Pegasystems Inc. (PEGA) Earnings Call Transcript & Summary

Hi. Good afternoon. Brandon Daye with Morgan Stanley Investment Banking. We have Ken Stillwell from Pega.

Before we get into this, Ken, in real detail, maybe quickly give us your quick background on your role because I think what's unique about you is you serve dual roles as a CFO and COO. So can you just give a little flavor there how you spend your day job?

Sure. So I had the benefit of, before Pega, being kind of involved in a number of private equity-backed companies that actually went through subscription transitions, so Dynatrace before Pega. So my background, although I've been a CFO many times, I have a little bit more of a lean not just on the business model but also on kind of the operation of a SaaS business. . So when we -- when I started at Pega, we were -- we did have some term licenses. We had really very little SaaS business, and we were a business that was predominantly perpetual license with a little bit of term and a really tiny amount of SaaS. I mean when I started, I think the SaaS business was like -- it was maybe like $15 million or $20 million in revenue. And so we made a big shift when I came on or maybe within that year that I came on to really stop selling perpetual. Of course, that was 2016, so we were a little bit behind on that model. But we also -- as that happened, we saw clients really pushing for SaaS. And so we went -- we made a quick pivot to say, let's not just be a subscription business. Let's actually move as fast our clients are willing to be a SaaS business. That then carried into us building out a kind of a world-class cloud operations team. We brought in a CISO. And as that all happened, it was kind of natural for those areas to report to me. And then that's kind of how that -- how my title became CFO and COO.

Okay. Perfect. So obviously, your background then lends itself nicely to that. And hopefully, probably no one is as well equipped to usher out that leadership. So if we kind of focus just back on Pega for a second, now that we now fully understand your background at how you're kind of going to kind of lead the organization, I think Pega -- folks who maybe aren't as familiar with the new story of Pega probably still think of it as a workload software that's kind of doing blocking and tackling. Maybe just give a more current view of everything that Pega is doing more specifically and kind of how they're going and solving some tough problems for clients.

Sure. I mean, so just a -- maybe a really fast kind of evolution of Pega. We started as really building the platform as an alternative to writing code. That was kind of where we started. That's our heritage. Really just a way to -- if you wanted to customize something, if you wanted to build something, don't write -- don't use C++ or at the time, whatever language they write in, probably C, and move more towards something that created a level of structure. That then evolved into some really common use cases that were -- that we were repeating. We kind of had what we called frameworks at the time, which were standard ways that you would deploy on the platform around certain use cases. That then carried into where we -- through an acquisition or 2, but also just through kind of evolution, we started to sell against companies like Salesforce. And it happened pretty fast. I mean, we went from being the kind of company that like wouldn't understand why we were in a campaign against Salesforce, but then all of a sudden, seeing them like all the time in our campaigns. And so that then brought us into really being more of a CRM, CRM being -- not necessarily us being a CRM company, but us selling CRM use cases. So -- and that -- and now if you look at what Pega is, Pega really has -- the majority of the business of Pega is around 20 to 30 different use cases that tie into marketing automation, customer service, sales automation and a number of things that are related to customer interaction that may not be defined by one of those 3 components. Things like managing disputes and exceptions or in financial services, kind of loan origination or in insurance, underwriting policies and renewal policies or health care, bringing on new participants into a health care plan or enrolling in a new plan year. So those are all things that I would say are really heavily B2C business models, but might not be the traditional way you think about CRM.

Okay. Great. And then some of those use cases that are customer focused, you mentioned financial services and the vast group of them there. When they're at the point of a buying decision and they're thinking about solutions, how is it that Pega ultimately becomes the solution that's best for them for those needs? Considering there's a plethora of tools and services that people could adopt, they could deploy to help solve some of the same needs, but why is it specifically for a Pega in those unique industries there?

So it's a great question. If you think of the -- if you think of -- I'll maybe frame this as there's a dimension of solutions. There's, on one extreme, a COTS solution that really can't be configured at all. And in enterprise, most use cases, they're not looking to buy that solution. Then there's the other extreme, which is I'm going to roll my own. I'm going to just write custom applications. And unfortunately, in the enterprise space, there are still some companies that choose to do that. I would say -- and your peers. So -- but I would say, not as prevalent as it was, say, 10, 20 years ago, but there are still decisions. You have a lot of engineers. You have a lot of technical talent. People like to ideate. The 2 that kind of border those, one would be maybe the way that like a company like Salesforce might approach it, which is to have something that's largely configured. But then, you're going to try to maybe customize a little bit into a unique workflow. And that, a client might pick that approach. Where we sit is a little bit more around the flexibility of the platform that can be standardized to not be a custom homegrown-looking acting solution that can modernize, that can -- that we like to call it future proof, which is when you build an application, you don't know what requirements are going to happen 5 years from now. And you don't want to have to rebuild the application. You want to be able to configure -- change the configuration. So when you get into that, we're not going to build custom, and we're also not buying a COTS solution, there's a number of vendors that sit in that, across that paradigm. And we tend to be -- lean on the side of it's an enterprise-grade application that needs to have a level of supportability, repeatability, consistency. But yet also, we need to be able to make it our own. We need to be able to include our own intellectual property or process inside that. So anything that's more commoditized, the more commoditized it is, the less likely we will fit there. The more custom it is, we could actually be competing against a homegrown solution. But more and more, it tends to fit more in the -- give me something that's 70% of the way there, and let me configure the last mile.

Great. So you don't have to deploy a bunch of implementation or service costs to do something, when you really have a platform that was designed with extensibility in mind. And therefore, giving the customers the ability to plug in those workflow-specific items that are unique to them to really deliver the 100% solution.

And allow also a seamless integration and orchestration of sorts with all the different best-of-breed applications, COTS applications that you might want to use to do certain steps in that process.

Okay. Great. And if we shift to go-to-market, I think on the recent earnings calls, there's been a lot of focus on go-to-market. And I know you guys have really made efforts in terms of driving more productivity there. But if we think about the opportunity, as you see it, regarding your current client base and landing versus expanding, how would you characterize the relationship there? And kind of where is the opportunity, as you see it, currently today?

So the -- so for -- our clients do not always fit in the same profile of what -- how they view Pega, right? Some of our clients, unfortunately, view Pega as a little bit more BPM workflow from -- and we sometimes -- we have to battle through that a little bit, right? So there's -- so there are some clients where the selling process is a more -- might put us more in the process bucket. We have -- the majority of our clients understand that heritage but have used us for use cases that are not just workflow, kind of back-office workflow process. And in that situation, the selling motion is much more fluid because you've got different buyers, different -- if you look at a company like Morgan Stanley, you've got maybe 6 or 7 different business units. Pega might be client -- you might be a client of ours in 3 of those. But there's a lot of opportunity to use the relationship you have with one division, say retail, to be able to go into wealth management, for example, or investment banking. In some clients, they have -- they only know the new Pega. They only know Pega in the last 10 years, so they view us as a CRM provider really doing something like one-to-one customer engagement or digitizing the contact center, et cetera. And in those scenarios, it's -- the selling is, I mean, I would say, is much more -- it's accelerated in terms of that cross- and up-sell motion. So what we feel like, if you think about the clients that may view us as the -- what Pega used to be, our big movement there is moving them to Pega Cloud or getting them in a use case on Pega Cloud. And we've got about 2/3 of our clients that have historically used us for workflow that actually have a Pega Cloud environment. Once they see Pega Cloud, that actually may not lead to them moving their existing legacy applications. But what it does do is it really opens up this view of like, yes, Pega did X, but they also do Y, and we're going to use them for Z. And so we've had a -- that's where Pega Cloud has been probably the most important. It's showing that modern application that we have, which, by the way, is the only application that we go to market with right now. But if you bought Pega 30 years ago, you might have this belief that it was what it used to be.

Got it. And what would you say has been the biggest challenge? I think a lot of times, if you have someone who's viewing you as this legacy product from 10-plus years ago and you do have the capabilities that can solve some of their challenges today, but their mindset and their psyche has already said otherwise, and perhaps they have a view on their road map that is X, Y or Z. How can you kind of insert yourself there to kind of really turn that dial?

That's where the selling model is important. So the reason why we actually shifted to a deep target org model, where all of our selling resources were aligned behind our account management team, is for exactly that reason. The best way -- the best success we've had is having clients engage with us in a deeper -- in an ideation, come to our enterprise, come to our briefing center, us taking teams to the client, workshop-ing. And that has been -- that is the most important aspect for us in selling to the enterprise. What we were doing before we made this change was we actually had selling to the enterprise, but we also had a sort of territory selling model, where it is much more of a lead response. It's much more of a -- you send out 10 quotes. You hope you get into 3. It's not really the relationship aspect. If you think about the way that Morgan Stanley Investment Banking sells its deep relationship, right, somebody's not going to call you and ask you to do it, right? You might spend 5 years working with a client before you actually get an opportunity. So your model or a Bain Consulting or BCG has a very similar model to us. You're really building a relationship. You're an expert in a vertical. You're an expert around a use case. And you leverage that to be able to actually help the client think about the architecture and why Pega is better.

Okay. Now you mentioned architecture. I think it's a good segue to gen AI, which has been a big theme of this conference. I think one of your differentiating aspects that you have been kind of going to market with and touting is that your unique Layer Cake architecture presents a unique opportunity for you all to capture this opportunity, maybe kind of better than others. So how would you kind of describe that for folks that may not be familiar with it? And then how that's allowing you to kind of call out and prosecute against this use case?

So let's -- let me first start by saying there are 2 dimensions of AI. We view it -- there's more than 2, but there's 2 that we think of. One is more the statistical AI. It's really around rules and probabilities and data, and it really looks at that and it makes predictions. That's what we acquired when we bought Chordiant in 2010. It's been a fundamental part of how we leverage workflow. You've heard of us use next best action, next best offer. That's fundamentally what we call Customer Decision Hub, which is the statistical AI brain that sits inside the platform of Pega. Then there's gen AI. Gen AI is not that great with data, right? It's much better with words, right? And statistical is not really relevant with words. And so you have these 2 different use cases, which can come together and help support clients. So we've always had the statistical. That's been in our heritage. And now you flip over to, well, how are you going to leverage this concept of gen AI? And how does that kind of -- how does that evolve into something that is really quite usable for our clients now and in the future? And so for us, gen AI becomes relevant in 2 ways. And the first way is we have these kind of gen AI accelerator features that are licensable features, that are sellable. Those things like automating a call wrap-up in a call center, right? Things like -- there's ones that we call Buddies, which are essentially a chat bot that actually can tie to an LLM to be able to answer questions or provide insight, right? We have other use cases that are around connecting kind of discussions and themes and notes from a sales automation to create communication to the clients' follow-up e-mails, proposals, PowerPoint presentations that can actually pull together content and produce. Those are all very real pragmatic use cases around AI. We have another -- we think we're different, and we'll kind of tie into the -- I know probably that you're going to ask me about Blueprint.

Of course, as always.

So I'll tie in a little bit to that Layer Cake and why our layering, why our dimensionality aspect is so perfectly aligned with gen AI, and it fits into Blueprint a little bit. So the way that Pega is architected is Pega has what we call the Layer Cake, which what it is, is it creates layers. The platform has layers of dimensionality that can have reuse across different use cases. So I'm going to -- I'll put that in more clear terms. If you're going to build out, say, a sales automation application, you can build it out for North America. When you decide to apply that to Europe, all you've got to do is change the rules that relate to Europe, and the rest of the application stays intact. You can then have an application that can combine both regions, separate them, now you add Asia. Now you decide you don't want to just do sales automation, but you want to do -- you want to layer in, say, entitlements. So the entitlements might fit into something that [ books ], and now you've got another layer. Then you might have a layer that layers in the different products that you might sell, so what you're doing is you're creating an architecture. You're not creating it because it's native to Pega that allows you to have maybe 50 different use cases, all in the same application, all being able to leverage the data. But yet, each application is, in and of itself, a separate application. So now you think about gen AI. What's one of the biggest problems with gen AI? It's being able to pull all of the information together across disparate systems to create the LLMs to be able to understand the difference. What many clients are doing is they're creating multiple LLMs. Like I want an LLM over here, but I don't want this information to be in this. In Pega, you can separate all of the LLMs through the Layer Cake structure of the -- and so that's dimensionality, which was not something we thought about gen AI when we built this 40 years ago. But it has become highly valuable because it allows you to really leverage all the data, all the process, all the activities, all the events, but yet with the discrete understanding of where those events fit in the landscape of all your applications.

Okay. And if we think about the use cases that people are deploying against gen AI today, with this Layer Cake approach and with Blueprint, what do you think that kind of unlocks for them? It sounds like about unlimited permutations.

So Blueprint, yes, Blueprint is a pretty targeted use case. It might become more than that in the future. But right now, it's a pretty targeted use case to address a really big problem for enterprise IT, which is a client might have a list of 30 different problems they're trying to solve. And it's really difficult for them, quite frankly, to pick which one is the most important because it's not just about which one is the biggest problem. It's also about the one that they feel like they can get the most value and be realistic about the deployment. So a client starts with 30 projects. And the way the process works without Blueprint is to say, all right, let's pick a few. Let's get people in a room. Let's start ideating. Let's whiteboard. Let's figure out what applications we have now. What are we looking for? What are the security concerns? You start architecting. This can take months and it can take years, right? And what happens is you never touch those 30 problems because you don't have enough time. You don't have enough bandwidth to be able to address assessing all the different aspects of the problems. What Blueprint allows you to do is you log into a browser, I mean, it's -- essentially, it's our website, it's our browser, which you log into a browser. And as simple as just typing 2 or 3 sentences into a text box. You can say, I'm a telecommunications company. I'd like to digitize my contact center. Give me a recommendation on how that should look. It will -- in that scenario, it will go and look at all of the configurations that Pega has ever seen. It will go to all the best practices. It will go out to the Internet. Anything that, that company wants to provide in terms of access, and within somewhere between 10 and 15 seconds, it will pop up the entire architectural diagram of how that needs to be built. It will show you the steps, the stages, the integrations, what personas, what data feeds you need, what questions you need to ask. And you can -- if you don't like that, if you want to go in and say, no, that's not really the step, you can click edit, and it will give you maybe 2 paragraphs defining what that step is. You can delete all that and type your own, and it will come up with a new step just for that. So at the end of that, you get a document -- this is what it does now, and then I'll tell you what it's going to do in about 30 days. Right now, it gives you a PDF document that actually shows you the architecture diagram for that application you wanted to build. If you ask our clients, what I just said can take as little as 5 minutes. Maybe it's an hour if you're really engaged with the client and editing things. But within an hour, you've got an entire document that shows you the architecture of how you're going to actually design the application. That would easily take 90 days, I mean, if you're lucky, plus flying people in, et cetera. And I'm being generous.

So you're being very generous.

Right. So now what's going to happen in 30 days? Maybe it's 30 to 60 days. What's going to happen is there's a button right next to print PDF that says implement. You click that button and it goes into a Pega application and builds the application. So now it's version 1. So it's not something you're not -- maybe not going to put that into production, but you're going to get an application that matches exactly the design document that you have with all the controls, all the standards, no deviation, future-proofed. And it will also then give you, here's what needs to be done. Here's my estimate of the time it needs to be done. Here's the level of the implementation person that needs to be able to do it. It might even give you the estimate of a cost based on off-shoring versus on-shoring. This is -- I mean it is revolutionary, what it could do for us, because that's the biggest hurdle for us to sell with our clients. It's the time it takes to say, let's get a project and let's figure out what it looks like to get it started because the clients can't do all 30. And even when they do one or 2, there's a lot of starts and stops, and you don't really necessarily land with a booking. So this allows us to build pipe for existing clients. Quite frankly, we're giving it to all of -- we already given it to all of our SIs. And we've said, use this as you're selling tool and your design tool with all the clients. We're going to give it to all of our clients. We're going to tell them, run all your projects through it. All of our sales teams are going to use it. It will -- and nobody in the industry is thinking about AI like that. They're thinking about AI like the Buddies, like the call wrap-ups, and we'll do those things as well. But this is going to transform how we design a Pega application. And then the last thing I would say is, which is the most interesting to me personally, is if you can sit down with a new logo and you can start with Blueprint and you can get through a 1-hour meeting with that new logo and ideate with a design document at the end of that, the chance of you actually turning that into pipe and turning that into an actual deal is infinitely higher than that 1-hour meeting where you try to explain to them how a Pega system might work and what we do.

Of course. Yes, you're trying to explain and then going back to your stakeholders internally and then trying to then get the buy-in, without having any of the architectural documents underpinned, understanding the sequence, the flows, the personas as you alluded to, the data models, how they're interacting, those things are complex. And obviously, something probably gets lost in translation from the initial conversation [ different ]. So great to hear about that.

And logistics of getting people in a room, even if it's virtual.

Yes, of course. I mean, this probably is basically going to take away my undergrad experience. So you've obviated that you have everything I've done there. So thank you for -- so just kind of shifting gears here and talking about some of the accolades more recently. You were named a leader in Forrester Wave for real-time interaction management. And I think just today also, Forrester named you a leader in their customer service solutions. So maybe a question here is what has allowed you to kind of -- to win? And really, the leading question is to continue winning? I guess, it sounds like -- I hear all the innovation that you're doing, but kind of what's maybe underpinning all this innovation?

So the one today we're really excited about, the customer service one with Forrester, because not only are we a leader, we are actually the leader. We are the highest mark. And right behind us is Salesforce, Microsoft and ServiceNow, right? Those are the only 4 in the leader box, and we're actually higher than all 3 of them. So it's pretty exciting. So the -- now, naturally, we need to turn that into accelerated growth. We need to execute on that opportunity. But I think what Forrester and Gartner, and quite frankly, our clients see is really the power of doing it the Pega way, which is allowing yourself to orchestrate and manage all of these enterprise-grade applications, leveraging Pega but yet not alienating all the other applications that you want to use. Even if Pega is not the system of record, even if you view the system of record as the ERP system or your sales automation system or your licensing system, having an ability to create the orchestration with that, and then you think about customer service. The customer service use case is really a customer service person that's actually accessing all different systems. If you think about a bank or an insurance company through acquisitions, they might have -- they have all different types of operating systems. I mean I interned at a bank when I was in college, and I can remember when somebody would call in, you'd have to look at the city and you'd say, oh, they're from Ohio, that was this acquisition. And you'd have to go in and like do a search to get into a different application to search for that person. Like that still happens today, so just that orchestration. And then when you get to the screen, using our next best action, next best offer, telling this -- anticipating why is the person there, what do they need to say, and that's where it's really interesting with customers with gen AI, which actually, Forrester did not actually even factor in our gen AI solutions into that, which is the ability for us to really make that kind of a headless transaction, so to speak, right? The customer comes in, they're interacting with a bot, leveraging voice AI to the actual system. And the system is using all the information to communicate back and forth. I need to add a new data person on my cell plan. I need to change my address. I want to dispute a charge. I have a late payment. I want to refinance my mortgage. Whatever those things are, it's -- customer service is like the perfect disparate use case if you think about it because it's connecting. And when you interact, you're typically connecting to multiple things.

So we're kind of hitting a lot of concepts here around the capabilities and kind of what you're deploying, what you're prosecuting against. And honestly, there seems to be a lot of opportunities to go and then kind of drive your AC growth significantly going forward. But how do you all think about the total size of this market? You're hitting on a bunch of different markets. And just kind of curious if you could just kind of distill that down or codify how you see it and kind of how that can enable you to continue to grow your ACV numbers.

So we -- if you add up all the markets that we're in, naturally, not all of those organizations are addressable. But if you add them all up, you're probably $150 billion, right, of spend in the coming couple of years. Now admittedly, we cannot address all of this. We can't address all the organizations, all the use cases. But because we tend to sit -- not tend to, we sit at the peak of the pyramid, we are in the largest organizations. If you pick a vertical, like banking is a good one, and you look at the amount of IT spend in the top 10 banks, it's bigger than the rest of the industry, right? By a long shot, right? If you just take the top 5 or 6 banks, it's probably bigger than the industry. So when you think about it that way, most of the spend sits in those large organizations. The verticals that we're in tend to have that same dynamic. They tend to have the concentration towards maybe 50 organizations, maybe 100. So we think of that $150 billion, if you just cut that in half, which is, I think, probably conservative, you're talking about approaching a $100 billion market, and we've got $1.5 billion. So we think that we are really just scratching the surface. Even with our existing logos, the ones that we are very concentrated with, and I'm talking about companies that might use us for 100 different use cases, I don't think we're 25% concentrated with any of them. So I think there's a tremendous NRR opportunity with our existing works. And quite frankly, that's where a lot of spend is.

Okay. And then you kind of touched base on that last comment about spend and NRR opportunity. How are you all seeing customers right now in their IT spends and their budgets, right? Obviously, from where we were last year to where we are now, I think a lot of people feel a lot better about it. I think you can probably start to see some of this translate to results given you had a great quarter. But I think it's kind of mixed across the board for some organizations. And you've probably seen some of the other earnings across enterprise software this quarter. So maybe for you all specifically in your customer base, what are you seeing?

So I'll start by saying growth rates in enterprise spending have definitely come down. The growth in spending has come down over the last 3 or 4 years, right? I mean some of that was COVID and some of the odd spending that was happening that might have been episodic, but spending has definitely come down. If you just look at software in general, as a space, it probably was growing 18% to 20%. It's probably growing more like 11% or 12%. So our growth rate has kind of trended pretty consistent with just overall tech spending. That said, in the last 6 months or so, our clients are pretty durable on spend. It's been a pleasant surprise, quite frankly, because I didn't really -- when we hit Q2 and AI started distracting everyone, and then you hear about inflation being longer, higher for longer. And just -- quite frankly, regulation is not becoming less in -- not just the U.S. but in Europe. So these are all like -- they're all innovation headwinds, right? They're all risks that we have. But when you got to the late part of the summer and into Q4 and into Q1, I mean, our clients have digital transformation initiatives, and they're nowhere near where they need to be. And the great thing about that is, there is no hiding of that. It's not like clients are trying to say that they're there, but they don't want to admit it. But they're actually saying, like, listen, we have big problems. And we need to -- and by the way, the regulatory environments just make those problems bigger, right? KYC, data privacy, data residency, I mean there's just the -- I'm sure that many of you have read some of the press about just even like sanctioned account holders for banks and trying to -- like just how complicated that process is to figure out. Like when you're letting the wife of a oligarch -- like it's just -- it's the world we live in. So I do think the modernization aspect is a big push. Banking is just one. I mean, you could go across all the verticals, and you have the same issue.

If we -- at the onset, you kind of led into your dual roles and how some of your background was additive to the transition that you all started a couple of years ago from just thinking about SaaS, but really having a true mindset and effort built around that with all the efficiencies. So you've focused investors on ACV as a kind of key metric as you look through this. But maybe just give us a quick update on where do you see the transition currently? Is it kind of complete or not? And then I think the follow-up question there becomes between Pega Cloud and client cloud, you said you're leading with Pega Cloud in kind of new initiatives. But kind of what's still the kind of mix for the client cloud and how are customers thinking about their deployments? And obviously, with the benefits of a cloud solution that it's just always updated, it's there, it's easy to use, et cetera, just some of the mindset or -- that's kind of happening there with the customers.

Sure. So the transition, we refer to the transition kind of in 3 phases, right? Phase 1 was the shift away from selling perpetual licenses into subscription/SaaS license. That's done. The next transition was really this -- almost a reporting transition, right, of moving away from revenue upfront and billings upfront to it being more kind of annually recurring and consistent. I would -- we're done with that. I would just caveat by saying because some of our licenses are term licenses, you do have some weirdness between the revenue side. But the billings are definitely streamlined. They're recurring. It's been that way for a couple of years. The third phase was really where you really turn that into margin expansion. And I think you've seen that start in '23 and certainly make a material move higher in '24. So the transition is behind us. I would frame it that way. Now in terms of the future of everybody being on Pega Cloud, I'll say it that way, right? It's the dream of, right, why wouldn't you want everybody on Pega Cloud? Our clients, if you look at new workloads, new applications, they're almost exclusively Pega Cloud. If you look at existing clients with Pega, they're moving to Pega Cloud for new applications and existing ones. But the pace of that move really has to be on their terms because there's such operational dependency. If Morgan Stanley is using Pega for a really critical workflow and it happens to be managed on their own, we can't say to you, well, we want you to move now. We have to say to you, what's your plan for how we can help you move? No client is saying -- to my knowledge, no client is saying, I don't want anything to do with Pega Cloud. It's more of a sequencing of when they're ready. And so that's different than what we said 2 or 3 years ago because 2 or 3 years ago, we were saying, cloud choice. Buy whatever you want. Clients really want to buy cloud. They don't want to manage it. They want us to do the updates. They want us to manage it, security, elasticity. And it's been a tremendous journey. I mean, we're -- Pega Cloud is now about 50% of our ACV, and that's up from -- I just remembered, when I started, it was -- our ACV was $350 million, and Pega Cloud was like $20 million. Like so it's a pretty big shift.

That's good, yes. Maybe kind of building on that, you recently announced earnings, which were great, right? I think the 11% ACV growth, Pega Cloud was up 21% year-over-year. I think for the guide, $1.5 billion of revenue. But more notably, $350 million in free cash flow, right? That's a number I don't think you've ever kind of come close to. But the 75% year-over-year increase, I believe, is what the math translates to. Give us some idea of how that's going to come to fruition, probably some margin efficiencies from kind of maturing some of the platforms. But it's -- the improvement and the pace in which the improvement has occurred is certainly impressive, so just kind of help give some flavor there.

So we -- in 2023, we did $200 million of free cash flow. But admittedly, it was probably more like $260 million to $265 million because we have onetime items in there. So if you start with a kind of a run rate of $260 million to $265 million and you say, how do you get from there to $350 million? Well, I'm going to be really kind of high level and say probably half of that comes from a restructuring that we did at the beginning of Q4 that has not fully annualized into the numbers and will for 2024. And the other half is just the margin on ACV growth, so the incremental ACV that we've added and the margin on that. And so that $350 million, which is -- which we are, by the way, we are very proud of and very excited because up until last year, we never had -- I mean, to my knowledge, I don't think we had free cash flow more than $100 million in any year. We maybe had 1 year where we were close, right? But that's a big shift for us. And when you think about $350 million, it's really actually closer to $400 million because if you add back onetime items and direct federal taxes, if you look at EBITDA minus CapEx, it's kind of more like $400 million. So that's the good thing. The great thing about that is, maybe a slightly humorous but maybe a little obvious statement, which is once you're $510 million, you're $510 million. Like you're not -- you're typically going higher, not lower, at least in our age or maybe at your age. But like -- so I think that, that standpoint is we know that the cash flow can only get better. Like we're confident in that because we won't allow ourselves to revert.

We have a question.

You had a medium-term target of, I think, 13% to 14% in ACV growth. This year, you were below that, and the guidance is also below that. So why the delta? And what does it imply in terms of net expansion rate and churn in that 13% to 14% target?

So I'll use the 11%. It's about 10% of net retention rate and about 1% from new logos. New logos, typically, even if we had a lot of new logos, it wouldn't contribute a lot of ACV in the first year because you typically don't sell bigger deals the first time. We had -- when we went out, we had kind of had a model of 13% to 14% and the difference of that to getting to rule of 40 being free cash flow. The reality is we've just seen -- we've been a little bit more, I would say, cautious with new logo expansion because we wanted to make sure our sales model was anchored in and really make sure that when we picked new logos, we didn't have a big risk of a lot of inefficiency. So we've leaned a little bit more on the side of trying to make sure that we got our free cash flow margins up closer to 30% before we accelerated some investment in new logos. We are -- we don't believe 11% is something that we should be proud of. And quite frankly, we think we should be growing faster. But more important than that right now is getting that free cash flow number up to a number that we could be -- that we felt was respectable. And so then I think then, we can calibrate some of the investment on new logos because I do think new logos are going to be an important part of our growth strategy. We just have to be smart about it. We can't fall into the trap that we did before.

We'll try to do one more quick one.

I have a question on balance sheet. So you have $500 million in converts outstanding due in less than 12 months. Obviously, you don't have that much cash on balance sheet. Like is the plan to issue new converts to retire the old converts? That's one. And second, can you talk about the $2 billion lawsuit? Would that be in like the -- what's the milestone from here like to the finish line?

Sure. On the balance sheet, we have just over -- I believe we have just over $400 million in cash at the end of the year. I mean, with a reasonable cash flow in Q1 and Q2, we have enough cash to pay off the convert long before it comes due. So as of right now, our game plan would be to -- that the convert would not be -- it wouldn't be a needed part of our capital strategy. That doesn't mean we wouldn't consider another convert in the future. But our main thing was to give ourselves options and flexibility. So -- and then on the Appian lawsuit, we had our appeal in November -- on November 15, and we're waiting on the appeal opinion right now. And unfortunately, the court's timing is the court's timing. And so I think it's reasonable to believe that you could see it in Q2 of this year. But once again, it's really -- we don't really have any control over that. So we're anxious to see it, but we're -- but we don't know when it's going to be.

And if you do the...

I think we have to see what the appellate court says. I can't -- I'm not -- I don't want to be speculating on all the different scenarios.

All right. So Ken, I think we're out of time here, but maybe give you a second to wrap on PegaWorld coming up in June.

Thank you very much. Yes, everyone is invited to PegaWorld. It is June 9 to June 11. It's in Las Vegas. It's at the MGM. You could register through the Pega website. You can also reach out to Peter Welburn at Pega, who can actually help you get a ticket to it. We will have an Investor Day on Monday and at noon. And we will -- we welcome investors. We welcome analysts. The reason why I think you might want to consider coming to PegaWorld is because it's the best opportunity to hear directly from our clients and partners what we do to help our clients. And it's -- and we don't restrict investors from going anywhere in the show. You can talk to anybody you want. And we've had really good -- we probably had 50 investors there last year. So you're welcome, everyone is welcome.

Thank you. Ken, I appreciate the time.

Thank you, Brandon.