All right. Thanks for joining us. Today we have Ken, Ken Stillwell, CFO, COO from Pegasystems, day one of the UBS Tech and AI Conference, so thank you all for attending. Maybe with that as a little bit of an intro, Ken, maybe for the investors that are a little bit newer to the story, I'd love to know if you could maybe just tell us a little bit about the company and we'll kind of direct questions from there.
Sure. So Pega has been. We've been supporting enterprise clients. And when I say enterprise clients, think of, you know, the largest and well-known brands in business, primarily in business to consumer industries, as well as, you know, public sector clients. And the solutions that we have are all based on solutions that really are enabled by workflow software. And so workflow software is things that, you know, trying to onboard a new participant in a healthcare plan or investigate a dispute on a credit card transactions or originate a loan. I mean, the use cases are very broad, and typically have a pretty strong vertical domain expertise, meaning they're very aligned to a vertical. So banking solutions tend to look similar across banking clients. Healthcare solutions tend to look similar across healthcare clients.
The difference with Pega is that our solutions are not, you know, off the shelf. They're typically something that are pre-configured in a large way around a specific use case, and the client really finishes the application in the manner in which they want to using a low-code approach, which means there's not code written. You're actually doing it in the UI of the product. And that really allows the product to be able to Build for Change , which is our tagline, actually, Build for Change . It allows the application to grow, evolve, change for regulatory requirements, scale, and you don't have to go back in and constantly be checking code in and out.
So clients love the enterprise-scale capabilities of our workflow platform and the kind of flexibility of configuring and changing it over time. And so we, you know, we tend to have a very high retention rate, and a lot of our business is growing our existing clients.
Got it. Maybe with that as a background, let's jump in.
Okay.
ACV Growth, you know, many of your peers across the software industry, you know, they actually use ARR or revenue as a maybe a better judge of the business. So why, why have you guys chosen ACV? And, you know, maybe you can start off with, you know, how you define ACV. That'd be great.
Sure. So, the first thing I would say is that, ACV, we call it ACV, but you could very easily refer to it as ARR as well. It's really the same metric. It's the amount of recurring billings, recurring spend that you get from your clients. The reason why we call it ACV is that, our contracts, the revenue aspect of it is only recurring for our SaaS, our SaaS business, our term license business. And our business is split about 50% SaaS and 50% term license. The term license revenue happens inconsistently, which is one of the reasons why, you know, we view ARR or ACV as a much more important metric because that is directly tied to the annual billings that we have, which is just there's some oddities in accounting for revenue on term licenses.
ACV for us is just like, you know, consider it, synonymous with ARR.
Got it.
Yep.
Maybe to drill down even a little deeper, last quarter at 3Q, 14% ARR or 14% ACV in constant currency.
Yeah.
Maybe you could talk through some of the drivers that helped you to accelerate?
So we've done a little, you know, we've been growing a little stronger than we had originally thought at the beginning of the year. I think the primary driver to that is just better execution. I mean, I don't believe that the market, the overall market is any better than it has been over the last year or two. I don't think it's any worse either. But I think it's the market's, you know, it's okay. It's not great. But when we started the year, I think we had an expectation of where we thought we would land, and certainly through three quarters, we're a little ahead of that. And I would put that on our execution. We went through a sales transformation in the end of 2022 into the middle part of 2023.
I think that you're seeing the benefits of that, you know, that kind of distraction being out of the way and our sales teams being realigned. So I think it's really. I would put it a lot on execution.
Got it. And then the next layer deeper would be, Pega Cloud also accelerated 26% constant currency. You know, why is Pega Cloud accelerating to 26%?
So, that maybe requires just a little bit of an explanation of the journey of Pega Cloud. If you go back to, you know, when I started in 2016, I can remember these numbers. When the first year that I was at Pega, we had about 3%-5% of our business on Pega Cloud. If you look now, we've got approaching 50% of our ACV on Pega Cloud. You know, Pega Cloud went from under $50 million to over $500 million in the course of about seven years, so the momentum of Pega Cloud has been building. But there was, I would say, some level of patience that we had on really pushing Pega Cloud as our primary go-to-market.
One was back in 2017, 2018, 2019. We really wanted to make sure that it was a world-class service that we were offering for our clients. And we didn't, you know, we had a small number of clients, small number of ACV and revenue. We just wanted to make sure that we were really giving our clients the best experience that they could. And quite frankly, you know, we learned a lot and we really improved the offering. That was one. Two, we weren't at scale margins yet. So the gross margin for Pega Cloud, you know, you go back to 2017, our gross margin was in the 30s, right, in terms of the gross margin. And, you know, now it's approaching 80.
So, you needed a little bit of efficiency and scale and some engineering changes to be able to drive the operating model up. The third thing was many of our clients were not using Pega Cloud with at least one application.
Mm-hmm.
So the combination of us putting more focus on it, us driving the offering, meaning the full package of the service, the technology, driving the margins up, and many of our clients experiencing Pega Cloud made it much easier to then accelerate saying, "Pega Cloud is our primary offering for all new solutions." And in addition to that, we've been starting now to talk to clients about migrating from their non-Pega Cloud environments over to Pega Cloud. So the timing just felt right as we finished the subscription transition, the product became more mature, the margins were not dilutive in terms of that move, and that clients really kind of understood the value proposition that a fully managed offering like Pega Cloud can provide. So the timing kind of all came together.
What you're seeing is a kind of a re-acceleration of the ACV around Pega Cloud from what you saw last year.
You mentioned some clients moving over to Pega Cloud. Can you help us understand a little bit about the tailwind to Pega Cloud and what that could look like as we get into 2025?
Sure. So, if our model plays out the way that it's designed, and we're gonna grow our ACV by, say, low double digits, just use that as part of the model, Pega Cloud really does need to grow by something approaching 20%, right, or probably even slightly greater than that to be able to achieve our goal of getting 75% of our ACV onto Pega Cloud in the next three to four years. So our goal is to move clients to Pega Cloud, also to sell the majority, if not all, of our new business on Pega Cloud, to be able to continue to get some improvement in margins as we scale.
In order for all of that to play out, Pega Cloud really would have to grow faster than our core ACV, than our overall ACV, which is probably, so we think, Pega Cloud has the opportunity to grow 20% plus in the next few years.
Got it. Amazing. It also sounded like more recently you had said, talking about growing new logos. So I guess I'd be curious about some of the profile of some of these new logos you're going after and, you know, maybe, secondarily, you can also talk to how it would impact your OpEx, if at all.
Sure. A couple pieces there. The first piece is the new logos that we're going after are going to look very similar to the existing customer base that we have. I'll just use random names. If UBS was a client of ours, then maybe we'd target Morgan Stanley if they weren't a client of ours. That's an example of where the use cases would be really similar. We would know the industry, we would know the vertical, we would know the challenges. We may not have the relationships that we might have at one firm versus the other, but it's not an unknown, you know, value proposition or problems that we're solving based on the vertical that we're solving.
So we would not go after in a big way logos that had no, they weren't, you know, business to consumer model industries. We had no understanding of how Pega would help them. We're not, we wouldn't do kind of outbound lead marketing just to be able to find any logo. Our logos would be very targeted. So we might target 100 or 200 new logos. They would be our core verticals and our core markets where we understood the value proposition and understood the problems and quite frankly could speak with credibility to those business users. So that's kind of the you know the new logo-like targeting aspect of it. I think the thing that new logos does for us is it naturally helps. It gives us an opportunity to accelerate our growth.
What we have to be very thoughtful of is the amount of additional incremental sales and marketing costs to be able to actually drive that growth. And so we look at an equivalent of LTV to CAC in our business, which is the amount of sales and marketing incremental costs that we have compared to the ACV growth that we project over a three-year period. It's similar to the LTV to CAC. And so that naturally is a model and it doesn't have certainty in it. So we've got to be very thoughtful about that. So we're gonna focus on some new logos.
We're gonna take some risks on some of our sales and marketing costs, but we're gonna be very thoughtful by selection, targeting the right orgs, the right type of structure of our sales team, and we're gonna measure that, and if it's working, we're gonna put more fuel on that, and if it's not, we're gonna reallocate resources to other logos, so we're gonna be, you know, much more nimble than we were in the past. In the past, when we targeted new logos, we did not have the discipline of which logo we targeted. We essentially let our salespeople sell into territories so they could go into any company in Pennsylvania, any company into the U.K., wherever, and that ended up with us having opportunities that were not in our core verticals, subscale opportunities that didn't have the growth opportunity.
And so those may look good as winning a new logo and a little bit of ACV, but wouldn't really play out to be valuable over a three-to-five-year period. It's really important that our new logos are set to scale because scaling our clients is a big part of our model.
Got it. Maybe shifting over a little bit to competition, talking about, you know, new logos. Can you help us understand if the competitive landscape has shifted at all? Are you seeing more of ServiceNow popping up? Maybe you could help us there, Ken.
Yeah. So it's probably the most boring answer that I give of all the questions. The competitive landscape is very similar to what it was seven, eight, nine years ago when I started. It's the same type of companies that we compete with. And I think part of that is not surprising. It's really hard to build an enterprise-grade workflow platform and then be able to get into the best and biggest brands in the world. It's a journey that not many companies can make. So it's not surprising that you're gonna see Microsoft and you're gonna see Salesforce and you're gonna see Pega and you're gonna see Adobe.
ServiceNow is an interesting one because ServiceNow's messaging and value proposition and really the way that they talk about their solution sounds very similar to Pega. It's a workflow platform. It's you know for automating end-to-end tasks, et cetera. We don't see them as much as we see some of the other providers that I mentioned. That may be a combination of they tend to sell to a different buyer that we sell to inside companies. That's not. I don't wanna overgeneralize that, but I would say that we do see them. They are in our clients. We do compete with them from time to time. They are someone we watch because they have been very successful. They're a very well-run company.
But they, I would say that the differentiation of why we win, we're really built much better than any of those providers that, that I just mentioned for enterprise scale, end-to-end automating, automating transactions, automating workflows, automating activities. If you're just doing like one open tickets, like, I need a new keyboard, I need a new mouse, I wanna put in a service request to move my desktop computer to another desk. Those are, those are workflow type activities, but much more simple ones. That's typically not the clients that we have. We typically have clients like onboarding a client, adding a participant to a cell phone plan, originating a loan, managing a dispute on a credit card. You know, things that are things that have like a series of steps and stages to execute. And that's, that's where we do really well.
Got it. I'll ask you a few more questions, but, for anybody in the audience, there should be a QR code at your seat. If you wanna ask a question, hit the QR code and I'll be able to ask it for you. Changing political landscape is upcoming, Ken, next year. How does, you know, some of the, you know, recent news around that impact Pegasystems? Is it a headwind for you all coming up or maybe conversely, maybe it's a little bit of a tailwind with some efficiency plays that is slated to come?
Yeah. So, I'll try to answer that with the least amount of political reference, so a lesser regulatory environment is empirically better for business. I, whether you know, believe in that, you know, emotionally or not, it is. It'll help the acquisition landscape. It'll help investment in technology. It'll help economies of scale. There's a lot of aspects of that. I get the sense that we'll have a lesser regulatory environment under this administration, and if so, it should create an environment for larger companies to take maybe a little bit more risk without the fear of being targeted for being too powerful or too influential, so those are our clients, so I think that should help the environment for those clients.
I think one of the most interesting things that I've heard in the you know in the political discussion as humorous as it sounds to talk about DOGE, if you think about the concept of, I'm gonna go into government agencies and I'm gonna look for areas of inefficiency and try to see if there's the value connected to the spend. Much of the and one of the references they talked about was looking at you know 11 systems and the fact that just looking at 11 enterprise systems, the government, they spent $550 million supporting these old antiquated technology systems. Digital transformation has really made very little progress in the government, in any government, right? It's not made that much progress in the commercial sector as well, right?
If you talk to large financial institutions like UBS and you say, how, what's your, you know, how far are you on your journey to cloud? I bet you most of them would say about 10%, right? Nobody's really there yet, but the government is, governments are even behind that. We have a massive value proposition at Pega to help get off of these old homegrown COBOL and Fortran-based systems that people built, you know, 50 years ago and get to something that is much easier to manage in the cloud and much cheaper, cheaper from a, from a, a cost of software and maintenance and also for people needed to run it. So I actually think there is some, there is a, there's a lot of credibility in the comment that the government has lots of areas of savings opportunity, and I think that that's a really interesting one.
That happens in the commercial side as well. But I just think the thing that I'm most interested in is this is less the regulatory environment and more is there a push to really, truly digitally transform parts of the government and get to the cloud and drive some of this unbelievable inefficiency that exists in these antiquated systems that we all see in our day-to-day life interacting with the government. That's the one that's the most interesting to me.
Got it. Maybe shifting over to free cash flow. Some of our conversations with investors have shifted a little bit more to Free Cash Flow per Share now. Is that something that you're focused on as well? And if so, maybe you could touch on some of the ways you're approaching that.
I think it's interesting how things kind of come full circle, right? It was always, you know, price to earnings ratio years ago, but then people started saying, well, the quality of the earnings, you know, aren't as good depending on the business model. And then technology companies that were growing fast didn't have quote earnings, right? But they were still valuable. So the valuations have kind of moved around from P to E to revenue multiples, et cetera. But one thing has stayed true, which is the value of a company is the value of the discounted value of all the future cash flows, right? Like no matter what, that was in the textbooks a hundred years ago. It's gonna be in the textbooks a hundred years from now. That's the value of a business. There's different ways to come about that.
I think when you have a company and Pega would be in that category where you have some scale where you are generating cash flow, the value of the cash flow and the growth of that cash flow for each share owner of the organization is I think has always been a fundamental part of how you value a company. So to me, it's just very logical that you would say, what's the cash flow? How much is it growing? And how much does each shareholder get for that? And I think that actually normalizes the playing field around companies that might grow organically and drive cash flow up and buy back shares versus companies that actually buy through acquisition and actually dilute their shareholders to be able to grow to larger scale. It kind of creates an even playing field so you can value both.
We're fully bought in. We believe driving a reasonable increase or sustainable increase in our cash flow and using as much of that capital as makes sense to retire shares to be able to, you know, focus on that free cash flow per share growth. Now, unfortunately, we're not allowed to report that, right? The SEC doesn't really wanna see that in our financial filings. But to be honest with you, it's right there. I mean, all the information's right there to be able to calculate it. And so we'll continue to provide that information because it's a valuable thing for investors to see. It's just that, you know, we're still kind of in the GAAP accounting kind of in a lot of what companies report.
Mm-hmm. If we do a little back of the envelope, Ken, I didn't just do it now, but if we do a little back of the envelope and you sustain ACV growth, you know, in the 12% neighborhood, does growing, you know, free cash flow per share maybe in the 14% neighborhood, 2% higher, sound like a reasonable assumption?
I would say if we're growing our ACV by 12%, I would view us growing our free cash flow per share by 14% to be, not that impressive. I think we should do better than that.
Got it.
That's a combination of getting operating leverage in the business. Remember, our gross margins are about 77-78% right now. They should be over 80%. Our sales and marketing efficiency has just started to really, I think we have much more room to go there. I think we, you know, we have, you know, objectively, you know, four to 10 points of free cash flow margin expansion over the coming year. So that alone would get us up into that 14-15%, maybe higher range. Then I think the question is, you know, how much do you use cash to buy back shares depending on where the value of the business is?
So I think we could be, you know, in that high teens range without a lot of, you know, without going through a lot of hoops. But we should certainly grow our free cash flow by more than what our ACV growth is. So that's why I say the 14's probably a, you know, a lower bar.
Got it. Looks like we had one question come in from the audience. Board recently authorized more of a buyback, $250 million of share buyback. Can you talk about the capital allocation priorities right now and where you stand on those?
Sure. So we had a just for those of you that don't follow it, we had like a very small buyback authorization that through 2023 and into 2024, which was maybe $50 or $60 million. It wasn't, there was no strategy of trying to be aggressive. It was more, we just had that as a placeholder. When we got to the fall and we knew what our cash flow trajectory and we could see our cash flow trajectory and we knew what next year looked like and we can see the retirement, you know, if we so choose to, of the converts that come due in March, it was obvious that we were going to have reasonable amounts of cash flow above that.
Where we saw the valuation of the business, we decided to authorize more and begin to buy back, which we've done, you know, starting in Q3. That 250 I think is, you know, the first step in a step of increasing the amount of buyback pace that we have.
Got it. And is it, in terms of the priorities, trying to offset dilution completely, maybe overallocating and more than offsetting dilution?
So I'm not, personally, I'm not as focused on a math model of it. I'm more focused on what's the relative valuation of the business compared to our peers and how comfortable am I that that valuation is, there's that value gap is something that's just a dislocation in the market that we should, you know, help our shareholders by actually helping to close that. I mean, I realize buying back $250 million is not a significant amount of buying activity at our market cap, but the reality is if we're trading at, use a number, 20 times forward and we think that we should be trading at 25, I'm just making up numbers, we should be a buyer, right? If we're trading at 25 and we think we should be worth 20, naturally we should buy less, if any.
So I think that our view is that, you know, we're going to be a buyer to the extent that we're not putting the company in an awkward situation with the level of buying, and we think we're well within that. So that's kind of our approach. It may end up being that we buy more than offsetting dilution, right? And that would be just, I don't think our board or myself or our CEO has any concern with that.
Got it. About five minutes left. Wouldn't be an AI conference if we didn't bring up AI. Maybe you could help us just understand a little bit more about Pega AI and the blueprint that you guys have kind of released. Maybe we could start there.
The way that the table stakes use of Gen AI that many companies are doing and I think is, I don't wanna call it a commodity 'cause that would make that would minimize it too much I think, but is things like, you know, our Knowledge Buddy , our Gen AI Coach, things that use information that we have in our libraries, in our data to be able to drive communications, documentation, enablement, faster execution, more of a guide or advisory to our sales teams, like in the instance of coach, where it's telling you, here's what you need to do next. Here's the actual note that you need to send to the client.
Here's, it's kind of really giving you kind of a much more intelligent way to manage the human activities that need to happen. Then, in the event of like Knowledge Buddy as an example, there's lots of use cases where clients will come in and have a service request or a ticket that's a question. It'd be much easier for them to actually go in and say, here's my problem and be able to have Gen AI say, here's exactly what you need to do to fix that as opposed to talking to someone on the phone. So, to me, I view those as table stakes, Gen AI.
And we've got, we're, you know, full like clients. We've got those pushed out to clients. Clients have purchased those types of AI tools. The thing that we actually did different and we have not seen a company that has actually taken this approach on Gen AI is we stepped back and said, what's the fundamental thing that can hold back Pega growing much faster than what we're growing? And that is client adoption. And client adoption meaning evaluating whether they wanna digitally transform an application, getting through the proof of concept or the production pilot or whatever you wanna call it to be able to get the configuration to get to the point where you can actually go live with something. And when you're building an enterprise workflow application, that has effort and time.
And what we did with GenAI was we created this tool called Blueprint. And what Blueprint does is Blueprint actually leverages GenAI through a series of prompts and dropdowns that you communicate with Blueprint. It goes and looks at all of the history of what Pega has around all the different configurations, how you build out different solutions. It understands information that you can, that it can ingest from the client, screenshots of their application, documentation manuals, selective code if you wanted to. And it takes that information and it will build the application. Yeah. I'm gonna say just to be clear, it's version one of the application. It's not a final finished one, but it's something that would otherwise take quarters and months to be able to do in a more manual way historically.
So we think that helps us new logos, new applications, faster assessments of which applications to move, which ties to the first point we started with or one of the first points, which is McKinsey would tell you that we're 15% of the way through our journey to the cloud. If you talk to large companies like UBS, I think you'd admittedly say probably 10%. If you talk to AWS, they would say 10%. Whatever, whoever you talk to, we're really early innings on the movement to the cloud, on the movement to digitally transform. So for us, Blueprint was the way to flip the whole, the whole problem that the industry has and do and use Gen AI for that. So it's a different angle.
Got it. I have time for one more question. If there's any from the audience, go ahead and hit the QR code. Maybe in the meantime, over 60,000 blueprints have been created. They're free actually. Go try it out. I tried it out myself. Quite impressive. Did that, it's just recently released 60,000, obviously a big number. Did that surpass some of your internal expectations?
I think that you know that when you release anything new, there's gonna be some buzz around it. But I think what's most interesting is the amount of unique users that have actually done a Blueprint. So, it's... has it surpassed? I'm not sure if I had a number in my mind, to be honest with you, but I would say to have the amount of clients that we talk to where we sit down with them and they've already done a Blueprint before we actually sit down, partners, the amount of our partners that have actually done tens and 20 and 50 and 100 Blueprints without us being involved. I think there is a level. There's a viral level of what Blueprint has done that is unique for Pega, right?
Because we typically have hundreds of customers and deeper engagement, and Blueprint is much more of, has a viral aspect to it.
Got it. We got through a lot in 30 minutes. I think we'll leave it there. Thank you very much again.
Awesome. Thanks, Seth.