Pegasystems Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 25, 2024

There are 13 speakers on the call.

Operator

Thank you for standing by. My name is Celine, and I will be the conference operator today. At this time, I would like to welcome everyone to the Pega Systems 2Q24 Earnings Call and Webcast. All lines have been placed on mute to prevent any background noise. After the speaker remarks, there will be a question and answer session.

Operator

Thank you. I would now like to turn the call over to Vice President, Corporate Development and Investor Relations of Pegasystems, Peter Welberg. Please go ahead.

Speaker 1

Good morning, everyone, and welcome to Pegasystems Q2 24 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, forecast, guidance or variations 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. Because such statements deal with future events, they are subject to various risks and uncertainties.

Speaker 1

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 Q2 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. And 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 obligation to publicly update or revise these forward looking statements, whether it's the result of new information, future events or otherwise. And with that, I turn the call over to Alan Trefler, Founder and CEO of Pegasystems.

Speaker 2

Thank you, Peter, and to everyone who's joined today's call. I'm very pleased with our performance in the first half of twenty twenty four. We continue to improve execution and I'm happy to see that our focus on profitable growth is working well. We're accomplishing our financial goals while continuing to deliver breakthrough technology innovation. Our center of architecture and approach to statistical AI and generative AI continue to be significant differentiators that we think our competitors can't easily replicate.

Speaker 2

Our newest offering, especially Pegagen AI Blueprint have captured the imagination of clients, prospects and partners, allowing them to identify new possibilities and help us drive deeper engagement. Client discussions I've had since launching Blueprint are some of the most positive I've had in the Pega 40 year history. In fact, when our clients see what we've delivered, they quickly recognize the power and the opportunities. I believe that the energy and confidence in our vision is increasing and is helping to drive the kinds of results we're talking about today. With tens of thousands of Pega Blueprints created over the last few months, we're identifying opportunities to accelerate growth and creating additional momentum for Pega Cloud, which will contribute to monetization.

Speaker 2

And we've barely scratched the surface of what we, our clients and our partners can do with this game changing technology. And we're really energized by this. I do believe that Blueprint is fundamentally changing how we engage, sell and deliver with our clients. Now I want to take a few minutes to remind you about what makes our approach to AI unique and powerful because a lot of the language we see in the industry is very buzzy and sounds very similar. But at the core, if you strip away all the tech speed, we're moving our clients way beyond the ability to write more faster code, which is part of many of our competitors are doing.

Speaker 2

This is the 100% wrong focus. No client has ever told us they want more code. They are drowning in code and legacy systems. They want to drive innovation, ensure their employees are satisfied and productive and ultimately serve their customers better, so the customers are satisfied, loyal and profitable. As we've always done, we're using AI to help clients solve business challenges by giving them the ability to completely reimagine their workflows and then execute quickly and effectively.

Speaker 2

Gen AI allows us to take this to the whole new level. And for decades, we've been investing in an application development approach centered around business outcomes on code. Things like enterprise processes, rules, data models and user interface. And this now is

Speaker 3

up perfectly

Speaker 2

with our approach to Gen AI. Now this allows business and IT to come together with a common visual language focused on business concepts in the customer journey, not on any particular technology or channel. Infusing GenAI into our approach lets users unlock new ideas and implement them efficiently and effectively. And because so much of our architecture is patented, we believe it can't be easily copied or reproduced. And we don't see anyone going at this problem the way we are.

Speaker 2

Now, on last few calls, I've talked about the 4 major areas we believe our Gen AI approach will have a massive impact for us and our clients by delivering situated solutions at first, double developer productivity by putting Pega skills at their fingertips. Secondly, ignite enterprise innovation through a powerful blend of industry expertise, Pega technology and incorporating client insights, all driven by generative AI. 3rd, maximize revenue and efficiency with real time optimization and personalization of customer interactions and workloads. And finally, streamlining their work processes and customer experiences by giving the right people the right access to enterprise knowledge and putting processes in their hands to execute based on that knowledge. We continue to deliver on that strategy, which we showcased at PegaWorld last month.

Speaker 2

We've added Gen AI capabilities that help all who use PegaDo more. Business and IT teams who design and plan their applications, well, Pega Gen AI Blueprint is helping them collaborate, dramatically accelerate the design phase, inject new ideas and best practices and use the power of AI and the Internet to stimulate best practice thinking in their applications. And developers where the PegaGen AI Autopilot helps them turn Blueprints into live applications, providing the ability to move from Blueprint to an application and providing potential guidance in the systems in every step of the development journey. And I also love Pega Gen AI Socrates, a first of its kind Gen AI tutor that revolutionize learning by creating an interactive tailored dialogue with each individual student to help them learn Pega's skills. Now, users of Pega applications across operations, service and customer engagement, where we have a powerful integrated suite of more than 20 productivity boosters aimed at different use cases are all seeing enormous benefits.

Speaker 2

Customers are leveraging self-service to get answers using GenAI Knowledge Buddy. Employees get their work done faster with expert guidance and direction from the AI through the GenAI Coach. Service agents can serve their customers better using Pega Gen AI Analyze to summarize conversations and do more relevant follow-up. And marketers who can effectively create, action and manage holistic customer engagement with GenAI CDH Assistant. As you can see, we've percolated GenAI through our entire product suite.

Speaker 2

This is the basis of how we want our clients to advance in the future. Now a moment on PegaWorld, it was really inspiring and as exciting as any that I've seen in more than 30 years. The attendees were super eager to explore the new innovations, especially PegaBlueprint, where we had multiple PegaBlueprint kiosks around the event. And there were a lot of people up to 5 gs waiting to get their hands on it. More than 1,000 new blueprints were created in just the 2 days of PegaWorld.

Speaker 2

And in client meetings I've had this quarter, including some of those at PegaWorld, clients are excited about our vision for GenAI and the potential impact it can have on their business. And that was early days. Several clients spoke about their blueprint experience. And I find what Aflac said particularly inspiring. For the 2nd year, they ran what we call a pegathon, which brought together about 70 of their teammates across the company for 2.5 days to develop application prototypes for key business units, all using Pega.

Speaker 2

The team included business stakeholders with no software experience, developers with no Pega experience, representatives from their partner, Goforge as well as VPs from the business units involved. This year, they used Blueprint to create the workflows for apps they had defined, that really fundamentally have the prospect of changing their business and driving digital transformation strategy. Terry Henry, the digital service delivery lead at Affleck, who delivered a presentation at PegaWorld said what I'm hoping that all clients will say. Well, we've been quite impressed with the speed, agility and intelligence of Pega Gen AI Blueprint. It helped us optimize workflow designs across an array of business scenarios and for a number of different business departments.

Speaker 2

By drawing on Pega's best practices via generative AI, we can quickly create apps and processes that meet our requirements in record time. This is truly a differentiated use of generative AI that will help propel our digital transformation project forward for the ultimate benefit of our employees and customers. Just terrific when customers stand up and say that sort of thing. We're also very excited to see that our partners have embraced Blueprints value and have themselves created over 10,000 Blueprints. With the latest release, we can upload their proprietary blueprints to Pega's best practice library for them to use in their client engagements and to help them create new services.

Speaker 2

About a dozen partners have already taken advantage of this new capability and have created about 70 best practice movements to use with their clients. Now it was a terrific opportunity I think for us to broaden the way we go to market by empowering our partners to take advantage of this new capability. And one thing I love is that the Pega team in the Q1 of this year engaged with our partners to make sure that they were really up to speed and able to get on their front foot with this new facility even as it continues to evolve. Now, I know many of you attended PegaWorld and came to our investor conference and it was great to see you there. For those who did it or missed day 2, I encourage you to check out our website and watch the keynotes.

Speaker 2

And if you want to hear the rest of what Aflac was saying, that is the dozens and dozens of videos is there as well. Now in addition to the incredible client stories, we also made several important product announcements to move our vision forward, including enhancements to Pegjet AdBlueprint that accelerate transformational design, including an improved more intuitive user interface, the ability for clients to import existing assets, content and knowledge that jumpstart their designs, The ability to have multiple people collaborate directly on Blueprints and the ability to upload and save partner workflow templates into our best practices wide range. Blueprint is getting better every week as a SaaS app that runs on penga.com. It's really empowered us to operate at an incredibly rapid pace with our clients. In fact, just last night, we added facilities to it to allow the import of BPMN, Business Process Management Notation diagrams to be able to turn them into the key workflows of a blueprint.

Speaker 2

BPMN is from my point of view, an ancient and derelict standard from the early 2000s that Pega has long passed by, but many people still use. We're going to make it much easier for people to do a legacy transformation of these old sort of difficult update systems into the extremely modern model driven design that underlies Pega. Now we also announced Pega Gen AI Socrates, which completely transforms the process for learning Pega's skills. This dynamic learning environment fosters an interactive dialogue And it's very new, but I think it's incredibly exciting. And we've actually had clients who have begun to put their assets and their information into some Socrates classes so that they can do a better job of teaching their staffs things that don't even apply to Pega.

Speaker 2

And we think this represents a really interesting opportunity to look at going forward. And we expanded our Gen AI framework with new connectors to Google Cloud and AWS that give our clients more options to use a different LLM if there's a good reason to. Our clients now have a broader set of capabilities to build generative AI applications. And we've really focused on trying to bring the security, privacy and key aspects of responsible AI into what our technology does. I also mentioned that this morning, we announced that we have received FedRAMP high ready compliance and in process status for Pega Cloud for government.

Speaker 2

We've been FedRAMP moderate for a long time. Now being raised to FedRAMP's most rigorous standard is something that we're very excited about and we'll be working on completing in coming months. As you know, the government business is quite important to us. So we think this just helps give us another vote of confidence in the U. S.

Speaker 2

And even around the world as people look at it. So in summary, we continue to improve execution to drive profitable growth while delivering, I think, revolutionary innovation. We have a vision for leveraging AI and Gen AI that is driving deeper engagement and absolutely inspiring increased confidence with our stakeholders. Now while we have a lot of competitors talking, we're delivering tangible groundbreaking solutions. And they're in an architectural approach that we don't think competitors can match.

Speaker 2

And this approach in architecture are unique. It's been the basis of Pega and developed by Pega over our decades. And what I love about the way we put statistical AI, generative AI to work is how perfectly it fits in with this heritage. Now to provide more color on our financial results, I'll now turn it over to Hegg's COO and CFO, Kevin Steelho. Take it away, Kevin.

Speaker 4

Thanks, Alan. Our execution was truly exceptional in the first half of the year and I'm really proud of the way our team is improving profitability, but also focusing on driving growth. This success reflects our continued commitment to delivering efficient growth and demonstrates that we're fully implanted a Rule of 40 mindset in the business. The most important metric to measure the success of our business is growth in annual contract value. ACV grew 13% year over year in constant currency, exceeding $1,300,000,000 Our ACV growth reaccelerated from Q1 to Q2 for three reasons.

Speaker 4

1st, we significantly increased client engagement, thanks to the go to market changes we made in 2023 and the enormous interest in what we're doing with artificial intelligence. Clients are very excited about our AI vision and execution. We've reinvigorated their enthusiasm about Pega and its driving strategic conversations. More specifically, PegaGen AI Blueprint is dramatically changing the way our field teams engage with our clients and prospects. Nailing down an app design used to take weeks or months, now it takes hours.

Speaker 4

PegaGen AI Blueprint helps businesses and technical teams align on a vision quickly. We've seen tens of thousands of new blueprints created so far, a strong sign that blueprint is transforming our overall selling process. Our decision to permeate our product line with AI is really energizing clients and make them more amenable to moving forward with us, which is also transforming our selling cycle and culture. To be very clear, we don't view the monetization of Gen AI primarily as the selling of new priced offerings. Although, we did see some of that activity in Q2.

Speaker 4

Instead, we see Gen AI as a totally different way to engage and ideate with clients to modernize legacy applications and enable digital transformation. The second reason ACV accelerated from Q1 to Q2 is because our latest innovations are serving as a catalyst for clients to build new workflows on or move existing workflows to Pega Cloud, where they can get access to our latest capabilities. Pega Cloud net new ACV contributed 81% of the total net new ACV added in the first half of the year, which is an acceleration and amazing to see. Pega Cloud ACB grew 19% year over year and Pega Cloud backlog passed $1,000,000,000 for the first time ever in Q2, just awesome. 3rd, our growth was more balanced in the 1st 2 quarters of 2024.

Speaker 4

In 2023, in contrast, ACV growth in Q1 was much stronger, while ACV growth in Q2 was far more subdued. So what you're seeing now is one of the reasons we love SaaS. Pega Cloud ACV is up 19%, Pega Cloud RPO grew 18% and Pega Cloud revenue was up 19% for the first half of twenty twenty four. Free cash flow is another important metric to measure the success of our business and our execution. Free cash flow totaled $218,000,000 in the first half of twenty twenty four, a record for the first half of the year for us.

Speaker 4

The 119% year over year increase in first half cash flow was driven by 2 factors. 1st, our continued improvement in sales execution was really resulting in a strong net ACV at $146,000,000 year over year in constant currency. ACV is a proxy for subscription billings. So greater ACV means greater recurring billings. The second key driver was our continued focus on operational discipline.

Speaker 4

1 of the biggest levers we have for free cash flow is gross margin expansion. And the biggest factor for gross margin expansion is our Pega Cloud business. Pega Cloud gross margin increased to 78% in Q2, a series of consecutive increases in gross margin for Pega Cloud. We're going to keep pushing to expand Pega Cloud gross margin with increased scale and automation. If I go back a few years, you might remember that we were targeting 70% gross margin for Pega Cloud and then 75% and now 80%.

Speaker 4

And we believe as this business continues to scale, there's significant ability to get that our gross margin increasingly higher, while still delivering amazing service to our clients. Our sales and marketing expense in the first half of twenty twenty four decreased by $26,000,000 year over year. Our view is that reducing expenses and therefore increasing cash flows provide us the capacity to make strategic investments in innovation that help our clients drive digital transformation. Our free cash flow momentum provides numerous options for executing our capital allocation strategy that will also lead to increased shareholder value. The combination of our solid ACV growth and robust cash flow margin demonstrates that our team has adopted the Rule of 40 mindset.

Speaker 4

We define Rule of 40 as our ACV growth rate plus our free cash flow margins adjusted for things that are not representative to core business operations. We're committed to being a balanced growth and profit company. While we always will strive for faster growth, we're going to do it in a smart way. Many of you have said it's helpful when I share some thoughts on modeling, so I'll continue to do that. In the first half of twenty twenty four, subscription license revenue was stronger than many of you might have expected.

Speaker 4

Although subscription license is recurring, we believe Pega Cloud is the best place for our clients and it's great to see more workloads transition to Pega Cloud. Given our Pega Cloud momentum, we believe subscription license revenue will decline year over year in 2024. We have a very low number of subscription license renewals planned for Q3 and expect the majority of any remaining renewals in 2024 to shift towards the back end of the year in Q4. Keep these dynamics in mind when you're modeling our subscription license revenue for the second half of 2024 with a particular focus on Q3. I also want to point out that PegaGen AI is making implementations easier to deliver and our partners continue to play a critical role for our clients.

Speaker 4

As a result, consulting revenue is growing at a more moderate pace than total revenue. We expect that trend to continue through the second half of twenty twenty four. Closing out my thoughts on modeling, I'll wrap up with a few comments regarding free cash flow. Once a contract is signed, we typically bill 1 year in advance or in some cases 1 quarter in advance. ACV ties directly to billings.

Speaker 4

So the seasonality of our free cash flow often follows the seasonality of our contract renewal cycle, which is typically stronger in the Q1 and the last quarter of the year. As a result of these dynamics, we believe it's more instructive to look at our free cash flow on a trailing 12 month basis. Over the last four quarters, our free cash flow was just over $300,000,000 In conclusion, we've been working hard to rev up our ACV growth and drive free cash flow. Our first half results show that the changes we made to our go to market strategy in 2023, increasing seller focus and productivity and also coupled with our latest AI innovations are working. Therefore, we can selectively and strategically grow from here and expand quota bearing resources in a smart way using a disciplined approach and also evaluating the impact of new logos on our growth strategy.

Speaker 4

It was great to see so many of you in person during our investor session in June in Las Vegas. We're also looking forward to seeing you on the road in August September. And with that, operator, please open the line for questions.

Operator

Thank you. We will now begin the question and answer session. Your first question comes from the line of Steve Enders with Citi. Please go ahead.

Speaker 5

Okay, great. Thanks for taking the question this morning. I guess maybe just to start, I mean, pretty impressive ACV, new ACV adds in the quarter here. Can you just maybe talk a little bit through about what's helping drive the performance in 2Q specifically? And I think looking back, it looks like one of the better 2Qs from an ACV ad perspective in quite some time.

Speaker 5

So can you just give a little bit of clarity around maybe what's going on in the deal environment and if there's any pull forwards or kind of like what drove the strength in the UCV ads here?

Speaker 4

So I'll start and then Alan feel free to jump in. I think that one of the big changes, Steve, that we made in 2023 that is really paying off is because of the focus on dense coverage of target orgs and really the approach of selling Pega Cloud, we're not as dependent on very large kind of episodic deals to actually for our sales team to make numbers. That's not to say that they don't happen and they won't happen, but our sales team is in a motion of much more of continual prospecting, selling, pipeline development, advancement. And we really embrace that because it helps to put less dependency on back end of the year and larger deals. That's not to say that we will be a completely linear business.

Speaker 4

It just helps to keep that focus quarter in and quarter out to produce and get numbers on the board. And I think that's kind of well ingrained in our culture right now. And I think you're seeing that in the 1st couple of quarters. So that's just from an operational execution. Blueprint and how that's really reinvigorated the discussions.

Speaker 2

Yes. I think if you go back close to a year ago, we made some organizational changes to bring together what we used to call the catalyst group, which was a distinct group back then with our solution consultants, the people who actually do the demos and touch the sort of systems our customers use to figure out if they really want to buy something. With our professional services people who actually would do work on delivery and with our partner teams because our partners are obviously absolutely critical to delivery. When we saw what was going to happen with GenAI last July and what was happening, we said we're going to bring these teams together and really use generative AI as a way to rethink how we engage with the customers. And as a result of that, I think make their ability to see what an application might look like and understand what it will take to deliver an application much, much clearer to them.

Speaker 2

And I think this is still in process, but I think it's working really well. And I believe that the energy that we're seeing from our clients really has a lot to do with having to connect having connected that chain together, but also to do something into that chain, which previously we really didn't use to do all that much, which is to actually have our account executives, the frontline people who are in the field actually be able to participate in the demoing and the seeing and the real invigorating of the clients with a hands on level of involvement, all based around how Gen AI empowers people to think differently. So I look, we need more than 1 quarter or 2 quarters here to make us feel that we've got this all nailed. But the early signs of what I see, as evidenced by the enthusiasm and the results from Q2 are actually pretty exciting.

Speaker 5

Okay. That's great to hear and helpful context there. I guess maybe a little bit more pointedly, I think at the Analyst Day on the Gen AI front, you maybe expected some contribution coming in Q3 from Blueprint. Are you kind of feeling the same way from that? Like are you seeing the pipeline are you seeing those conversations build into pipeline?

Speaker 5

And how are you kind of feeling about that pipeline converting over to deals at this point?

Speaker 2

Well, no, I think one of the things that's different about Pega's approach is and if you look if you go back and listen to my 20 minute keynote at PegaWorld, we talk about the three forms of AI, statistical AI, machine learning. We've done that for 15 years, really, really critical to next best action, making recommendations, doing process improvement. The second form being these productivity tools of which we've got several dozen that do the nice stuff like summarization and other sorts of bits that are can be important. But the 3rd type of AI we spoke about was AI that was transformational, which is using generative AI to profoundly change how the organization did its very processes. And we had an enormous opportunity to do that because we're model driven.

Speaker 2

We don't go from the Gen AI input from customers to code, which candidly more code is just more mess. We go into the model, the same model that we've been perfecting for decades. And that means that we've got Gen AI plugged in, in a way that is not just faster, but it's also transparent to the customers. They can see what's happening and also changeable. So I think that this energy from GenAI represents a fundamental change to all aspects of our business.

Speaker 2

We've really woven it in everywhere, which is why we don't sit around talking about GenAI SKUs. I would say that there's not a single sale anymore or a single pursuit that does not have JetAI at the heart of it because that's now the way you use our products.

Operator

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

Speaker 6

Hi, thanks for taking my question. Alan, you had mentioned the federal segment. So maybe if you can give an update there kind of the trends you're seeing with the federal business, how is growth trending there relative to kind of the broader Pega growth? And maybe if you can touch on kind of the strategy there. Is it similar to the broader Pega strategy of going deeper into the existing accounts?

Speaker 6

Any color there would be helpful.

Speaker 2

Yes. I think that one thing you need to realize, when we go deeper into an existing account that actually involves things that are as much new pursuits and new accounts as anything else. I mean, the Department of Commerce is an existing account. Department of Justice, the U. S.

Speaker 2

Army, those are existing accounts. The IRS, the ability to do massive new things for them is you. Tiny fraction of what that potential landscape is. So we definitely have a target org strategy. I think that's something that helps our business be more reliable as a business, but also frankly helps us do a better job for our clients, which is key.

Speaker 2

So we've definitely taken a target strategy there. And I'm thrilled with what I'm seeing. I'm thrilled with big organizations themselves experiencing success and looking for ways to get broader. By the way, not just in the U. S, but we've had massive work recently with Her Majesty's Revenue and Customs doing work across well across the globe in governments.

Speaker 2

And I think it's going to continue to be really important for us.

Speaker 4

So Kevin, just to add one thought on. So what an interesting dynamic that maybe kind of similar to what happened a few years ago is that the government went from being a little bit more skeptical of SaaS and cloud, say, 10 or 15 years ago to really embracing it, in the last, say, 5 years or so, maybe a little longer. But so they're really and I think you're seeing that same trend around GenAI, right? The government companies are always skeptical of kind of like the risks of something like GenAI because they want to understand how to control it, how to risk changes to their business that they might not have anticipated. But I do think you're going to see the public sector, the U.

Speaker 4

S. Government and other governments really leverage GenAI. So we're focused on the impact of GenAI into our government solutions as well because we think it's going to be relevant there too, including Blueprint.

Speaker 6

Yes. That's great color. Thank you. And then Ken, you had talked about license term license maybe being a bit stronger this quarter, but it doesn't sound like your full year expectations changed. So was that just really kind of pull forward, maybe you see a weaker 3Q and you see that typically strong 4Q?

Speaker 6

Anything else you could add there or any changes in customer buying patterns?

Speaker 4

Yes, that's a great question. And you actually caught that in my script. So I was consciously trying to give you guys some insights on that. We actually think if anything, our term license will be lower for the year as opposed to higher. There's more and more clients are moving to Pega Cloud.

Speaker 4

What happened in Q2 was just timing of renewals, right? It's just so what you should anticipate, Kevin, is exactly what you said. Q3 will be pretty weak in terms of renewals On the revenue side because there's some it's just like you know how that is. It's just our business isn't linear on the timing of renewals. Q4 will still have term renewals in it, but Q3 not many.

Speaker 4

And we think we still think the term revenue is likely to be down low double digits, right, for the year because more of it's moving to Pega Cloud.

Operator

Your next question comes from the line of Jake Roberts with William Blair. Please go ahead.

Speaker 7

It was great to hear the traction that you're seeing with those Gen AI blueprints. I'm curious when you think these blueprints actually go live into production. Like are you seeing starting to see some customers take the blueprints in the live run time today? Or is that still a few quarters away to actually really impact that ACV growth?

Speaker 4

So it's interesting, Jake. We actually just met yesterday with one of our key partners who has actually closed 2 engagements where they were driven from BLUEPRINT. So like they've actually done BLUEPRINT and they've turned into engagements for them. Now that doesn't necessarily mean they're license orders for us, but that's okay. Those are the engagements that lead the license orders.

Speaker 4

So we see our partners really on the front end of this, which is really amazing. Because typically companies like Pega, we have we typically move fast and we have help enable our partners to keep up. Our partners are actually kind of out in front on this in a lot of cases and really leverage BLUEPRINT to be able to deliver solutions to our joint our mutual clients. So we're already seeing that. And I think that momentum is going to pick up.

Speaker 2

Yes. And I've seen it also with some direct clients who have used Blueprints to accelerate products through applications that they brought live. When Ken talks about these always don't lead to an immediate license sale, we've been moving for a number of years our customers to more of a kind of consumption model based on levels of consumption. So that it's easier for them or candidly years ago, I think we made it really hard for our customers to get started on a new application. Now we want a customer to be able to find it easy to start on a new application, to not have to sign a piece of paper with us to be able to do that in most cases.

Speaker 2

The side effect of that is we've got a real interest in them getting benefited and using our system. So we're thrilled with increases to this consumption, whether it leads to an immediate license or to the next time in their agreement, when we take a look at what they're doing and true it out. Both of those are fine outcomes from our point of view here. I think that the level of enthusiasm that we have that's touching the entirety of the Pega product suite, both where we've got Blueprint implemented and where we've talked about putting Blueprint in, in the 3rd Q4 is generating a level of excitement and understanding about how AI can really help their businesses that's unlike anything I've seen before.

Speaker 7

Yes, that's great to hear. And then also good to see Pega Cloud representing 81% of net new ACV growth. How are you seeing GenAI impact the cloud migration timeline for your customers? Are you seeing any of those customers accelerate the journey into Pega Cloud? And then, Ken, how should we kind of think about that mix heading into the back half of the year, just in terms of Pega net new ACV growth?

Speaker 7

Thanks.

Speaker 4

Sure. So you're going to see, Jake, like the clients were already on a pace of migrating to Pega Cloud. And we have been, I would even say, more patient with that move and not really pushing anyone. And I think there's just a lot more incentive for clients now with Jet AI. They want to move to cloud anyway, right?

Speaker 4

This is part of their digital transformation plans. So I think Jet AI just gives them another reason and a very important reason to actually make that transition. So I think you'll see the pace of our clients migrating to Pega Cloud accelerate as we go into 2025.

Operator

Your next question comes from the line of Pindjalim Barra with JPMorgan. Please go ahead.

Speaker 3

Hey, thank you so much and congrats on the quarter. Alan, what are you hearing from customers around kind of that last mile implementation of Blueprints? It's clear that to create Blueprints, it's pretty easy and people are probably getting a lot of value from creating those blueprints. But I'm thinking about actual go live from creation of blueprints to the actual go lives. What are are there any hurdles people are facing?

Speaker 3

Is that actually easy? What is the feedback from customers at this point?

Speaker 2

Well, the feedback continues to be very excited. What we're seeing customers tell us is this has fundamentally changed the way they do design thinking about new applications. They're able to take harvest practices, their input, things we're able to glean from the Internet, bring them together and use that to challenge the conventional way that they would have thought about doing a business process or built the system. And it's really as you all have seen and everybody is welcome to use it on vega.com. It's very innovative.

Speaker 2

I mean, even if it never, never made it into the application, the fact that this changes the way you think about a business process and does it literally in hours as opposed to weeks is all by itself a huge advantage. And I do know of some customers who are playing with this for systems that may never actually become a Pega system, which by the way, I think is just fine. Now having said that, the ability that we introduced at PegaWorld, so realize how incredibly new this is to be able to import this into an actual new or existing Pega system, have it blend with their existing rules and processes, That's gotten a tremendous amount of excitement. Unsurprisingly, it's led to a lot of enhancement requests from clients And we are pounding those in, which we're able to do because Blueprint is a SaaS system. So we're able to do this weekly and biweekly release cycle, which is adding value.

Speaker 2

So the feedback we're getting from the clients is they love what they're saying. They want some more stuff, which is always a good thing when a dozen customers are really interested and we're providing it. So I would say unlike many things I've seen in my life and technology rollout, this is all good.

Speaker 3

Understood. Thank you. Very helpful. One question for you Ken. You just in the previous answer before me, I think you said the pace of migration to cloud should continue to accelerate.

Speaker 3

In that context, how should we think about kind of the maintenance line going forward and the kind of the dollar of maintenance converting to cloud that multiple that you typically get, how should we kind of think about that as we think about the next couple of years? Yes.

Speaker 4

So it is a tough one even for us because not every situation is exactly the same. But if you think about $700,000,000 of term of non Tega Cloud ACV, if you just think about that number, And if all of it converted, right, you should see somewhere between a 25% and 50% expansion off of that number. Now in some cases, the number will be 2 to 1, right, or more. And in some cases, it will be more modest. It really kind of depends on the actual situation with each client.

Speaker 4

So we do have that. Now there will be some markup for all clients because naturally there's a managed service that we're providing an infrastructure, etcetera. But I think just using a rule of thumb, I'd say 25% to 50% across that. So you're talking about a few $100,000,000 of incremental opportunity.

Speaker 2

Next question?

Operator

Hi, Rishi. I think your line is mute. Thank you.

Speaker 8

Yes. Sorry, I did not hear my name. It's getting called. Thanks, Alan. Thanks, Ken, for taking my questions.

Speaker 8

Maybe 2, starting with Blueprint, really exciting to see the momentum here. Can you talk a little bit about some of the more common applications and workflows that you're seeing going into production? And maybe if we think about some of those use cases over time, maybe over the next 1, 2, 3 years, how do you see that evolving?

Speaker 2

So a lot of the uses as you would expect, have to do with customer service and aspects of it like the onboarding or the dealing with addition of a new product and how you make those choices and how you get the right approvals and implement that. Those are very common types of workflows. But we're seeing the lots of workflow uses that fall into what you'd call the master data management space. That's kind of how do you sit in front of an SAP system or some old big system that is maintaining the records of your business and make sure that your products are defined correctly, parts of your business are defined correctly, really putting those types of workflows in front, which leverage our ability to work so well with some of these big old back end systems, but give them a state of the art workflow that brings AI to how they want to operate. So it's incredibly broad is the way I would describe

Speaker 8

it. Great. That's really helpful. And then if we just think about kind of the increasing mix towards consumption and then Blueprint is probably going to accelerate that, how should we be thinking about just kind of the overall revenue mix of kind of more traditional subscription versus its consumption component over time? Or is that just not the right framework to use?

Speaker 8

Thanks.

Speaker 4

So I don't I understand your question completely, which is fixed versus variable revenue, Rishi. And I don't know that that's necessarily the right way to think about it because what Alan said was the way that this works is think about it as a commit with flexibility, right? Clients are committing to a certain amount of usage because that gets them better economics on pricing. They have the ability to flex up. As they flex up, they typically commit to higher levels.

Speaker 4

That gets them once again better economics as they scale, as you get volume discounts. And it's very similar to Amazon or Google where they actually have pricing discounts, but then there's better discounts you can get by making annual commitments. So it's a very similar model to that. So there's still going to be a commitment level, but there's going to be this ability to allow clients to almost grow organically within their arrangements as opposed to having to go through a contracting and paperwork process every single time they want to get a new application, a new workflow, a new case type started. So I don't think we're not bifurcating those numbers because we view it as all part of a continuum of how we grow with our clients.

Operator

Your next question comes from the line of Patrick Walbravens with Citizens JMP. Please go ahead.

Speaker 9

Hey there, this is Austin Cole on for Pat Walrins. Ken, I think at the Analyst Day, you made a comment that the kind of long term getting to that $2,000,000,000 ACV in 3 to 5 years that there's an upside case driven by Blueprint. Did you mean that that upside case with Blueprint is getting to that $2,000,000,000 and kind of closer to the 3 years rather than 5? Yes.

Speaker 4

That's naturally, we're going to do everything we can to get there as fast as possible. And we think Blueprint could help us get there faster, which is where that range came up, Austin.

Speaker 9

Okay. And then just I know it's super, super early days, but following that event in the 1 month since that event, we're definitely was very centered on Blueprint. With the interest you're seeing, I mean, is there anything in these early days to suggest that we're not going to be close to that 3 years rather than 5 from a Blueprint standpoint?

Speaker 4

I would say, we given where we are now, Blueprint's excitement, momentum, even the improvement the advancement of some of the capabilities of Blueprint are really on pace with what we had hoped. Jumping to the it's 3 years versus 5 years is probably a little premature to start to predict when we think we can get there. But I would say we feel great about the opportunity. And naturally, we're internally, we're pushing to get there as fast as possible. And then 3 years would be our that's like our that's our desired state.

Speaker 4

But once again, it's we're a month in from when we talk.

Operator

Your next question comes from the line of Raimo Lenschow with Barclays. Please go ahead.

Speaker 10

Perfect. I have two quick questions. 1, given the uncertainty that we had on the software spending side with the off cycle Q1, and I don't know if you followed what we saw at Salesforce, Workday, etcetera. How what did you see this quarter kind of playing out? And did you change anything in terms of kind of penciling and or like being a little bit more sharper on sales execution, etcetera, because you delivered a very, very strong quarter.

Speaker 10

So the questions that we all have is like, are there certain pockets in software spending like yours that is with Gen AI is doing better than others? Or like can you talk a little bit about it's so slightly broader in terms of sales? And then I have a quick follow on.

Speaker 2

Yes. They were this is an example of a quarter where there were really no what we used to call whales. We love whales, but it's okay to be able to have a good quarter without anything. That's we'll take lots of tuna. It's just the way we think about So there weren't any whales.

Speaker 2

There weren't regional differences that were massive or driving the outcome. And I do think our sales execution has improved as we've really moved to adopt the Target ORG model and as that has now become part of the DNA of the company. And what we need to make sure is that as we grow, as we continue to go forward, that the organization continues to base its energy on the things we've learned about doing it in a more efficient manner and paying attention to the cost as envelope as well as the hitting the growth targets. But no, it was a nice broad and broad outcome.

Speaker 4

So, Rainbow, can I let me add one little piece of information that I know you're aware just to remind you? We are not as dependent on licensing at the user level. And so I think a lot of software companies that license at the user level actually do have more risk with this whole like automation, gen AI, trying to get efficiency. And quite frankly, our entire solution is about automating end to end to drive efficiency and optimization and consistency. So we think that and not to say that we are insulated from global economic trends because we are absolutely subject to all of that.

Speaker 4

I do think our licensing model being more of a consumption value based licensing model where the amount of transactions that Pega does ties to the value ties to our business helps us. And also the space in which we sit is very congruent with what we're trying to what the market is trying to do with AI, which to drive efficiency and automation. So maybe that helps us a little, those 2 levers. Our

Speaker 2

philosophy is the more work the system does, if the system is doing more work, then the customer should be willing to pay more. The folks who are doing this based on users, I think that's just an antiquated model that's all. Our whole point is we're going to go to an autonomous enterprise that is more self driving and the number of users is going to massively reduce, doubled with self-service. So I'm really happy that we have the right thinking when it comes to a model.

Speaker 10

Yes. Okay, perfect. Okay, thank you. And then Ken, on the cash flow number, very strong for the first half. Obviously, like the Q1 was the strong one, Q2 is never the strong one because of the seasonality.

Speaker 10

Like if you think about the cash flow performance far this year, is there any thinking from you that the trajectory is changing or are we still kind of good with what you kind of communicated before? Thank you and congrats from me as well.

Speaker 4

Thanks, Remo. So I think so first off, I think we'll try really hard to have positive cash flow in Q3. I think it will happen, but when you have lower billing quarters, it is harder to generate lots of cash. Q4 is always a bigger billings quarter. It doesn't always mean the cash flow is big as some clients may pay you in Q1 or Q4.

Speaker 4

So I think that teetering of when you get collections continues to make Q1 and Q4 the biggest quarters. But for the year, we still see the year like kind of shaping up as we thought it would be. But Q1 gave us a really good start. Q2, quite frankly, was better from a cash flow standpoint than we thought. I think Q3, we will try to keep our positive cash flow momentum, but it is hard when you don't have as much billings in the quarter.

Operator

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

Speaker 11

Hi, thanks for taking my question and nice job on the quarter. Ken, during the Investor Day, it was noted that the company was planning to target new logos that have the potential to be $1,000,000,000 ACV accounts. So it's a little bit of departure from the past. I was wondering if you could just provide some additional details on how you plan to go about this market go to market wise. So for instance, should we expect like a dedicated sales team to go after these new clients?

Speaker 4

Sure. So let's go back a year or 2 ago. We wanted to transform our go to market team. We knew that by doing that and changing the way sold to add a bunch of new logos was going to be terribly disruptive to the progress on that. So just a reminder of why we are where we are.

Speaker 4

We really limited net new logos. It was very small amount and very targeted. And when we go forward, we are going to be just as targeted in terms of the new logos, but we are feeling like it is time to add more focus on new logos. Those new logos will not be a new team that we have our teams already segmented where some of our teams actually focus on more prospecting, more logos. We call that major accounts, which is an account that is very significant that is typically looks just like one of our existing organizations that we feel like we can sell into.

Speaker 4

So it's going to be very target org model and it will be focused in some of our teams right now globally that already have prospected for some new logos. But once again, they're going to be targeted.

Speaker 2

And what targeted means is that you don't give somebody some random territory and say, go hunt. You basically say, hey, Paula, hey, John, here are 6 orgs. This is where you're going to play. Get one of these or maybe even here's 1 org that we want you to break into. So very target forward driven so that we don't have this investment in general purpose marketing expense, which we found when we did it before, we just didn't get the returns from.

Speaker 2

We're very comfortable that on our hand to hand combat with orgs, we can work our way through.

Speaker 4

And one last little piece of color there, Mark. Organizations that we will target will probably look like the organizations that we already have and also may have former Pega buyers and influencers that have moved to those organizations, which actually helps as well. Meaning somebody that already used Pega at another organization and took a new role, that's kind of how we're thinking about that strategic targeting.

Speaker 2

Great. Thanks.

Operator

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

Speaker 12

Yes, thanks. Can you talk about on these AI cycles, how that's changing your overall spending environment? I mean, are you getting brought into more what I'll call AI driven deals?

Speaker 2

Yes, we are. People have seen what we've done and are intrigued. And so we're really being seen by our customers, in many cases as the way that they should go about implementing AI. I mean, what better way to implement AI than to make the way your workflows work better or to cut down on manual steps or to make better decisions for clients. Those are perfect use cases for AI.

Speaker 2

So we're a way for companies to incorporate AI in the core of their business without having to craft it by hand from something from Azure or AWS. This is a way for them to incorporate AI as part of something that's very tiny.

Speaker 12

And of those, how many tend to be more new customers versus existing?

Speaker 2

Well, yes, our strategy was very much about expanding into other areas of existing customers and that has been our strategy. But I consider another area of a new customer, I mean another part of the U. S. Department of Commerce that's really kind of breaking into something new. So it's not as clean as you might want, but we're definitely going to be looking at figuring out how do we open that aperture and bring it to more new organizations, but do it in the style we're already using.

Speaker 4

And by the way, Dan, just to add one other piece of color. Our partners are actually very helpful in assisting us in the selection of some of those target organizations because they may actually be talking to those exact organizations and make recommendations for ones that we should cover. So that's where another helpful connection to AI as well.

Operator

That concludes our Q and A session. I will now turn the conference back over to Alan Trefler, Founder and CEO of Pegasystem for closing remarks. Please go ahead.

Speaker 2

Thank you, everyone. We're working hard. We're seeing our customers engage with us, which is enormously invigorating. When we talk about GenAI excitement, I will say that it is palpable and we're going to continue to improve it, drive it and hopefully continue to show the good results. Thank you very much everyone.

Operator

Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.

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Earnings Conference Call
Pegasystems Q2 2024
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