Pegasystems Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
April 25, 2024

There are 15 speakers on the call.

Operator

Thank you. I would now like to turn the conference over to Peter Welburn, Vice President of Corporate Development and Investor Relations. You may begin.

Speaker 1

Thanks, Jeannie. Good morning, everyone, and welcome to Pegasystems Q1 2024 Earnings Call. Before we begin, I would like to read our Safe Harbor statement. Certain statements contained in this presentation may be construed as forward looking statements as defined in the Private Securities Litigation Reform Act of 1995. The words expects, anticipates, intends, plans, believes, will, could, should, estimates, may, forecasts and guidance or variations of such words and other similar expressions identify forward looking statements, which speak only as of the date the statement was made and are based on current expectations and assumptions.

Speaker 1

Because such statements deal with future events, they are subject to various risks and uncertainties. Actual results for fiscal year 2024 and beyond could differ materially from the company's current expectations. Factors that could cause the company's results to differ materially from those expressed in forward looking statements are contained in the company's press release announcing its Q1 2024 results and in the company's filings with the Securities and Exchange Commission, including its annual report on Form 10 ks for the year ended December 31, 2023, and in other recent filings with the Securities and Exchange Commission. Investors are cautioned not to place undue reliance on such forward looking statements, and there are no assurances that the matters contained in such statements will be achieved. Although subsequent events may cause our views to change, except as required by applicable law, we do not undertake and specifically disclaim any obligations to publicly update or revise these forward looking statements whether as a result of new information, future events or otherwise.

Speaker 1

And with that, I will turn the call over to Alan Trefler, Founder and CEO of Pegasystems.

Speaker 2

Thank you, Peter, and thank you to all who have joined today's call. We're off to a strong start in 2024. Our results reinforce the soundness of our go to market strategy and we continue to improve execution resulting in strong cash flow and significant expansion of Pega Cloud gross margins. This quarter, we continued to grow by deepening and expanding client engagement throughout our target account model and to drive our Gen AI strategy forward with significant new and enhanced technology. The reactions we're seeing from clients as they begin to experience and fully understand the potential impact of PegaGen AI is tremendous.

Speaker 2

It's opened up full new avenues for collaboration between us, our clients and our partners as well as inside our client organizations across their teams and functions. I'm even more excited than when we last talked about the incredible opportunity to leverage GenAI to drive success in 2024 and beyond for Pega and for our clients. Now to talk about the strategy, as a reminder, when we apply GenAI, we're not using it to generate code. We're using it to optimize the business outcomes and best practices that our customers are able to follow. Our unique technical structure is built around business concepts and enterprises processes, their rules, data models, UI, all organized into layers that can be built on and reused.

Speaker 2

It's turned out that this is a perfect architecture for GenAI and I think it gives Pega a unique advantage because we directly offer, enhance and optimize the business concepts themselves in a way that both business and IT can understand and collaborate on. And it's a patented architecture underneath it all that I don't think can be readily copied or reproduced. Now you may remember on our last call, I talked about the major areas where we believe our unique approach to Gen AI will drive massive impacts for our clients and for us. Delivering solutions that will first double developer productivity and bring Pega skills to the fingertips of our customers that will ignite enterprise innovation through a blend of industry expertise, Pega expertise, Pega technology and client insights that will maximize revenue and efficiency with real time optimization and personalization of customer interactions and will streamline work processes and customer experiences by giving the right people instant access, not just to real time enterprise knowledge, but to the processes that are necessary to get the results they want. We've continued to deliver on that strategy to help our clients unlock business transforming outcomes.

Speaker 2

This amazing technology will be showcased in PegaWorld in our 10,000 Square Foot Innovation Hub featuring more than 200 interactive demos that will be showing off the latest of the AI advances and how it will drive the future. It's an experience you can only have if you're there in person. Now here are just a few highlights of the newest technology you'll see and hear at PegaWorld. 1st, we announced Pega GenAI Blueprint in mid February and began immediately testing it with partners and clients and we've now made it available to anyone who wants to use it since late March. Whether you're a Pega client or not.

Speaker 2

All you have to do is go search on Pega for Pega Blueprint and you'll find our website really just has everything you need to get started. You can be up and running in minutes. I think that no other competitor has anything that can do with you. And we think it's a major competitive advantage. In the lunch last month, hundreds of clients have generated thousands of blueprints.

Speaker 2

Together, we, our clients and our partners are finding new ways to leverage this technology every day and stretching the boundaries of what's possible. Based on user feedback, we're enhancing it continuously. And because it's a SaaS application, we're releasing new versions every 1 to 2 weeks. In just the last few weeks, for example, we added new capabilities that allow you to import blueprints directly into a Pega application to allow you to really do game changing work in seconds that otherwise would have taken weeks. And this enables people to iterate on application requirements and regenerate blueprints as they have new ideas and experience what's going on in their collaborative efforts.

Speaker 2

Now more enhancements are planned in the coming weeks months And as more clients and partners use it, we're getting extreme of additional ideas that are both being met with great excitement by the partners and customers and great excitement by us. For example, we think that we're seeing many customers looking to use BLUEPRINT to be able to rethink and to modernize their legacy estate. These are large collections of often ancient applications that all customers want to try to drive down in terms of complexity and quantity. And Blueprint makes envisioning and designing for the replacement of legacy apps completely different experience. It incorporates design thinking and best practices from both Pega and the Internet, integrates them and uses GenAI to synthesize the information and make recommendations on how they could improve.

Speaker 2

This is where our use of GenAI, I believe, is truly groundbreaking as we allow enterprises to explore entirely new ways of envisioning their business processes, building on what is known on the Internet and what we have done over our decades of experience, making it dramatically easier to align business and IT. We think it's a great opportunity for us and we'll be talking much more about it at PegaWorld. Now in addition to Blueprint, we continue to introduce and enhance our Infinity suite of solutions. Last week, we launched Infinity 24.1 with transformative capabilities to help our clients become self optimizing enterprise, Incorporating enterprise grade AI and automation, this newest release empowers organizations to optimize service, sales, marketing and their business operations with new capabilities including the Pega Gen AI Knowledge Buddy, which helps users synthesize knowledge scattered across content libraries to quickly answer employees and customer questions. There are 100 of 1000 of chatbots out there these days.

Speaker 2

Everybody has a couple of chatbots, but they don't include the kind of robust enterprise based capabilities organizations need to audit what's going on, provide the right security, the right control and be able to have confidence in the answers. That's what we focus our knowledge and body on. We're also introducing the Pega Gen AI Coach, which serves as a real time mentor, analyzing employee workflows and providing actionable insights to optimize productivity. And we have new accelerator bundles, what we call PegaGen AI Automate and PegaGen AI Analyze, which surface and summarize insights about cases, data, meetings, conversations to make it easier and faster for salespeople and service agents to follow-up and engage with prospects and customers, as well as many, many other enhancements. We see a terrific long term growth opportunity as these capabilities are the ones that are coming, help clients adopt our software more quickly and find new use cases for PACCAR.

Speaker 2

Now I've talked about PegaWorld a bit and I want you to really consider strongly coming to Las Vegas and joining us because it is going to be terrific. As exciting as the new product announcements we'll be showing are, what really separates FEGAR World from many other tech conferences are the incredible real world, very, very deep examples of how our clients are using the software that they themselves bring to the PegaWorld and talk about them in ways that, well, candidly, we couldn't talk about them because we have to maintain our clients' confidentiality. But when they get up and speak about it, we think it's wonderful. And we are honored that they're willing to discuss some of the amazing things that they're doing. Some of the customers who are coming will be, for example, T Mobile, who will talk about their focus on customer centricity, the customer service overhaul that not just led to improve efficiency, but massively improved customer satisfaction and how AI driven insights are empowering their frontline staff to build stronger relationships.

Speaker 2

We'll also talk about the key success metrics that they've achieved and provide insights into their ambitious AI plans. Booking.com will describe how they are leveraging Pega capabilities to meet evolving traveler needs, while also maintaining their super high customer satisfaction levels. Pega supports their customer centric approach, ensuring that thousands of agents around the globe can deliver unparalleled experiences to travelers worldwide. National Australia Bank will explain how they're bringing together the left brain of analytics and the right brain of creative thinking to build real relationship led personal experiences relevant in the moment at any channel. They have a fascinating story about how the blend of data, creative experimentation and Pega technology are disrupting conventional approaches communications and how they've used this to deliver 91,000,000 customer engagements and a 40% increase in customer successful engagements in just over a year.

Speaker 2

And finally, just to pick another one, the Department of Veterans Affairs will discuss how they're modernizing their benefits program for veterans, spouses, children and caregivers to improve responsiveness in this essential program. As a reminder, we scheduled our investor session for Monday, June 10, local time is noon, and we are hoping to see you there. You should have received your invite by now. If you haven't, let us know and be sure to register. It's going to be a fabulous event.

Speaker 2

So in summary, our go to market strategy and focused model are deepening relationships and driving good results, including a healthy balance of growth and profitability. We continue to focus on leveraging the latest Gen AI capabilities to deliver advantages to our clients. Pega has been through massive technology transitions through our 40 year history. We've done 5 completely architectures of what we've done and I believe we are perfectly positioned to incorporate GenAI into the architecture we have and the way that we're going to deliver for our clients. This experience of being able to manage through and well in extreme changes in technical environments is, I think one of the reasons that GenAI is going to be especially advantageous to us.

Speaker 2

Our newest offerings are truly enhancing the relationships with our customers and our clients' relationships with their customers. I think we have a huge opportunity to drive success in 2024 and beyond, and it's going to be very transformative. Now to provide color on our financial results, let me turn it over to our COO and CFO, Ken Stilwell. Ken?

Speaker 3

Thanks, Alan. I'm very excited about our start to 2024. Annual contract value or ACV increased 9% year over year, which is where we thought it would be in Q1. As I explained on our last earnings call, ACV growth faced a tough year over year compare in the Q1 of 2024 because the net ACV add in Q1 of 2023 was unusually strong. And as a result, we knew the ACV growth rate would be at the lowest point as the year began.

Speaker 3

Pega Cloud drove the majority of net new ACV add in the Q1. And Pega Cloud ACV, which is approaching 600,000,000 dollars continues to be the largest and fastest growing portion of ACV. Moving to free cash flow. When we started our subscription transition in late 2017, we knew the transition would over time result in more predictable subscription billings and free cash flow. Now that the transition is complete, it's great to see that vision become reality.

Speaker 3

We generated $180,000,000 of free cash flow in the Q1, a record by far for any quarter in the history of the company. Our strong free cash flow performance was driven primarily by 3 factors. 1st, ACV grew by about $100,000,000 year over year. ACV is a strong proxy for subscription billings. So an increase in ACV will naturally drive a material increase in subscription billings.

Speaker 3

2nd, we're doing really well on our cost management initiatives, which improved operating leverage again in the quarter. For example, sales and marketing expenses decreased by about 15% year over year in the Q1 of 2024 versus the same period 1 year ago. 3rd, many of our deals close and renew in the last quarter of the year, which means collections often occur through the Q1 of the year. Our fast start on free cash flow generation may be a little surprising to many of you. And it's quite frankly a little better than we had even expected.

Speaker 3

But naturally, starting off strong gives us that much more confidence in our progress to improve margins and our cash flow momentum. Moving on to margins. Pega Cloud gross margin increased to 77%, a 500 basis point increase from a year ago, and that's just awesome to see the continued improvement. The improvement was driven by 3 factors. First, the increasing scale of Pega Cloud, which grew 21% year over year to $131,000,000 in revenue in Q1.

Speaker 3

2nd, more active planning and management of our global cloud capacity to optimize performance and to reduce cost. 3rd, an increasing use of Kubernetes for cloud scalability and efficiency. Now that we've released Pega Gen AI Blueprint in Q1, I'd like to share some thoughts on the timing of Gen AI monetization. In 2024, we expect PegaGen AI Blueprint will both change the way we engage with our clients and also decrease the time it takes for clients to envision and build new applications on the Pega platform. And we're already seeing evidence of that.

Speaker 3

Though we're still in the early days of Jet AI, we can see that this innovation is going to be central to our clients' buying decisions. And it beautifully complements the statistical AI that we've delivered for decades. We expected Jet AI would be central to our products as we put our 2024 plan together and that's what we're seeing. Thus, monetization will be as a result of improvements in the selling cycle, which we believe will be fully realized in 2025. I've received feedback that is helpful when I provide thoughts on modeling our business.

Speaker 3

So today, I'll continue to share some insights. First, we expect our ACV bookings will be more back end loaded this year and the majority of our subscription billings will occur in Q1 and Q4. So for the full year, we expect our cash flow to be strongest in the 1st and the last quarters of the year. 2nd, our sales and marketing expenses are slightly higher in the Q2 as a result of PegaWorld cost, our annual client conference, which occurs in June. 3rd, we expect term license revenue will decline year over year in 2024 as Pega Cloud continues to become an increasingly larger portion of our overall business.

Speaker 3

And this is certainly connected to GenAI momentum. As cloud accelerates, an increasingly smaller part of our growth is coming from subscription revenue subscription license revenue, excuse me, which is term and maintenance revenue. Both of those are expected to continue to decline as a percentage of our revenue and also subscription license, I. E. Term revenue is going to decline year over year.

Speaker 3

In fact, term license revenue will likely be less than 25% of our full year revenue and it will be back end loaded. But that's okay because it doesn't impact cash flow timing and we'll gladly trade term license revenue variability and decline for having a business accelerate faster to the cloud. Turning to our capital structure. As many of you are aware, we have about $500,000,000 of remaining outstanding convertible debt at 0.75 interest rate that matures in March of 2025. We continue to evaluate alternatives, but at the end of Q1, our total cash and investments balance was about $619,000,000 So we are now in a net cash positive position when factoring in payoff of the convert.

Speaker 3

We are still waiting for the opinion from the Virginia appeals court. We don't know when that court will issue an opinion, but of the cases our panel of judges has heard, the majority of those cases have been decided. I also would like to provide you with a brief update on the shareholder class action suit that was filed in 2022. We reached an agreement to resolve that shareholder suit for $35,000,000 We look forward to putting that distraction and the associated legal fees behind us. I'm looking forward to seeing all of you at PegaWorld, which is being held at the MGM Grand in Las Vegas again and starts on Sunday, June 9.

Speaker 3

We'll hold our investor session, as Alan mentioned, on Monday, June 10 at lunchtime. To register for the investor session, please email pegainvestorrelationspega.com or reach out to Peter Welberg. Featured speakers during our investor session will include our Founder and CEO, Alan Trembler as well as other members of our senior leadership team. We will provide updates on our long term strategy, our latest product innovation and our go to market approach. In conclusion, I feel really, really great about running a sound business.

Speaker 3

Our strong cash generation in Q1 demonstrates the power of a SaaS business and we're in a great position to accelerate our profitable growth from here. Operator, please open the line for questions.

Operator

Thank you. The floor is now open for questions. Your first question comes from the line of Raimo Lenschow with Barclays. Please go ahead.

Speaker 4

Thank you. Congrats for me. I have 2 quick questions. 1, Alan, for you or maybe it's actually for both of you. If you think about the monetization, so if I understand you correctly, it's going to accelerate the line adoption of Tega quite nicely.

Speaker 4

Is that kind of the main things we should think about monetization? Or are there also kind of SKUs that have more AI versus less AI that could kind of drive monetization there. So that's question 1. Question 2 would be for Ken. On the cash flow, you obviously gave us last quarter like an annual cash flow idea with a very strong Q1.

Speaker 4

Was there like some timings that helped you? Or how do you feel about the full year number? Thank you.

Speaker 2

So we're permeating our products with GenAI. So that this is really becoming something that I think is going to be a reason that people say, boy, we can get this to work faster, better cheaper and more broadly in the organizations. And that's the way we monetize things. And if you want to get a feel for that, just try Blueprint. It makes perfect sense to you in 2 minutes.

Speaker 3

Ken? Yes. On the question about annual cash flow, I think that's probably a very common question on the minds of lots of people listening to this call with its hard results. So it's a great question. I'm generalizing a bit, but if you think about Q1 and Q4 being big cash collection quarters and Q2 and Q3 being more subdued and quite frankly not significant cash generation.

Speaker 3

To get more than half of your full year target in the Q1 is certainly a great start. I wouldn't go as far as to say that changes our view for the year. I would say what that does is really reinforce the momentum that we're on and the confidence that we have for the full year. But it is it's great. Naturally, you always want cash flow as soon as you can get it in the year.

Speaker 3

But it wasn't it was expected that Q1 and Q4 would be bigger collection quarters.

Speaker 4

Okay, perfect. Thank you.

Operator

Your next question comes from the line of Kevin Kumar with Goldman Sachs. Please go ahead.

Speaker 5

Hi, thanks for taking my questions. I wanted to touch on Blueprint. It appears that interest is pretty strong there and I've gone on demoed it as well and it looks great. Alan, just curious about, I guess, the second order impacts of just being able to speed up the design process with Blueprint. Are you seeing any early indications that this could drive more applications being developed on the platform?

Speaker 2

Yes, we are. I mean, we're seeing an enormous interest from clients and from partners. And we see blueprints being included now in RFP responses and in bids that are going to customers. So it's I think it's a big step forward and it's candidly a step that's only going to get bigger as we continue to add in some of the features that are planned for even now to PegaWorld. So we're really, really seeing concrete uses with clients.

Speaker 2

I also think this opens the door to Pega being seen as an engine for legacy transformation. We talked to people in the tech world who have literally thousands of applications. And being able to use a technology like this, it helped take them out faster and better, get rid of some of that technical debt, hook them all together in what we call a process fabric, which is a technology we've talked about in the past that lets you have multiple Pega apps that act as one. It's I think it's a very appealing message even in its early days. So we're pretty jazzed about this.

Speaker 5

That's great. And then Ken, one for you. You called out sales and marketing and seeing some year over year decreases in expenses there. And just curious kind of where you're seeing opportunities to kind of reduce expenses within that org and should we expect that to kind of continue throughout the year?

Speaker 3

Yes. So we're kind of at a we're a little bit of a stabilization point in terms of the run rate of expenses is right now because we essentially normalized some of the restructuring that we did last year. Gross margin definitely will continue to improve in Pega Cloud because there's a lot of things that we're implementing that are not actually not been impacting margin to the positive yet and will continue to. And think about our go to market costs as less around where we can take costs out and more about leveraging that resource pool to accelerate growth, Kevin. We're really a great growth opportunity, acceleration through the rest of the year.

Speaker 3

We feel very confident that we will accelerate growth. And GenAI is really just a massive catalyst for pushing productivity in our go to market teams because of that speed to ideation, the speed to getting clients to see the vision, the speed to getting them to realize their architecture designs and their workflows. And actually now with the latest changes to Blueprint, the improvements of Blueprint to actually get the PEG application started. So we feel like that is just such a tailwind, so to speak, to sales productivity. We're focused on really putting those resources in the right place to accelerate scale and become more productive as opposed to a cost cutting exercise.

Speaker 5

That makes sense. Thank you both.

Operator

Your next question comes from the line of Pinjalambhora with JPMorgan.

Speaker 6

Just two parts. One question for me. Are you starting to see some of the G and A capabilities that you're introducing in cloud drive customer conversations around cloud migrations from the self managed product that you have? And then I guess cloud ACV growth seems like has kind of reached a low point. Wondering if it is kind of at the trough level at this point as Blueprint and other Gimiad capabilities drive consumption going forward?

Speaker 3

Let me take the second part of that. We do think Q1 was a trough for ACV growth. We had thought that, that was the case when we guided. We had said that really in Q1. I think most of you know that because we saw the models that all of you had built.

Speaker 3

And so I think you definitely heard us on that. In terms of the ability for cloud migrations and GenAI and the connection, Alan, thoughts on that?

Speaker 2

Yes. So we've hooked our GenAI capabilities, which are unfolding so quickly to Pega Cloud, which only makes sense because we're able to roll out so much more efficiently and effectively. And we definitely see customers being interested in moving to pega cloud. They've been historically because I think it's such a both cost effective but also offers some scalability and other features that they may have difficult emulating in other environments. So we've historically seen a strong interest.

Speaker 2

We're definitely seeing that the Gen AI makes that interest even more critical for customers who weren't already heading in that direction.

Speaker 3

One last point on that. The about 2 thirds to 75% of our clients have seen Pega Cloud now, meaning that they have at least environment for Pega Cloud. As that there's a natural momentum that as clients have one application on Pega Cloud, they look at moving all or other applications to Pega Cloud. So you do have a little bit of the flywheel on people buying more Pega Cloud, more clients getting exposed to Pega Cloud, which then will lead to the migration discussion that you mentioned. So I do think it's really a good time for that to happen now.

Speaker 6

Got it. Thank you.

Operator

Your next question comes from the line of Rishi D'Aurea with RBC Capital Markets. Please go ahead.

Speaker 7

Hi, thanks. This is Rich Poland on for Rishi. Thanks for taking my question. So I guess first one, Ken, just to clarify, I believe you said AI contribution embedded in the full year guide when it was provided was 0. So if we take a step back, can we just think about what needs to happen to achieve the guidance?

Speaker 7

And what kind of early adoption Blueprint or Blueprint accelerating the adoption curve be upside to those numbers?

Speaker 3

Yes. So yes, your question is you guided at the beginning of the year 11% ACV growth and we did say that we did not believe that factored in a noticeable impact to ACV from Jet AI. Your question is, if there was a notice of impact, would that provide upside to the growth number? And if that's the sense of the question, which is what I read, I would say, yes, significantly faster adoption of JetAI and influence into the pipe and the conversion of pipe is certainly an upside opportunity.

Speaker 7

Okay, great. That's helpful. And then one for Alan. You mentioned the industry expertise as kind of a differentiator around AI. Can you just kind of expand on that a bit and just what you're seeing right now in terms of use cases in specific industries or just maybe any domain expertise that you're infusing into some of the solutions there?

Speaker 2

Sure. We took our industry experts and we have them pull together the templates that made most sense for common industry problems in the areas where we have a lot of experience. We have a lot of experience, as you know, in banking, insurance and healthcare and government. And you can see that if you use Blueprint, we have before we go out and begin infusing the Gen AI content into the analysis, you can see our standard templates actually visible in the blueprint choices you make. So if you say, hey, in banking or in financial services and credit card and I want to take a look at collections as a function, you'll see a whole collection of our best practices pop up.

Speaker 2

And so I think we've been able to use the things that we've learned about the industry, the things we've learned about technology, which is how we've been able to pull this in. And I think the team's done a great implementation to be able to bring this together in a way that's very tangible and will be the basis for a lot more coming.

Operator

Awesome. Thank you. Your next question comes from the line of Jake Roberge with William Blair. Please go ahead.

Speaker 8

Hey, thanks for taking the questions and great to hear about the hundreds of customers that are already using Blueprint. Just curious what type of use cases are you seeing customers target with that solution? And then I know you have 20 or so other GenAI accelerators. Are there any other solutions that you're starting to see customer interest pick up for? Sure.

Speaker 2

We're finding that the customers are creating Blueprints all over the map. There's a lot that are tied to particular service flows. So things that you want to do in customer service, the onboarding and lifecycle management of clients is another place where I'm seeing a lot of blueprints being done and being created. Being able to think about how you can modernize the front ends to your SAP and other back end systems is an area that's central. So it's really the multitude of processes that historically people had to go and sit down in front of a whiteboard and brainstorm.

Speaker 2

You can now ask our history and the Internet to come together and have you do it 2 minutes what used to take 2 weeks. And I think that's going to be pretty game changing, particularly as it continues to evolve. Now, other accelerators that we have, the ones that I think one of the ones that I think most interesting is we're going to be showing off at PegaWorld and have a client actually talking about the ability to do what's called voice AI, which is to have the AI listen to the stream of little conversation that's going on. And use that to both make sure the person is saying the right things. So if you're on a regulatory business, you have to say certain describers to make sure those things are actually set, but also to default fields of the screens and really very, very substantially improved productivity, both through that and also through things like being able to summarize the call.

Speaker 2

So I would say there are lots of features out there in AI and you're going to see lots of vendors talking about feature A and feature B and feature C. What I'm most excited about is not just we won't have a great set of features, we absolutely do have and will have terrific features. But the ability to use the Jet AI to fundamentally optimize the way the business runs, to be able to use it to build processes, I think it's something I'm not seeing anyone else doing. And that makes me excited.

Speaker 8

Yes, that's very helpful. And then Ken, great to see the improvement in Pega Cloud gross margins. Where do you think those ultimately trend over time? And are there any costs to consider in that metric as it relates to GenAI?

Speaker 3

Yes. That's actually insightful question, the second one. So the margins we see the margins getting above 80. Percent. And I don't when I say above 80 percent, I'm not talking about 5 years out, right?

Speaker 3

I'm talking about in the relative near term. So we think we'll get above 80%. The question of once we get above 80%, Jake, it's a question is how far can you really push that? I mean, if you look at like other companies in our space and best of class for a multi tenant SaaS solution is probably like low to mid-80s. I mean, that's about as good as you as I have seen companies get.

Speaker 3

For us to get above $80,000,000 at less than $1,000,000,000 of revenue, I think it's actually quite good. But I think there is still room to optimize there. So we're not in any way taking our foot off the pedal on that. The second point that you made about Jet AI and Jet AI utilization in the cloud, as of right now, the costs are relatively modest. I think as they scale naturally as the Gen AI costs scale, our infrastructure costs are running, there will be a direct correlation from that to actually ACV and cloud revenue that we're getting from our clients.

Speaker 3

So we do not believe that will be a headwind to margin expansion by any stretch. We think it will be just a cost of doing business like our AWS and GCP costs are.

Speaker 2

Yes. And we've been, I think, very aggressive and thoughtful in working through how at this point we want to apply JAI. And so the way that we've done it and we've got information about this on our website, our CTO has a nice little 7 minute video about how Pega applies this technology is through the use of vector databases and what are called RAG techniques, retrieval augmented generation that allow us to use a conventional model, say, chat GPT, think Gemini from Google, think Bedrock from Amazon and being able to pick the right model to use to be able to assemble the analyses from the work that we're doing in a way that I think is very cost effective. So we, I think, have a way of doing this that is going to scale up nicely as the business grows.

Speaker 8

Very helpful. Thanks for taking my questions.

Speaker 9

Thanks, Jay.

Operator

Your next question comes from the line of Dan Ives with Wedbush. Please go ahead.

Speaker 10

Yes, thanks. So on the go to market strategy, when you were Nithimat AI, can you just talk about what we could expect next 3, 6, 9 months? Like is it more partnerships even ramping up internally in terms of types of individual? Can you talk about from a go to market in terms of like the next steps there?

Speaker 2

Yes. So we definitely are working with some key partners and looking to broaden the partner relationships. And there's a lot of enthusiasm from partners to be able to apply some of this new technology here as well. What I'm excited about is I've never seen such quick uptake, never seen such quick uptake of a capability like what we've put out there with Blueprint. I mean, by like a factor of 10 in terms of the number of customers, the number of things they're actually doing with it.

Speaker 2

And it really gives them a taste of Jet AI, probably not just in English. What I love is I was over in Europe 2 weeks ago and we had I couldn't read any of them. We had people generating the blueprints in Dutch in Italian. And it was really quite remarkable to gauge their reaction to the stuff I couldn't understand. So the uptake on this, I think our go to market is going to end up being a lot more viral than it has been historically.

Speaker 2

And we're looking to ramp up to support that one.

Speaker 10

Thank you.

Operator

Your next question comes from the line of Steve Enders with Citi. Please go ahead.

Speaker 9

Okay, great. Thanks for taking the questions here. I guess, moving to the start, like I know ACV kind of came in, in line with the growth expectations for the quarter. But I guess how would you kind of like frame where the macro environment is today and how people are viewing opportunities in budgets and maybe the impact that AI is having on that so far? So I'll

Speaker 3

take it first and Alan can add some comments. So Steve, I would say that the economy continues certainly in the organizations that we're engaging with continues to be pretty resilient in terms of clients wanting to invest in digital transformation. And I think that GenAI is just an accelerant to that momentum because the clients are looking at GenAI and digital transformation not as 2 different things. They're looking at them as being very related. How do I manage this legacy application situation that I'm in?

Speaker 3

And when I think about developing new capabilities, how do I want to insert GenAI, we're actually taking even a different angle to that, which is how do we leverage GenAI to help you accelerate your digital transformation to get you faster to the place that you want to get to. So I think that there's still a tremendous amount of resiliency in the market. And quite frankly, I think clients are thinking at the same organic increasing pace around digital transformation than they were over the last 12 to 24 months. So I think we're feeling very good about the appliance interest in Pega Solutions and how we can help them with digital transformation. Naturally, we have Interest rates are still high.

Speaker 3

Inflation is kind of coming back a little or not. I mean, there's a lot of macro distractions there, but we see our clients really investing heavily in their digital transformation journeys.

Speaker 9

Okay, great. That's helpful. And then I guess just on the now that blueprints are out there, like are you seeing have you seen like customers actually convert that into production apps yet now that that capability is out there or, yes, how should we kind of think about, maybe the impact it was having on like top of funnel or the kind of conversations that you're having today with that?

Speaker 2

Well, we're talking about something that's really been out there for a grand total of 2 weeks. So it's a little premature, but we see that happening imminently. I think 5 PegaWorld will have a number of success stories to talk about.

Speaker 9

Okay, perfect. That's helpful. Thanks for taking the questions.

Speaker 4

Thanks, Steve.

Operator

Your next question comes from the line of Austin Cole with Citizens JMP. Please go ahead.

Speaker 8

Thanks for taking the question.

Speaker 11

I've got yet another Blueprint question. I think the excitement around that is tangible. I was wondering if you can share any detail, as you mentioned in your prepared remarks, partners coming with new ideas, maybe you can't go into detail on that just yet. But then also, anything you can share on maybe the breakdown between Pega clients using Blueprint and non Pega clients, that are coming to Blueprint and those two buckets and where you're seeing that distribution? Any detail there would be helpful.

Speaker 11

Thank you.

Speaker 2

Sure. So we made the decision to preview Blueprint with our partners a couple of weeks before we made it publicly available to clients and prospects on our website to make sure the partners felt respected and that they were part of the communities moving forward. And they were enthused. One of the things they asked for, which we're in the process of implementing, is the ability for our partners to themselves create blueprints that they could use to capture their intellectual property and the structure of a Pega system in the way we talk about cases and stages and steps and interfaces. And given the ability to create their blueprints, which would then be proprietary to them to make it so that when a customer blueprint was created, that customer blueprint, which today is an amalgam of Pega best practice and best practice from the Internet would now be able to be an amalgam of Pega best practice, the best practice from whatever partner was there pitching them, plus the Internet, putting those all together.

Speaker 2

I think that's going to be hugely, hugely powerful. So that's our agenda for the next 60 days is to get that working. And that was directly based on what we heard from partners as to how they want to leverage this to be able to help their go to market, which obviously helps our go to market. So we're seeing a lot of enthusiasm there. We are getting customers in very significant quantity.

Speaker 2

I mean like very significant quantity doing literally thousands of these blueprints in just a couple of weeks. And we are seeing prospects coming in. I think we'll see more of that as this begins to take hold and as there gets to be more buzz about that. It's still once again very young, but as you can experience it yourself, it's very real.

Speaker 8

Great. Thank you.

Operator

Your next question comes from the line of Mark Schappel with Loop Capital Markets. Please go ahead.

Speaker 12

Thank you for taking my question. Alan, with respect to BLUEPRINT, I realize it's still early, but

Speaker 2

I was wondering if you

Speaker 12

could just talk about some of the consumption trends or patterns that you've seen on the Pega platform with respect to the early BLUEPRINT adopters?

Speaker 2

I never would have expected we get 1,000. There have been 20,000 blueprints created, some by Pega staff, those doesn't count as well, but many, many thousands by customers and partners. And I would say that actually would have exceeded my expectation a month ago when we were beginning to talk about how we're going to roll this out and make this happen. So it's garnering quite a bit of excitement. If you come to PegaWorld, then I hope one of you will be there, then you'll have a chance to talk to clients themselves.

Speaker 2

I think you're going to hear great things.

Speaker 3

Mark, I think just to add one thing on that. The new feature that we just rolled out recently where you can actually implement a blueprint in a Pega systems, originally you could turn it into a PDF, right? You can look at it as a PDF. And recently, we have the ability to actually convert that into a Pega system. That to me is possibly the glue that connects what you're doing in a blueprint to the realization of how fast an app can actually be built.

Speaker 3

And it is really I mean, I know we're talking about it, you could probably envision it. But to think about sitting down, spending 30 seconds to 2 minutes, getting a framework of a workflow, going in and making it your own through the course of what could be 20 minutes, could be an hour, and then clicking a button that says implement it and you're looking at an application that actually So

Speaker 2

you can react to it. So what's interesting, so we've now and once again, it's all very new, but very real. We've for a lot of years, or less than 2 years, had a program we call Catalyst, where we would go in with a real design thinking sort of approach to help customers envision how they wanted to rebuild an app or rebuild a part of their business function. And we have a very talented team that's able to do this sort of work at a high level. I just saw the video of the first catalysts that we're doing with Blueprint instead of the traditional way where people would candidly end up at a whiteboard with stickies, Post it notes on the whiteboard and using mural technology to kind of imagine here what they wanted.

Speaker 2

What they were able to do in 2 days was both of enormously high quantity quality. This is 2 half days. It blew the customers away. And it was really able to do what we always wanted to do with Catalyst, which is to catalyze new thinking and leverage what they were able to do. So this was a major European bank that we did it with.

Speaker 2

And in 2 half day sessions, they knew what they did what I would have actually candidly would have expected to take 3 weeks or a month. And the customer was thrilled. So it's not just a little tech thing. It actually organizes the way people think about how they want to automate their processes in a way that makes sense with Pega Architecture, which I think we've refined over all these years of doing it to be just a very effective way to thinking about process automation and being able to get rid of some of the historical barriers about well Pega, it's tricky, it's hard to use, it needs a lot of experience. I think give us another couple of weeks.

Speaker 2

That's just not going to be true. So really exciting.

Speaker 12

Great. Thanks. And then Ken, real quick, given the strong free cash flow generation this quarter, is there any update to achieving your Rule 40 targets this year?

Speaker 3

Well, I mean, certainly, we are dependent on hitting both our growth and our cash flow for the year, which is obvious. Us having a start with the cash flow in Q1 is moving the ball, so to speak, down the field quite a bit. So that side of the equation, and our previous comments about the fact that we knew Q1 was going to be a difficult compare. So we knew that we were going to start with ACV growth decelerating in Q1, and we'll work our way back to that 11%. That was exactly how we modeled.

Speaker 3

So I'm feeling just as confident as I was last quarter in our achievement of Rule 40. And it's right there in front of us, which is great. And I think everybody could see in the numbers how we get there. But we've got 3 more quarters to execute, Mark. So we're going to keep focused on that.

Speaker 12

Okay. Thanks.

Operator

Your next question comes from the line of Blair Abernathy with Rosenblatt Securities. Please go ahead.

Speaker 13

Thanks very much. Just Ken, following on the last question, what are your what's your renewal book look like this year, in the back half of this year versus last year? And I guess I'm just looking for sort of the key incremental drivers that gives you that confidence that off this 9% growth number that you're going to average it out to 11% that's a pretty back half is going to have to be a fair bit stronger?

Speaker 3

Sure, Blair. So Q4, we mentioned last quarter that our renewal book is skewed towards the back end of the year this year in 2024. No less and a little bit more than a typical year. What hurt us in this year in Q1 is the strong Q1 of last year. Certainly, what helps us through the middle part of the year is that the compares in the middle part of the year are not as difficult as the beginning of the year.

Speaker 3

So some of this is just timing of when ACV growth happens in the prior year and as you know how that fits into the trailing 12 month calculation that we have. So renewals are still always we always have a lot of renewals in Q4. That's no different for this year. So we've got we certainly have expansion opportunities. But also the activity through the middle part of last year was much more subdued than we expect this year.

Speaker 13

Okay, great. And then just shifting on to the product side, any update at all on the LaunchPad initiative you launched last summer?

Speaker 2

Yes. It's I think it's going very, very well. We ended the quarter with 11 partners who are building apps on Launchpad. And that's been we've been doing this on a very sort of bootstrap basis. And we've seen our first partners bring their first customers into production.

Speaker 2

So we're really quite pleased with how it's going. So it's not going to be the driver of growth this year. The Gen AI and the core business is going to be what gets us to the growth objectives that we have for this year. I think LaunchPad is hopefully going to continue to develop in the way that it is, and it's going to be a nice driver for next year and into the future.

Speaker 13

Great. Thank you.

Operator

Your next question comes from the line of Tom Blakey with KeyBanc Capital Market. Please go ahead.

Speaker 14

Hi, good morning everyone and thanks for taking my questions. Alan, maybe for you, just on the success of Blueprint, sorry, a little bit of redundancy in terms of topics here. Can we talk about the maybe the roadmap? I know it's early, but I'm sure you have a roadmap here in terms of using utilizing some of your other technologies in terms of process automation process mining rather in terms of automating some of the further automation of ideation here, just creating some of the other an end to end solution here. On the free cash flow, Ken, can you just maybe to remind us, first question on the call here, maybe this is the last one.

Speaker 14

Remind us of some of these metrics. I think it was a $350,000,000 free cash flow estimate for the year. You started off so strong here in 4Q is usually better than 1Q. I think we might all be looking for 4Qs here a little bit more guidance here in terms of how to manage and model free cash flow there for the rest of the year. Any visibility there would be great.

Speaker 14

Thank you.

Speaker 3

Yes. So this is more of a general comment, Tom, but I think to your point, Q1 and Q4 is where we get the majority of our cash generation in 2024, even more skewed that direction than what you saw last year. Q1 started off strong. I think our billing and collection process is good. Our day sales outstanding is very strong.

Speaker 3

But the reality is you have more bookings in Q4, which do help the Q4 and Q1 billing and collection cycle. And Q2 and Q3 is, as in most enterprise software, is a little bit more subdued than that kind of hockey stick towards the end of the year in bookings. And so that's just kind of and by the way, a lot of our renewals we bill typically annually in advance. So you have a lot of those annual billings that happen in that same timeframe. So just picture Q2 and Q3 being much more subdued.

Speaker 3

In some cases, we may not even generate cash flow in a quarter in the middle part of the year with our cash flow really focused on Q1 and Q4 in terms of the timing. So hopefully that's kind of helpful.

Speaker 2

And relative to the road map, we have a very robust road map. The things we recently implemented around being able to pull the blueprint into a Pega system and actually turn it into a running app was very recent addition that obviously contemplated, but makes a big difference. I think some of our next big steps you're going to have to do with how we actually incorporate our customers' data structures and their existing data repositories into the Blueprint to be able to make it. So this thing really can plug into the real life that our clients have. And also I see Blueprint being able to be fed by process mining and other sorts of analytical things we do that will also help supercharger.

Speaker 2

So lots, lots more to come. And with that, I know we're at the top of the hour. Let me say thank you to all of you letting you know we're working hard and we look forward to seeing you at PegaWorld.

Operator

Thank you. This concludes today's call. You may now disconnect.

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Key Takeaways

  • Strong ACV Growth: Annual Contract Value grew 9% year-over-year in Q1 2024, driven primarily by Pega Cloud as it nears $600 million in ACV.
  • Record Free Cash Flow: Generated $180 million of free cash flow in Q1, the highest quarterly cash flow in company history, fueled by subscription billings growth and disciplined cost management.
  • Cloud Margin Expansion: Pega Cloud gross margin expanded by 500 basis points to 77%, benefiting from scale, optimized cloud capacity, and increased use of Kubernetes.
  • GenAI Blueprint Launch: Released Pega GenAI Blueprint to all users, enabling rapid business process design with thousands of blueprints created within weeks and deepening client and partner engagement.
  • Infinity 24.1 Release: Rolled out Infinity 24.1 with new GenAI features like Knowledge Buddy and AI Coach to enhance service, sales, marketing, and operations, with monetization expected via accelerated sales cycles in 2025.
AI Generated. May Contain Errors.
Earnings Conference Call
Pegasystems Q1 2024
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