Thank you, everybody, for being here today. Steve Enders, as part of the software research team here at Citi. With us for this next session, we have Ken Stillwell, CFO and COO at Pegasystems. So, Ken, thank you so much for being here.
Thanks, Steve.
Maybe just to start off, you know, I know Pega's been around for a long time. I wanna say almost 40 years at this point. I guess maybe can you talk about what's new with Pega today and kind of what's been the journey over the past few years going through a subscription and cloud transition?
I think, you know, let's start there. So, you know, when I started, the company had been very successful for, you know, over 30 years, getting from, you know, a true, you know, roll-up-your-sleeves start-up to, at the time I started, we were probably doing $600 million or something like that, of revenue. So, I mean, you know, pretty, you know, pretty amazing run. And that was largely done in a non-cloud, perpetual license model, like many companies had done. With professional services being, at the time, was probably about a third of our business was professional services. So what it was - what, you know, what you ended up...
Kind of what happened was, every year you'd have your maintenance amount, and you'd have some term license, but you had to resell the perpetuals, and you had to essentially resell all the professional services. So it was really a kind of a deadlift every year. And so one of the observations I had was, "Listen, the, you know, the market really is looking to buy subscription to build predictability for customers and for vendors, and we really need to think about whether it's the right time to make that shift." And at the time, you know, our management team and our board was very supportive and said: "You know, we've been kinda doing a little bit of that over the years, but there's no reason why we shouldn't.
The market demands, there are retention rates were high, et cetera." So we started that journey on moving to a subscription business in 2017.
Mm-hmm.
What happened was, at that same time, there was so much momentum about moving to SaaS, that trend, that subscription transition we started, which was really more of a perpetual to term license, became quickly, "Let's move to cloud.
Mm-hmm.
At the time we started, we had about $20 million-$30 million of Pega Cloud revenue, and it really wasn't true cloud. It was more kind of hosting kind of situations, where we helped clients, you know, manage their applications, you know, at, in AWS environments, but we were not that sophisticated.
Sure.
We went out, and we hired a leader, Frank Guerrera, who started in the summer of 2017. We built out a really mature operations center that we use to manage Pega Cloud. We changed all the comp plans, we changed the messaging, we talked to all our clients, got our clients on board. And, you know, now, five years later, we're done with the transition, and we have a business that is all recurring, or 97% recurring. We have a business that's, you know, 60%-70% of growth is Pega Cloud. Most of new workloads, much higher than that number, are Pega Cloud. Pega Cloud is now $500 million, up from, you know, $20 million or $30 million that it was less than five years ago.
And the last part of the transition is really that profitability, free cash flow transition, which you've seen happen in the first two quarters of 2023 and will continue to happen as we go forward over the next, you know, two years. You know, we were a little bit behind on the profitability where we wanted to be five years ago, as a combination of two things. One, the move to SaaS happened in a much greater way than we first anticipated. And second, we had made some strategic bets on go-to-market to try to accelerate our growth, going, you know, broadening our coverage, going into some new areas, even a few new verticals.
And it just really didn't pay the dividends that we expected, and so we had to kind of correct some of those decisions that we made. And so now I think what you're gonna see is really a really solid operating model of all recurring business, SaaS becoming a bigger piece, and really kicking off quite a bit of free cash flow. So it's, you know, mission accomplished there.
Great! No, great, great to hear. Great overview there. Maybe we can talk about... a little bit about where the macro and market is today. I guess, how would you kind of describe where your current customers and potential customers are thinking about their budgets for Pega and how they're thinking about their kind of broader broader IT budgets?
So I think, in general, the enterprise spending market in 2023 is definitely feeling some, you know, a little bit of headwinds from what we may have seen over the last few years.
Mm-hmm.
I wouldn't say they're material, but I would say you can feel a little bit more scrutiny on buying, a little bit more pressure. When you think about where priorities would go, right? Naturally, priorities have... You know, the number one priority for IT spending is operations. Like, they have to keep the business going.
Sure.
And so many of our engagements with clients are heavily, you know, tied to the foundation of what they do. And so I think those relationships are very strong, and there will be opportunity for new workloads and increase capacity on those applications. Then, you jump to the next one, which is kind of evolution of moving from maybe legacy applications to something more modern.
Mm-hmm.
And I would say clients are still putting a lot of, of wood behind that, behind that arrow, but they are a little bit more sensitive to making those big, long-term commitments and really being thoughtful about, you know, "Do I have to do it this year? Can I wait a quarter? Can I wait a year? How fast should I roll that out?" And so that's probably where we see some of the pressure is on those new workloads, those new systems, something that maybe they don't necessarily need to deploy right now. They could wait a little while, although they will lose some value. It's not, it's not something that requires them to disrupt their business if they waited. And then, there's the kind of the, maybe the-...
You know, that second bucket and the third bucket, which is much more like R&D and testing new things, those two things become kind of in conflict at times, right? 'Cause there's only so much money to go around.
Right.
Clients have to pick what they do. That's where I think AI has probably caused the most distraction. AI is amazing. It's gonna be amazing for Pega. It's super interesting for our clients, but it also is a little bit of a science project right now.
Yeah
... to understand, like, what it's really gonna look like and how those use cases are gonna play out. So we've been working really hard and tight with our clients to say, "Listen, here are the use cases that we believe are really important. Here's how you can leverage GenAI. Here's how you can improve the applications that you use right now with Pega, and even some new use cases." And we've been trying to help them, you know, companies like Citi get through that journey. And maybe try to spend their precious resources and mind share on the right use cases-
Sure
... and the things that could drive the most value. But I think if you ask me, like, the general spending environment, I would say it's okay, but it's a little softer in terms of 2023. But I would say the bigger question is really, like, the distraction risk-
Yeah
...of AI and making sure... It's not a distraction, like it's not valuable. It's more like, you know, you wanna make sure you're really putting that energy into the right projects-
Right
... and picking the right things, as opposed to a scattershot approach to AI.
Right. I mean, I think, you know, every company now is talking about AI and talking about their products that's out there, and hard to differentiate, you know, what's real and what is, yeah, maybe a project. I feel like at your Analyst Day in PegaWorld in June, you talked a lot about what Pega is doing in AI. I guess, can you lay out the strategy today, what you've announced, and kind of how you're thinking about the impact that AI could have to Pega and your customers?
Sure. So there's three really key ways that we see AI helping our clients. The first, which is probably the one that's, I would say, most widely accepted and kind of quite frankly, almost becoming mainstream, which is the insertion of conversational AI into managing customer interactions, right? So that could be in the service environment. That's... You're really going away from, like, the rules-based chatbots, right? Where it was like yes or no, and really moving into, like, a more free-flowing discussion with clients and that's gonna solve so many problems. It's gonna reduce the dependency on CSRs, reduce the dependency on processors. It's gonna get customer satisfaction up.
Customers are gonna be able to interact quickly, you know, all hours of the day, all days of the week, all weeks of the year, like, to be able to get that, that information that they need. And that, to me, is very real. I mean, we use it internally. We've got, we've got some test pilots running, but we're also using it with our sales team. We're using it to produce content, like... And so that, I think, is... I would even put that at the point where that's almost, like, accepted, that that's a value of AI. And really, what clients are doing is trying to figure out, like, what library do I want to use? How do I segment my data? How do I control PII and things that could seep out?
How do I make sure that the AI doesn't become, you know, kind of flaky in terms of how it actually interacts and the decisions it makes? The second piece of it is really what I would call the ability to create kind of quick start speed, right? I wanna get started with a sample workflow. I wanna get started with a sample application. I know it's not gonna be what I use, but I don't wanna have to spend hours and weeks designing and workflow and mapping out the workflows and requirements documents, everything, and by the time I get three months in, I haven't even started anything yet, and that's unfortunately what large companies get caught up in.
So if I could just say, "I'm gonna go to AI and Pega," and I'm gonna say, "Give me an insurance renewal workflow." And it's gonna go, and it's gonna give you a framework. Maybe it's a three-step, four-step, five-step, maybe it's for different lines of business, and you're gonna be able to have something to start with, something to even put test data through. And that's kind of... That's, that's, we're really excited about that tool because that helps clients get started, even get things into beta testing or pilots. But it also allows them to start to think about, "Is this the way I want it to look? Like, how is this gonna look in a mobile environment?" And AI can drive a lot of that, kind of that first round or even second round. And then there's the question about the...
This is something I think that we're more kind of in the earlier stages of realizing clients really leveraging and using this, which is using AI to actually implement and improve the application.
Mm-hmm.
You know, which steps should be deleted? Which steps should be optimized? Where are customers getting hung up? Where do you have rejections? Where do you have people leaving the process? Where do you have a lot of paper, a lot of interaction from processing teams? Where... and that's actually quite easy to see when you look at the data. So AI, being able to see that, being able to look across different applications and say, "I see a common trend here, and this is what we need to do to fix the application design, and this is the actual changes. And by the way, I'm just gonna go ahead and do that.
Mm.
When you come in tomorrow, you can basically look at the new view, and you can click Accept, and now you have a modified workflow." I think that there's... We gotta work out some of the risks of that, but that, to me, is those are really tremendous opportunities to drive efficiency. Some being very straightforward, like conversational, all the way through to, we should be able to get to a point where AI is actually building the application, and a person is just kind of supervising that build.
Sure. No, I mean, I think the demos at PegaWorld looked really impressive and were, I guess, encouraging. At this point, how are you viewing the monetization potential, and when does, you know, AI and what you're doing there begin to impact ACV and begin to really drive customer outcomes and driving that towards revenue?
So we license, not exclusively, but primarily on a usage-based model, on a case-based model. That doesn't mean it's not like a pay by the drink model, where clients literally have no commitment, and they just pay each week or month.
Sure.
But they make commitments on a period of time, say, an annual basis, and then there's a certain amount of volume of transactions. So we have an opportunity, which AI can drive more transactions, more use cases, you know, really connect, really have Pega be the foundation of a lot more of the transactional volume. So there's an opportunity there for AI to really drive more volume, and when you drive more volume, we actually... We share in that value creation with our clients. Compare and contrast that to a user model. For user models, and there are a number of companies that have user models, that have went out and just said, "We're gonna mark up the price of a user 40% or 60%" or pick the number.
Although that is probably the only option that you have when you have that kind of licensing model, because you don't want... You don't wanna have to have people pay a lot of money just to get the rights to it, but you want people to use it. But you're almost incenting them not to use it by trying to charge more per user.
Mm.
Almost giving a client a reason to argue, "I don't want to have all my users-
Right.
just my power users." Well, then the 40% or 60% doesn't work, right? So it's very complicated when the pricing model to a client is disconnected to the value to the client. And so we really believe transactions and usage and how much the system does is completely connected to the value that they get. So that's why we license that way. In terms of the monetization timeframe, I would expect very little, if any, impact from AI in 2023. And I would say 2024, although we haven't guided for 2024 yet, I would anticipate you would start to see monetization from AI in 2024. Probably more in the back half, but maybe in terms of something that we might actually be able to talk about and observe.
Sure.
But it's gonna be relatively—this isn't a three-year or five-year. By the way, I have... For those of you that may have known me or heard me talk in the past, like, I've always been skeptical of the time horizon that technology impacts monetization models. I'm always like, "Oh, I—now you say it's gonna be two years." It's like, I'm always, I'm always a little bit more safe in that. I will tell you, AI is the, one of the first, you know, innovative areas that I've really been like, "I, I know that this is gonna move fast, and this is gonna get adopted fast." And it's just, it's totally different than, than automation, robotic process automation. It's different than all the other things that have come, even cloud, right?
Cloud took time for people to really think about and adopt. It was a commercial model just as much as it was a technology model.
Sure.
I just think AI is gonna move very fast, and I think you're gonna be at risk to be behind if you're not using it.
Sure.
So that's why I think the monetization's gonna happen. You know, we're gonna start to see it next year.
Okay. So as we think about customer budgets today, and they're thinking about investments, like, are, are they opening up new budget for, for AI, or is it really coming down to, you know, the, the use cases, that you're talking about and, and just trying to drive more usage to then drive the AI angle here?
So what I've seen with clients is, take AI off to the side for a second, and then they have... Our clients have problems. What are the problems? They are way too dependent on people. Those people are harder to get. Many of those people are aging in the workplace. They're not replacing... Younger people are not replacing into many of those roles, and you end up this model just becomes very difficult to manage. As you double your customer base, you don't wanna double the number of programmers that you have.
You don't wanna double the number of processing customer CSRs or so you end up with this situation where clients like, you know, like Citi or your peers are saying, "I've got a problem, and I've got to deal with this disconnect between my resource allocation and what I can actually afford." Then you have another problem, which is, "I have systems that may not meet the security standards, the modern... You know, I really can't leverage some of the new technology advancements in some of the systems that I have." So you've got this issue of, "I've gotta, I've gotta modernize some of my environments. I've got to think about my resource constraints." Now layer AI in. And so with AI, it's not becoming a discrete budget, from what I've seen.
It's becoming a part of the budget that gets allocated to AI initiatives to solve a problem that you're already dealing with, which is a resource-constraint problem and an innovation, you know, kind of a modern innovation- modernization innovation problem with legacy applications. So I think what's AI is gonna become is the tool to bridge large- larger enterprise organizations from where they are to where they wanted to be five years from now. So it will become a bigger part of their spend, and they're gonna get the savings from that because they're gonna actually need less people to support. They're gonna have less systems to support, and quite frankly, they're gonna have less time to the lag between when you start something and when you go to production.
Okay. So maybe as we think about the use cases that customers are investing in and caring about today in 2023, how has the mix of the use cases that Pega works on and you target for your customers changed, you know, in 2023 compared to 2022 or 2021?
In 2023, I think a lot of the... There's a larger amount of our applications and solutions that we're supporting our clients that are requiring real-time integration with all the systems that connect to the workflow. I think real-time integration was a differentiator and a value proposition, but not every client leveraged it. And so it was a lot of times you'd build a process that was a sophisticated process, but might still not necessarily connect in a seamless way with all the pieces. They might send information in more of a cache way or in an offline way to be able to connect, 'cause, you know, there were humans involved.
Yeah.
So if a human shut down their terminal, it wasn't that necessary, that they didn't start the next step till the next morning, right? So there was a little bit more of an acceptance of a human factor into that. A lot more of our clients are really moving more towards robotics and really trying to create what we, you know, we're talking about and calling the autonomous enterprise, which is an enterprise that the system can operate without any humans, right?
Mm.
I mean, that's a, that's a little bit of a dream right now, but let's operate with the least amount of human interaction. That's not a dream. So I think that that's, that's a big shift. Another shift is, you know, a few years ago, clients were moving off of desktop customer service software into, like, kind of virtual customer service software. I think COVID probably and the whole move to remote location really just made that, like... I mean, you have no choice, right?
Yeah.
It was, it was more of a decision that clients made about when they move. Now, it's like, "I need someone to go to a URL. I need them to be able to manage from anywhere. I can't actually even manage those systems because I can't even maybe even control data, depending on the country that they're in or what their access is." So you end up with really this push to say, "I've got to go to cloud systems, and I've got to go to vendor cloud systems.
Yep.
So I think the combination of the way the workplace has changed to be people not working in large employment centers, to being all over the place, to being able to have to access URLs, to the really regulatory control around data flowing between countries and regions, has really made it so that vendors have to solve that problem, right? Companies like Pega need to go into AWS, and GCP, and Azure. They need to figure the problem out.
Uh-huh.
And so I think what you've had, that means all the certifications get pushed to vendors.
Yep.
What's happening is we're now required to be a true solution vendor, as opposed to selling technology.
Yep. Okay, that makes sense. I guess maybe if we think about, you know, again, back to kind of the main environment, I think, you know, first half was... I think Q1 was strong, Q2 was maybe a little softer. How are you thinking about, like, what the second half of the year looks like and, you know, maybe how is 3Q kind of shaping up from a demand perspective right now?
Sure. I think if you looked... I think objectively, if you looked at the half year only, you probably wouldn't ask that question. That's a good question to ask about the difference between Q1 and Q2, right?
Yeah.
Because if you looked at the first half, it's largely landed in line with where we thought it would've been. But because we had such a strong Q1, the Q2 is an obvious question to say, "Well, why was Q1 stronger than Q2?
Yeah.
I think the reality is, in our business, we're selling enterprise clients. We're selling typically larger deals, smaller numbers of transactions. So you do get more of a skew between quarters than you might if you were selling, you know, Starbucks selling coffee, where you don't have that kind of variance between the quarters or the times of the year. I think Q3 and Q2 have typically been our weakest quarters in terms of net new activity-
Yeah
... just historically, not think, but it has been.
Mm-hmm.
Q4 is typically the strongest, and then some deals flow from Q4 into Q1. So that's the reason why Q1 tends to be a, you know, kind of, the reporting seems to be a little bit stronger than the other quarters. Q2 and Q3 historically have not been strong quarters. They've just been, they've been more, mediocre, right? And so I think that, I think that Q3, the demand environment in Q3 is certainly no worse than the demand environment in Q4. So I think that's not working. You know, that's not in our face. But I think Q3 is probably not where we make our year. But, you know, I also think there's a lot of activity in Q3. But we, we really are dependent on Q4-
Okay.
... right? Like, that's just historically we are. They're just—it's when, it's when enterprise buying tends to happen. It's when a lot of our sales teams have, like, kind of, kind of cutoffs to hit their commission accelerators. It's, quite frankly, a lot of our renewals happen in Q4, and a lot of our upsell and expansion happens on the backs of renewals. So when you have a quarter where there's... For us, when you have a quarter where there's not a lot of renewal, and it's not a seasonal quarter that would be active, typically, for our clients, and there's not as much of, as many compelling events to drive more activity. So, so I think, you know, I think Q3 feels like a stronger quarter than Q2.
Mm-hmm.
But, you know, Q4 is where we make our year.
Okay. So maybe if we think about that a little bit differently, I think you were guiding to, you know, $125 million-$145 million in ACV, new ACV for the year.
Yep.
I think that kind of implies you need to hit about $100 million or so in the second half of the year or two-
Yep
... to get there.
I guess, how are you feeling about the pipeline and the ability to kind of hit those, those numbers at this point?
I don't think pipeline and opportunity is really our risk.
Okay.
I think our risk is execution and any distraction of execution from some of the actions that we may have taken earlier in the year and recently with our sales team. That's always a risk. When you have disruption or displacement of people in your organization, there's a settling period that happens. So that's the reason why we did it this early in the year, as opposed to waiting till Q4, because we felt like, you know, this was the better time to make that call.
Yep.
But I think that's a risk. I don't, like I said, I don't think it's pipe or opportunity or client spend. But renewals are a big driver, and so if you just use that as a it's a driver, and renewals are skewed towards Q4.
Okay.
So that kind of helps you give the, you know, give the color. And then the last point I would make is, you know, the organizations that we're targeting, the ones we're covering, are the right ones to be able to expand.
Yep.
So, I think we do have a little bit more visibility and comfort with the pipe because those are companies that we know well.
Okay.
So that helps.
Makes sense. You mentioned the RIF activity, which I think happened earlier this year, and then in the past couple of weeks.
Yep.
What has changed... First of all, what has changed in the go-to-market? What's different now that you decided to do this? And secondarily, I guess, what does this mean for Rule of 40 and how you're thinking about the future margin and leverage that can come out of the model from these changes?
The change that we made in December-
Mm.
December, January of this past year, was a change around organization coverage. So what we did was we said, "All right, we're starting the year off..." Well, it was right before we started the year. "But we're starting the year off. Here's the orgs that we're gonna cover. Here's how we're going to cover them. Here's how much we can spend in coverage," based on where we thought what we thought the bookings were gonna be for the year. So that's what happened at the beginning of the year. We did not go as far as evaluating all the roles that we had across the sales team, because we wanted to really anchor in on the coverage model.
As we got through the first couple quarters, we knew that there was probably a risk, unfortunately, that we were gonna have to go a little deeper than we did to make sure we were on our Rule of 40 targets and our sales productivity targets. So then, when we released earnings in June, you know, in our prepared remarks and in my quote actually in the earnings release, I kind of signaled that this was happening. I don't think, you know, you or many people were surprised that it happened. But we were 'cause we talked about go-to-market organization, further optimization happening in the second half of the year.
Yep.
Then what we did, so what we just recently did, was we looked at roles that should be customer-facing and putting them together under the same management structure, and roles that were more technical in nature being part of a value continuum and being kind of co-managed. So we did a little bit of an organizational shift to bring the client success people closer to the account executives. And with that, you're gonna have some thinning of managers, you're gonna have some thinning. And then we moved the sales engineering to be part of the continuum with our enterprise architects and some of our implementation, and kind of deployment architects. So we felt like that would get people a little bit more aligned for a kind of life cycle of support for clients.
With that, you have some efficiencies that were kind of a next round of efficiency.
Sure.
That's kind of what happened between the beginning of the year versus the one that we just did.
Okay. So as you're thinking about it now, what does that mean for productivity rates for sales going forward now? And I guess secondarily, what does this mean for the margin and your continued push towards Rule of 40?
So what we just did will have very little impact on 2023.
Okay.
This is really a 2024 activity. That said, we're doing pretty well on free cash flow generation for this year, so I'm very optimistic on where we'll land for 2023. But what this really does, a combination of the beginning of the year, which by the way, will not have a full year impact in 2023 either, because some of those things didn't even happen until Q2, right? In terms of the timing, 'cause depending on the country you're in, et cetera. And the one we just did, which really will have very little impact this year.
The combination of those two and the combination of our increasing ACV and managing gross margin going up, et cetera, you're gonna end up with a, you know, a potential for a reasonable jump in our free cash flow levels from 2023, where we landed, to 2024. So I mean, this was something that was necessary. It was something that is completely aligned with our journey to drive to being a Rule of 40 company. And I think by the time we get to the end of 2024, I don't like to say we're there-
Mm
... but I would say we're pretty much there, right? Because our free cash flow, you know, has a good potential to be in the mid- to high-20s next year, right? And that's not, and that's not a, I don't think that's a dream. I think that's very possible. And that will then solidify our $500 million free cash flow number that we talked about in our Investor Day, which was like, you know, out there kind of in a, in a, you know, in a kind of a 3- to 5-year period. Can we get to be a $2 billion company generating 25% free cash flow, which is $500 million? So I think this is all part of that journey, and very consistent, and I think we're right on track.
Okay. So if we think about the math you just laid out there, I think you said mid-20s margin for free cash flow-
Yep
... exiting next year, kind of implies a 15% growth rate then to get to 40. You're talking about 11%-13% for this year. If I remember the medium-term guide, I think kind of in a similar range. So I guess, how do we get to that growth number you're talking about to that, you know, kind of mid-teens to make the Rule of 40 math work out?
So I, you know, I think one of two things is gonna have to happen, right? The one is, you know, we're gonna have to see growth rate acceleration in 2024 over 2023. And if that does not happen, which it is not, that is not a foregone conclusion, that is a risk.
Yep.
If that does not happen, then we should be doing things to manage the business to basically make up as much of that on the free cash flow margin that we can. You know, we really talked about Rule of 40 as we exit 2024, right? So we wanna be in a position when we enter 2025, that we're looking at the business saying, "We are a responsibly run, balanced organization," you know, within, within kind of spitting distance of the Rule of 40.
Yeah.
I think as we if our growth rate is lower in 2024, it puts more pressure on us being at the kind of math of Rule of 40.
Yep.
I think we will be, in spirit, on our way there, but that is definitely the risk we have. We wanna try to. We wanna, you know? So but I think we can do some things. I mean, certainly, we can, we can, you know, free cash flow can be higher than. There's no reason why 25 is, you know, some magic number. I mean, it certainly can be higher, and should be higher if our growth rate is lower. But we just have to think about the combination of, is that a terminal growth rate, or is that just one year, right? Right, and could the growth rate be higher in a future year? So we have to just be really thoughtful about that decision.
I think that's a great problem to have if we're within that range, because we're kind of close enough that, you know, it's... I think we'll get, you know, we'll be able to make some decisions without feeling like we've missed, you know, in spirit, our commitment that we said we were gonna do.
Sure. Okay, that makes sense. We have a little bit under 10 minutes left... Just want to make sure if there's any questions in the room, that we can address those, and we can go from there. Okay, so I do want to ask a little bit, maybe a little bit more towards the long-term guide that you gave at the analyst day. I guess, for one, can you just kind of like break it down, what's kind of being assumed in there? And, you know, kind of what's being assumed for macro, what's being assumed for AI contribution? Just how should we be thinking about what that looks like, and I guess, also the free cash flow component going forward?
In our long-term guide, we were assuming that the market would be slightly better than what we're seeing right now, but not materially better. I would say more like what we saw in 2022.
Okay.
So I think it's not really, we're not assuming four years of, like, a tougher enterprise spend in that model. The second thing is, we're assuming that we're on our way to getting closer to 80% gross margins in Pega Cloud, which would then drive our overall margins up. We're assuming professional services would become a slightly lower mix of our overall revenue. Still probably grow a little bit, but admittedly, at a lower pace than the rest of our business. We're assuming that R&D and G&A would actually grow at a slower pace than our overall ACV or revenue growth, which would give us a little bit of accretion there. And then, our sales and marketing would be one of our biggest lever factors, right?
Which is basically getting us from a 43%, you know, of sales and marketing as a percent of revenue, down probably closer to the 30 number, right? I think that's kind of the... And we'll have made really good progress at 2023 on that measure, and certainly in 2024. But that's kind of how we're thinking about it at a high level. Now, where's the growth gonna come from?
Yeah.
Right? The majority of the growth is gonna come from the, from the traditional growth lines that we've had before. AI is gonna be a, a factor in that, but I would say we're still early days to think about AI. Probably not gonna be a material component of 2024, but we will start to see it. I think when you get to 2025 and 2026, I think AI will help both on the revenue side and the cost side-
Okay.
Because we'll be leveraging AI to drive a more efficient business. So I think AI will help on both. And I also think Launchpad will be an interesting thing to watch. Like, how much of our revenue will come from Launchpad? Because when we get to 2024 and 2025, we'll now be a year into Launchpad being live. We'll have providers on there. We'll have some revenue. So I think you know... I don't know that we'll report Launchpad separately in 2024 because it may not be big enough to be but at some point it may be, you know, it may be something that we're talking about as a separate revenue stream, so to speak.
Got it. Can we talk a little bit more about Launchpad? Maybe just for those who might not be as familiar with it. I guess, how is it different than what Pega has historically done, and how do you think about it augmenting the go-to-market, from where it sits today?
So if I can maybe just maybe go back in history just a little bit to connect this. So a few years ago, we started an initiative to sell what we called corporate markets. What corporate markets was, was our sales teams, but maybe with a little bit of a thinner sales coverage going into more of a mid and a down market, and we were selling Pega Infinity to companies that needed workflow, but probably weren't our traditional size of an organization. They might—I mean, we're not talking about companies with 50 people, but more like in the $250 million-$2 billion range.
Companies that probably wouldn't have the capacity to spend $20 million, $30 million, or $40 million with Pega in a year, every year, excuse me.
Yep.
So we had some success there, but it's an inefficient model, and our product really needed to be multi-tenancy to be able to sell some of those use cases because our minimum deal size had to end up being, like, $100,000, and a lot of clients didn't want to spend $100,000. Even a $100,000 deal, the margins were not great for us in terms of, you know, we weren't gonna get 80% gross margins on that. So we didn't shut that down, but we more refocused some of those teams to go after major organizations that were newer logos, but still had large, large kind of spend opportunities. And then, we went a different path on that market, which was Launchpad. And so what we did with Launchpad was we essentially took all the capabilities of Infinity.
We made it multi-tenancy. We tightened up some of the flexibility that's that may have been native to Infinity and made sure that Launchpad had good controls around what you could do. In other words, not allowing a developer in Launchpad to get in trouble in a multi-tenant environment, which is, by the way, every multi-tenant software provider has to do that. If you Google Salesforce, you'll see 85 pages of all the restrictions that you can't do in their multi-tenant cloud. 'Cause they have to do that, right? Because that's the only way they can run an efficient cloud, you know. And then they... And if you wanna be a more of a, kind of a, on your own, you maybe go a Force.com route or something. You go a different route.
So we knew that that was the difference between Infinity and Launchpad. Then we thought, "Okay, we don't want to sell this. We don't want to have our own sales team because that's not really our selling culture.
Mm-hmm.
So we started to think about, how would you distribute this? The way we thought about distributing it was through ISVs or partners or our own clients that may want to sell software subscriptions to their clients. And so if you think about a company like, you know, I use this example 'cause I just think it's a little bit more of a clear one. If you have a company like Boston Scientific that's selling equipment to hospitals, those hospitals may actually need to buy some level of a subscription service or an application, so they can manage those pieces of equipment and manage the consumables and manage the billing to the patients, and the reimbursement, and all that. But they're not gonna go hire engineers and try to go build their own platform.
By the way, Boston Scientific isn't gonna hire engineers and build a workflow platform. So how about if Pega says, "We'll loan you the platform. You essentially build your use case on it. You sell that to your customers, and we'll get a revenue share for that"? And so you get all the power of Pega into kind of the mid-market, but typically through either a vertical partner or through a company like Cognizant or Capgemini, that might actually want... I'm just using those two, it could be any of our SIs, that might wanna actually build an application that they sell. Because Accenture, and Ernst & Young, and Capgemini, and Wipro and, you know, Cognizant, they all want to build subscription businesses.
Mm-hmm.
They all are not software companies, but yet they have very strong software technical skills, so just letting them almost, like, white label, so to speak, the intellectual property to be a... So that's what Launchpad is. It's a way for us to enter end markets that we couldn't get to with our traditional selling model, and we, and we made the product such that it fits that market, so we have a better product market fit. So we're, we're literally in the first year of that. We have less than 10 providers, as we call them, actually working on use cases. But we're really optimistic about that being almost a business that could become a flywheel.
Imagine companies like Veeva and nCino, and the companies when they started, that they could've used the Pega Platform to actually start their businesses as opposed to what they did.
Right. Right. No, that makes sense here. We only have about a minute left here, and I do wanna make sure that we ask about some of the lawsuit that's going on here. I guess, is there an updated timeline on how you're thinking about that, and yeah, just what does the future look like of that?
So the next step is the appeal, and the appeal is in process. We don't know when that will be heard. We filed all our appeal briefs, as did they, and you know, we expect. You know, we're guessing a little bit, but we expect in the next quarter or two that there would be a hearing for the appeal and maybe some type of a feedback from the appellate court. And then we kind of, you know, both parties will figure it out from there. There's other levels of appeal after that, that either party can choose to pursue, but right now, we're just kinda waiting for that next step. So it's a little bit kind of no new information right now.
Okay, that helps. Lastly, I know you had a convertible from February 2020.
Mm-hmm.
I think it comes due in 2025. Just how are you thinking about that, and how do you think about capital allocation going forward?
So the beauty of, the beauty of our situation right now, which is very rare for technology companies that went, went and did converts, is that we will actually... It looks, it looks to be that we will have plenty of cash to actually settle the convert if we so chose. Not all technology companies have that option, so when they get within a year, they kinda have to, like, because of the going concern issues, et cetera, they have to kind of refinance, like, a year or two in advance. I think the, the good thing for us is it certainly appears at this stage we don't have that, those kind of constraints. Now, that doesn't mean we wouldn't wanna consider those. It's just that where the stock price is right now, refinancing a convert doesn't seem like... I mean, we're essentially issuing new equity, right?
Yeah.
So do we wanna issue new equity when we think that the value creation is so significant that we can have over the next, you know, 18 months, just using it to get out to March? So I think right now the convert is, it's out there. It's something that we're basically building a cash war chest to be able to settle if we wanted, or maybe we will decide not to do and refinance it. Or, you know, be strong convert holders, and I think our convert holders have a lot of belief in the company just based on where the converts are trading, 'cause they're really trading with very little risk, you know, if you look at the yield to maturity.
So I think we got a really strong support from those convert holders that would love to participate in another convert if we did it. We'll just have to see how that plays out. In terms of capital allocation, I think we're gonna have a really fun discussion in probably a year or two, because we're gonna have a couple years of generating $hundreds of millions of free cash flow. The convert may not be... And we're gonna really start to think about, like, "Okay, we're a different business now.
Mm.
Before we went to the cloud—before we went to the subscription transition, I'm not sure Pega generated more than $100 million in any year. I mean, maybe they did one year just because of the timing of collections. But most years, we were under that. We're gonna now be a company that's generating multiple times that number, and it's gonna give us lots of options, acquisition discussions, re—you know, just, you know, buying back shares, distributions of sh—like, it just gives us, like, lots more to be thinking about. And so that, that'll be fun to have the true capital allocation discussions—
Sure
... that, quite frankly, right now it's more just, like, looking at the convert and making sure that we put that behind us if we wanted to.
Sure. Good problem for our CFO to have, though.
I look forward to those days.
All right, great. Well, Ken, thank you so much for being here, and thank you everybody for being here on the round.