos that aren't the right clients for Pega. That's the most important thing. The targeting is just as important as the actual sales execution. Because if you're going after a company that doesn't really fit the profile like it isn't a B2 C company with a significant amount of transactions that would need Pega, that's just as much of a waste as having a poor sales team.
So, this is if I'm understanding this correctly, this isn't about adding more dollars to the sales and marketing line, generally speaking.
Yes. That is not.
It's more about finessing the current go-to-market strategy.
It's around some selective investment around new logos. But for existing logos, it's really around executing the model.
Is that a vertical focus? Are you function focused? What does that mean?
We tend to go vertical first and then use case second. So the vertical tends to drive a lot of the use cases, right? You don't have loan originations in insurance, right? You don't have insurance policies typically in financial services. So we tend to start vertical. And then we go, we have some solutions that look similar across verticals. Like a disputes or an exceptions application can look similar in insurance, in financial services, in healthcare. So they might have the same like kind of infrastructure, so to speak. But the fields would look a little different. So we tend to go vertical first then function.
Excellent. Well, well, looking forward to PegaWorld in June of this year in Las Vegas. And for updates on Blueprint. It sounds very exciting.
We have an Investor Day. We have Investor Day scheduled around lunchtime on Monday, the first day of PegaWorld. I know, I know you'll be there. And so, everyone's welcome. And investors are welcome, so.
Thank you for your time.
Thanks.