All right, I think we're ready to kick things off. I'm DJ Hynes. I'm the senior software analyst here at Canaccord. You guys are probably tired of hearing me say this, but this is the 44th year that the firm has put this conference on. We couldn't do it without the participation of the companies who bring the content, the investors who show up and ask all the good questions. So thank you, everyone, for being here, we appreciate the support. We have Pegasystems here, CFO Ken Stillwell. We're gonna do this as a fireside chat. If there are questions in the audience, please feel free, raise your hand, ask at any point, we can work them into the conversation.
But, Ken, maybe just to kick things off, why don't we do, like, a high-level intro to Pegasystems, kind of the problems you solve, the products you sell, you know, why you're winning in the space, and then we can dig into some of the details.
Sure. So, thanks for having us. We appreciate it. It's also... We appreciate you bringing the event to our backyard.
Yeah, me too.
So.
I'm a Boston guy, too, so nice to have a home game.
So yeah, if you think maybe I'll just kind of start with a real quick high level of the large organizations, large companies, you know, like Canaccord, you know, large banks, large healthcare providers, insurance providers. They have significant engagement with their constituents, whether that be customers, whether that be resellers, you know, even their own employees. And those engagements happen, you know, high volume levels, high frequency, and many of those engagements required, historically, a lot of human interaction, a lot of management and systems, and multiple systems, highly inefficient, and would really kind of drive the cost to serve up significantly. So the...
One of the big challenges that I think these large organizations have taken on is this concept of digital transformation, which is: How do we move to an environment where the engagement that we drive is digital? Whether that be self-service, automating, using things like AI, et cetera. And so Pega was really at the forefront of helping clients to digitize years ago. This space was called business process management. It's kind of evolved into digital process automation. It's really around trying to take the cost to serve, the cost to communicate, the cost to execute work end to end, and try to create high levels of efficiency, predictability, auditability. And so Pega became...
You know, we've, we've led for years in the space of helping our clients to, to manage these very high volume and, many times, very sophisticated, multiple steps, multiple systems to be able to execute things like a loan origination, onboarding a new client in a healthcare plan, an insurance, you know, an insurance renewal, like, bringing on doing Know Your Customer in banking or adding a new participant on your cell phone plan, et cetera. Things that we do every day that really, that really drive costs to our clients. And so, so that's really... That's, that's kind of the problem that we solve and who Pega is. We do it with a concept of a model-driven architecture, which is we do not write code to build an application.
We use the model, the Pega Model, to build the actual process automation, so that when you wanna change it, when you wanna add it, when your use case, or your company, or regulatory environment evolves, it's as simple as changing a step in the process as opposed to trying to go and figure out what code you deprecate and what code you write, and quite frankly, just sometimes deciding, "I just need to throw that application away." That's really kind of how Pega differentiates to give people what we, what we refer to as future-proofing your application environment.
Yeah.
This is not exclusive, but I would say companies that have large client bases, significant volumes, tend to be the companies that we do the most business with.
Yep, yep, makes sense. Business is performing well. I mean, a good quarter. I saw growth... Accelerated ACV growth from 9 to 13.
Yep.
Maybe just talk a little bit about what drove that acceleration and kind of what's top of mind coming out of the quarter.
Sure. So one of the maybe the benefits. There's an obvious benefit moving to a subscription business and moving to SaaS. But one of the benefits that may not be as obvious is that it creates an ongoing cadence of engagement with your clients.
Mm-hmm.
And so when companies were selling perpetual licenses years ago, and we were certainly one of them, you tended to have an engagement style that was almost a sell-out on a use case, right? That's just the way the market was. You'd go in, you'd say, "You know, I'm gonna try to solve this problem. I'm gonna..." You're gonna purchase enough volume maybe for the many years into the future, and you created, like, some real negative behaviors. You created over-discounting, the concept of shelfware that, that all of us have heard about... when you move to SaaS, that dynamic changes-
Yeah
Pretty significantly, because it's really all around the volume of usage, the activity measure. And so what you have is you have clients scaling these applications up, or quite frankly, building new use cases, new applications, new case types, new, new, new aspects of how the work is done, and that creates a little bit more of a regular engagement with the client. And instead of having that once every five-year kind of deal, you end up with more of an annual cadence with many of your clients. With that, we've actually seen in the first, in the first half of the year, more consistent growth in ACV. That's not to say that we are the kind of business that will not have spikes or will not have larger quarters and smaller quarters.
Yeah.
But I think the business has moved in a direction under the ACV model, where the extremes are not as extreme.
Yeah. Yeah.
Right? And so there is a
Linearity.
We benefited from that. I think this - the other benefit is really operational. We made a pretty hard, but we think really critical decision to make some changes in our go-to-market organization. In 2023, there were two big changes we made. One was we were very much more scrutinizing the organizations that we targeted than the companies that we targeted that were. Because we feel like deep engagement in is critical, and these organizations can spend - have a high propensity to spend. Then the second thing we did was we really kind of centralized a lot of our selling resources at that org level, with kind of that quarterback being the account executive for the org.
We used to have a situation where you'd have a primary AE, and you might have specialty AEs, you might have a partner seller, you might have... And so you created, unfortunately, sometimes multiple paths to the conversation, which on the surface might not seem terrible, but it, it causes confusion and can lead to inefficiency in the engagement with those clients. So those, those two things are, are well, solidified in 2024, and we've, we've seen the benefit of that.
Yeah.
The actual dollars of ACV growth in the first six months of this year versus last year is up probably 40% in terms of absolute dollars.
Yeah, that's great. So more frequent touch points with the cloud model and kind of a better structured-
Yeah
sales org is yielding
Yeah
some nice results. So at your Analyst Day last June in Vegas, you guys laid out kind of a goalpost for where cloud ACV could go over time, right?
Yeah.
I think you said 75%-
Yep
Over the next several years. Maybe talk about why that's important for the business, and where you are today, and kind of the path to getting there.
Sure. So when we started this journey in 2017, approximately, less than 5% of our ACV was SaaS, which is Pega Cloud. In the last quarter end, it was 44% of our ACV. We put a model together in our Investor Day that talked about getting above 75. Quite frankly, I think, you know, looking at 80 or 90 is probably more realistic where we think we can get to. And that is a dramatic change in many aspects of the business. One, it's a dramatic change in the ownership that we have for client success, because we're really, we're running the application, we're managing the application completely for the client, versus selling them even a term license that they would manage.
Second, it creates a lot more predictability in the actual, like, unfortunately, the accounting of it, right? Because SaaS accounting is much cleaner than, you know, managing, you know, term license 606 , which is just you know, a disaster, and quite frankly, probably the worst accounting literature that's ever been written, to be honest with you.
Agreed.
So those are just like some... Those are some benefits of it. But really what it does is it creates a completely different cadence for enterprise clients, because they always have access to everything new. They're always current, right? We're working, we're supporting them to make sure that they are always getting what is current, what is available, what is new, versus if you weren't on Pega Cloud, it is somewhat dependent on them, making sure that they actually do that work. And many of our clients do, but it is still-
Yeah
one less thing that they have to worry about. And so it's a, it's a tremendous, it's a tremendous opportunity for us. Naturally, with GenAI, you can, you can also envision the relevancy of everybody, you know, being on Pega Cloud with GenAI, and how much, how much that helps the, the engagement model with our clients. And then the last point is our... You know, when we started this journey, our... Well, I would say started. When we were, when we were, you know, call it 5-7 years ago, our gross margins on Pega Cloud were in the thirties, 30%, right? And now they're approaching 80%.
Yeah.
So we've actually now hit, you know, margins that I think are much more reasonable, and we're only $500 million in SaaS ACV, and our margins are already approaching 80%.
Yeah.
So if you look at any other company, and you look at those, you know, I would challenge you to find many companies that saw 80% under $1 billion in revenue. Some do, but it's-
Yeah
... I would say, you know, more don't.
Yeah.
So I think that there's just a bunch of things in that recipe that make for real value creation.
Yeah
for our stakeholders.
Yeah. Yeah, makes sense. The last few years, there's been more emphasis on kind of cross-sell and upsell in the installed base, and it seems like now the plan is to kind of start leaning in a little bit more on, on net new logos. Can you just talk about kind of strategic rationale and why, why now is the right time for that?
So when we made the changes to our go-to-market organizations, one of the things that we felt was really critical is that we stayed true to the target account model, the target organization model. And it was very important for us to make sure that we minimized distraction, and that we had our sales teams very laser focused on the organizations that, quite frankly, it's not like you have to really, like, struggle to find the organizations. There's thousands of them that we could target, but you have to be committed to who you target, right? You need to make sure that. If not, you will thinly cover those organizations, and you have low engagement, and therefore you'll have less success. So the first piece of that was really, we had to really be careful with our new logo focus when we were going through that transition.
Now, you fast-forward, transition is solidified. We've seen some of the, the benefits of that. The cadence is really at a much different pace in terms of that engagement. It's, it's... And we did, by the way, we did have some new logos in 2024 that we targeted, and quite frankly, we've even booked some new logos in the first half of the year. But I think now we're starting to really be thoughtful about what's the next level of investment. Now, I want to be very clear, though, we're that does not mean that we will rule the Rule of 40 out the window, and we will just start covering every single org that we possibly can. That would be silly, and quite frankly, we wouldn't get the results that we want anyway.
We want to focus target org model organizations that fit the profile being high propensity to spend, and then really run that through our sales cadence that we're operating. So we will, you know, we will add. I'm certain that we'll cover, you know, 50-100 new logos next year. I'm certain that'll be probably the number, and that's a pretty significant opportunity size. Now, the good thing is, with Blueprint and the way that we've leveraging GenAI to help engagement in our selling process, that should require not the same team composition to scale, right? We should be much heavier on the primary quota carriers as we scale that out, and that really helps with the operating model as well.
Yeah. Yeah. One of the things we didn't touch on when we were talking about kind of moving customers over to the cloud-based version of the product is the economic benefit, right? The uplift that you see when-
Yeah
... a customer goes from paying maintenance to a cloud subscription. Maybe you could just unpack some of those numbers, and, you kind of laid out the goals, right? We get to 75%.
Yeah.
But, like, on a microeconomic basis, what that does to, you know, an existing customer relationship.
So, this is a... Naturally, every client has a specific, you know, commercial rationale that we and they need to go through in terms of that relationship. But I would say if you think about the cost savings that we're giving to the client, is they are actually getting a fully managed service on Pega Cloud. They no longer need to buy compute, they need to buy servers, need to buy, you know, AWS, GCP costs, whatever. They don't have to build out, you know, teams to do the upgrades, to manage the product. There's a lot of work, a lot of savings that the client has. What we ask for that, right, in our commercial model, is some modest increase to, you know, to compensate for the managed service.
When a client has already purchased Pega under a previous licensing model, there will likely be some type of an uplift. Now, it's. I will say that it's not every client, because sometimes, you know, the economic relationship that we have with a client may mean that an uplift is not warranted in some cases, depending on, because we can't price ourselves out of the market.
Right.
Right? But I do think in most cases there will be some uplift.
Yeah.
That uplift can range from, in some cases, that could be as, you know, as much as a 2x, you know, or more. It could be, you know, something more modest, like, you know, 25%-30%. I would say that most of the uplifts that we tend to see... Because remember, we are a largely subscription business right now. So you have people moving from term license to Pega Cloud in the majority of cases. If they move, that number, you know, that uplift is probably in the 25%-50% range typically.
Yep, perfect. One more on the numbers, and then we can dig in on product a little bit more. Numbers is your sweet spot anyways. Record free cash flow in 2023.
Yep.
Record in the first half of 2024. So clearly a big emphasis there. Maybe talk about why that's been the focus. And then second, with kind of the plans to go out and more aggressively pursue new logos-
Yep
... is there any reason to think that that changes? Do you have to spend more to hire reps? Like, how are you thinking about the trajectory from here?
Yeah, it's a great question. So, it was certainly our response to move to a recurring model and to move to the cloud was equally driven by our clients' desire for us to be in the cloud, and also, quite frankly, that the business model is just the modern model, right? And there's some economic benefit for clients and for us in that model. So, when you think about cash flow, when we started the model, we knew, and I think if you go back to even comments that I made, probably as far back as like 2018, we knew that when we exited the cloud transition, we were gonna be generating $a few hundred million of free cash flow. I think that surprised people because it didn't look like we were on that pace-
Yeah
... right? Just because of the nature of the trough and the way. But, but now that we've exited the cloud transition, you know, we'll be generating, you know, over $300 million in 2024, and that number will grow in the future. So the reason why the numbers scaled so fast was really just the model.
Yeah.
It's really just the business transition, and what would you expect to see from it. To the second point that you're on, which is: so if you're gonna go invest in new logos, you're gonna invest maybe even in innovation, try to get into new verticals, new countries, et cetera, all the things that companies do to grow, how can you... You know, how committed are you to maintain that discipline that we've built over the last couple of years? And I would say that, you know, we view it very critical that when we're growing the business, we wanna make sure that our growth in free cash flow is at least or better than the actual growth in the ACV or, you know, or I'm gonna use ACV because revenue's a little bit weird with a 606.
So growth in ACV, which is billings, the growth in billings, and the profit margin against those billings, if you're growing ACV by 15% a year, you should be growing free cash flow by 15% or greater-
Yep.
Right? You shouldn't be less efficient as you scale. You will have some things that happen. You'll have investment cycles, et cetera. But that's a principle kind of behavior that we're instilling. We've used the Rule of 40. I mean, I would say I've been using Rule of 40 probably as long as any public company CFO, 'cause I, you know, I lived from private equity before that and kind of brought that over. But I would say that Rule of 40 is well anchored now in the culture of Pega. I think kind of that next evolution of that is really thinking about kind of that free cash flow growth, and certainly free cash flow against dilution, right?
Yep.
The cash flow, you know, per share growth. So that's a real big focus for us.
Yep.
So we'll try to grow faster, but we'll do it in the context to make sure we don't dilute our profit margins.
Yeah. Perfect. Let's transition to product a little bit. You mentioned, GenAI Blueprint-
Yep
... earlier. We didn't get into the details of what that is, but I know there's tens of thousands of blueprints that have been built. It's not a product that you're selling today, but it creates a lot of value for clients. So maybe just talk about kind of what you're doing and strategically how that fits into the roadmap.
Yeah, so when... You know, I think it was probably a little over a year ago, when we really started to kind of frame up what we, you know, this concept of Blueprint, right? And how were we gonna leverage GenAI, but in a differentiated way for Pega? And one of the biggest, maybe, headwinds, hurdles, kind of obstacles for clients to digitally transform faster, is that they typically have to spend a lot of time going through the ideation, the architecture, the prototyping, proof of concept, you know, whether that be their own time, professional services time, et cetera. And naturally, clients need to go through that process to purchase a Pega license, just to make it simple.
What we recognized is, if we could leverage GenAI to fix that, to address that problem, to make it easier for our clients to engage, leveraging technologies like GenAI, but in the framework of the Pega platform, the Pega architecture, the model, that we could maybe create a way for clients to drive digital transformation faster. And now, a little over a year later, that's exactly what we have. So what Blueprint allows you to do is, through a very small number of prompts and structure, it allows you to really define what you're trying to accomplish, and the output of that is quite revolutionary. The output is essentially a working production app in Pega. That's essentially the output. You go through a step of seeing what it might look like. You can, you can actually configure it.
You can make some changes. You can go back to the original Blueprint, change it if you add a couple sentences of clarification. You can delete steps, add steps. There's lots of things you can do in that, in that process. But at the end of it is an actual production-ready application, and that, that's like... If you think about the start to finish of where you-- Now, is that necessarily gonna be the final app that a client uses? Probably not. But man, that's a hell of a way down the journey in terms of what you would had to do if you did an operational walk-through, and whiteboarding with Post-it notes, and trying to get co-stakeholder alignment, and get an SI in, and go through the procurement process to get that started.
So we just view that as the single biggest impediment to our clients moving faster on digital transformation. So then you might ask: "Okay, great, so, you know, 45,000 blueprints produced in the last 10 weeks. What's next? What, what, how does Pega monetize that?" Pega monetizes that because a certain percentage of people that touch Blueprint are gonna actually move forward with the project. When they move forward with that project to digitally transform, and it's likely going to be with Pega, Pega can help our clients move faster on digital transformation, and we monetize because we're helping our clients drive end-to-end automation through our platform.
Mm-hmm.
And so as they do, we actually receive through our licensing models, you know, a share of that savings-
Yep
... with the client.
Yep, yeah, it makes sense. It's a good strategy. I wanna hit on kind of macro and how that influences kind of your planning and thinking, but maybe before we go there, one of the other strategic initiatives you guys have knocked down was FedRAMP.
Yep.
I think it was FedRAMP High certification.
FedRAMP High, yep.
Yep. Just talk about how important public sector is to the business, what this FedRAMP High certification does, and then if you have any thoughts on, you know, what's been a tumultuous presidential election cycle. Any thoughts on kinda how resolution there might feed into public sector spend?
Okay, that's. I might be a little underpaid to make that assessment. But, but I would say-
You and me both.
What I would say... So, FedRAMP is a standard in the U.S. public sector that is a bar that if you can't meet, you can't actually sell cloud to the government. I'm making it simple. FedRAMP Moderate is typically the standard for civilian agencies and some Department of Defense agencies that don't handle classified data. FedRAMP High essentially covers more of the Department of Defense agencies, things like Secret type. Most DOD, you know, you guys have heard of, like, Secret clearances. It's the kind of the now. So FedRAMP is essentially a set of controls and certification and audits that you do to validate that your application meets certain security standards. If so, the government is allowed to do business with you.
Because we got FedRAMP High, it opens up lots of the Department of Defense agencies that we couldn't otherwise do in cloud. We could still sell it to them on-prem-
Mm-hmm.
Right? But we couldn't sell cloud without FedRAMP High. So that's the opportunity set. I mean, you know, information technology in the government is a big spend area, as it is in corporate America. In the Department of Defense, specifically, it's a there's a lot less vendors.
Yeah.
Right? Because of the hurdles, the barriers to entry to be in there. So we think it's a very large market, and quite frankly, for the problems that we solve, I mean, legacy digital transformation, I mean, where would you find a vertical that has more old stuff than the actual U.S. government?
Yeah.
So I think there's a really, you know, big opportunity for us. So we're excited. I look, in terms of the political winds, the reality is, no political party that I have seen in the United States has truly been committed to spending less in the government, and so I, I'm gonna say that I don't believe that that is going to be a risk.
Yeah.
I think the question about which programs get funded, whether it's DOD or it's social services, et cetera, the reality is we cover them all.
Yeah.
So I mean, we'll, you know, we'll just shift our alignment to wherever the dollars are and whatever programs, you know, we can help to advance. And so that's... I would say we're-I'm not gonna say we're agnostic, 'cause I don't know what the policies are of either of these groups, to be honest with you. But I would say in general, the government, you know, has a lot of money to spend, has a lot of projects to do it, a lot of technical debt.
Yeah.
Pega will be there to try to help advance, you know, the ball.
Yeah. We have, like, three or four minutes. Are there any questions in the audience? I have a few more I can go with. Sure.
Can you outline the legal battle that you were in that's recently concluded? Oh, sure. There was a case in Virginia that probably most of you are aware of, and there was a verdict that was in, like, May of 2022. The appeal process in Virginia happened, quite frankly, took a long time, but we just heard, I guess it was maybe two weeks ago, actually, I think it was two weeks ago today, that the appellate court agreed with the substance of our argument and overturned the verdict. So, the next step in that process, I believe the other party is able to petition to the Supreme Court of Virginia for a further review of that appeal.
And then if the appeal is upheld through that process, then it would go back for a retrial. So that we don't have any idea of timing. I mean, that's if there's a retrial, it's gonna be likely years before that goes back just because of the legal process. So thank you. Yeah. So we feel very pleased. We've said from the very beginning, if you look at my first note on May 9th, 2022, I actually said that this trial and the verdict was from a significant error. And if you look at what the appellate court said, the words were a series of errors. So I think they used pretty much the same language we've used for over two years, so.
Yeah. Maybe we could just talk about current environment. It's been turbulent, certainly in the stock market. I feel like, you know, we started to hear the April quarter, kind of, enterprise companies put a little bit of a pall in the space as they talked about, kind of, softening demand signals.
Yeah.
Curious, kind of, what you guys are seeing with respect to the macro and, and kind of how that informs your plans for 2025 as you start thinking about setting budgets and, and kind of what you need to do next year?
So I don't like to say that we're different because that is like, you know, you kind of can jinx your performance. I wouldn't say... What I would say is there are a lot of companies out there that sell heavy amounts of their business through user models, and I think that would—if you look at some of the feedback that have come, it's come from... You know, Workday is a good example, where there are companies that are heavily dependent on user models, and user models are really contrary to saving clients money.
Yeah.
If you think about the correlation, if I save you money by actually you needing half the people to do the work, should I get half of the license revenue from that? Or, you know, there's a disconnect there. By the way, conversely, if I actually give you an application and money, you need to double the amount of people to use it, should I get twice... Like-
Yeah.
So I think the user model is one, DJ, and then you've seen that. And then I think the second one is, there are ebbs and flows in the hyperscaler and associated vendors-
Mm-hmm
... like MongoDBs, et cetera, that none of that buying, those buying trends are not straight lines.
Yeah.
Right? And so, I think the. So I don't look at any of that information and read into that, that's a macro thing. If you, if you look for us, our clients are pretty much in the same situation they've been over the last two years, right? It's an uncertain time, inflation's high, you know, it's not the healthiest economic environment, it's not terrible either, and they've got a lot of work to do. Well, that's where I think Blueprint fits in. Like, if we can help them advance the ball further by actually spending less of their resources, I think the relevancy of Blueprints and the problem that they have with digital transformation is highly correlated. But I would say in general, the macro environment, like I said, not terrible.
Yeah.
It's not, certainly not that much different than it was over the last year. But I would say what I hear and what I see is, I do see a high connection to user-based licenses and just some variability in the, you know, in the compute, you know, kind of OEMs-
Yeah
... so to speak.
Yeah. But, look, to your point, if you're driving modernization and you're driving efficiency, it's easy to... Easy is not the right word. It's possible to come up with budget for those types of projects and get those deals done.
That work's not gonna go away.
That's correct.
The reality is, those systems just become more aged if they don't modernize them.
Yeah.
The reality is, sure, that technical debt's not going away from our clients.
Yeah. Yeah. We covered a lot. Any parting thoughts you wanna leave folks with as we go into the back half of the year, or think about kind of the setup for the business and the stock?
I think we have covered a lot. I would say that we're deeply committed to our clients. We always have been for 40+ years, and I think that, you know, moving our clients and helping our clients move to the cloud is a very, very critical thing for us and for our clients. And we think that Blueprint and leveraging GenAI is our way to help our clients move their roadmaps and their agendas faster. So we're just working hard to do that, and at the same time, drive value for, for all of you.
Yeah. Awesome. I think we did it right on time. We hit the buzzer. Ken, thank you very much for doing this, and congrats.
Thanks, DJ.
Thanks.