Pegasystems Inc. (PEGA) Earnings Call Transcript & Summary

Awesome. Well, welcome everybody to Day 2 of the Citi Technology Conference. I'm Steve Enders, part of the software research team here. With us for this session, we have Ken Stillwell, who is CFO and COO at Pegasystems. Ken, thank you so much for being here.

Thanks, Steve.

Yes. Maybe just to start off, I mean, I think Pega has been around for 40 years at this point. Maybe you can just like walk us through high-level takeaways from the recent quarter and kind of what you've been seeing out there?

You bet. So I think what's -- we're really at kind of an exciting, I'm not sure I would maybe call it an inflection point necessarily, but I would say an important stage, which is we made a very significant change in the business model about 7, 8 years ago where we pushed very hard to kind of evolve our business into more of a modern subscription relationship business with our clients. And what followed shortly after that was movement to our SaaS product, Pega Cloud. And if you go back and look at 2017, we were less than $50 million, I believe, in revenue, now that business is approaching $600 million. So we've got a pretty significant change in the business. And it's really been driven by our movement to SaaS. We just finished the cloud transition, the movement to really selling cloud as a primary offering, probably about 1.5 years ago. is really when we started to hit that last kind of those last couple of quarters. And so the business is now about 50% of the business is SaaS and about 50% I would call it moving to SaaS at some point likely with our -- helping our clients get there. And given that we had finished the transition, we also saw that increase in our free cash flow margins that you typically see when you kind of get through that transition trough. So really, it's an exciting time. We're a very different business now than when we started. And I think we have the best clients, I think, that any company would want, and we just now have to really leverage this new GenAI kind of momentum to help accelerate our growth, because we think it's a big tailwind.

Sure. No, that's great to hear. And I do want to touch on the AI stuff in a bit. But I guess just for people in the room, we want to keep it interactive. So if there are any questions out there, we'll make sure to get to those. But maybe we -- before doing that, can we just talk about the deal environment and the macro situation and what you're seeing today? How is it kind of translating over the past couple of quarters? And how do you feel like the macro setting up for the second half?

Sure. So I am not one to minimize the complexity to close enterprise software deals. So sales teams and clients alike. I mean these are transformational deals, and they're not $5,000, $10,000 deals. So it is always an exercise to be able to get through that process. That said, I would say the market is what I would characterize as stable. We have not seen significant headwinds to clients wanting to do digital transformation. That said, I don't think it's a wonderful market either, right? I don't think that it's a market where clients are really accelerating their spend and looking at getting incremental investment given to them by their leadership teams. I wouldn't put us in that category. But also, it's not some environment where I see people like not doing projects or wanting to hold back or really being timid. So I would say I would put that in kind of the okay, stable kind of -- and that's probably about the way it's been in the last 2 years from our perspective.

Okay. You did mention that you're not necessarily seeing an acceleration deal environment, but ACV did accelerate this past quarter. I think came in 13% constant currency, which is up a few points quarter-over-quarter. I guess what was better than expected because it did feel like it came in well above your expectations here. And maybe how does this change about how you think about the growth outlook for the year? I think you're originally targeting about 11% ACV growth. So can you just kind of talk about what -- kind of what that means?

Sure. So I'll kind of take piece by piece on that. So our growth rate did accelerate from Q1. Admittedly, we had a much more difficult compare in Q1 than we did in Q2. So some of that is just the math of the compare, just to be fully transparent. But that said, our net ACV add in 2024 is up like 40% over a net ACV add in 2023. So that dynamic is if you just look across the 6 months and not at the quarter level. And you might say, well, so what's that? What's that -- what's driving that? Our engagement, we want to -- we really engage in a target organization model, which is we focus on a client. We understand that vertical. We understand that client. We understand their use case. We have deep engagement, deep relationships and we solution with them to help them prioritize and build applications that would typically replace legacy applications that are -- or in some cases, new functionality. What I think you've seen happen at Pega is there's a more disciplined execution around our sales cadence because we're so focused on the organizations. And that noticeably changed, I would say, we made that shift in '22. And I would say in '23, we saw some of that towards the back end of '23, and I think the first couple of quarters of '24, we've seen good execution. I think that is really critical for us because if we are executing well with our target model, it allows us to look at new logos. It allows us to take some risks in terms of repositioning more dollars to be able to selectively focus on some of those new enterprise logos. So I think the execution was solid. I think there was a compare difference. But all that said, Q2 did finish with more deals closing where if you -- just like any other software company, if we have 10 deals, all 10 aren't going to close, right? Whatever percentage closes, we saw a slightly higher percentage of them closed in Q2. So even though we knew that the compare was a little easier in Q2 than Q1, we did see a little bit higher win rate. And we are attributing that and whether we -- whether this is 100% the reason or not, I'm sure it's not 100%. But whether it's a big factor or not, we think the release of Blueprint and the excitement that, that gave with our clients and the relevancy that our clients have around Pega really being an innovator, didn't hurt and actually clients deciding to pick us over other alternatives.

Okay. Maybe this is a good time to transition to talk about the AI strategy and what you're doing there now. So you already talked about Blueprint, but maybe you can just give a little more detail around what the AI portfolio looks like today and how does GenAI Blueprint fit into that?

Sure. So we have a number of, what I would call, AI accelerators, which are feature capability packages that we could sell to a client to solve specific or to add value, I would say. Things like we have a Pega knowledge buddy, for example, which think about knowledge buddy in the simplest terms as a way to kind of chat and interact with the data that you have in the organization. We have other things like GenAI coach, which is -- could be used in a selling process or a workflow where you're trying to have the system give you good intelligence around what to do next, what to say, right, drafts of communications. So there are things, those are things that we would license and sell to our clients, that our clients would use to better optimize and get more value out of existing Pega applications or other applications. Then there's a completely different aspect, different dimension of GenAI, which we call Blueprint, which I've talked about and you mentioned. And what Blueprint really is intended to do. is to accelerate digital transformation for our clients. Well, what problem is kind of then reel that back. Why does digital transformation need to be accelerated? Because every legacy application that a client wants to digitally transform, needs to go through a process of ideation, of architecture of you, sketching it out, writing all the documentation materials, creating the workflow, setting the case structure, going through and filling out the data fields, looking at the data migration, I could go on and on. That process takes, in some cases, months to build the architecture, to get the client kind of where they think they want to move forward. Then they have to start to implement the configuration. That's why selling cycle for legacy transformation tends to take 6 to 12 months. What Blueprint does is it helps to shortcut a lot of that. How does it do that? It gives you an ability to write information into props in a very structured way that leverages all the knowledge that Pega has around workflow and the numerous industries and the scores of use cases to be able to understand what problem you're trying to solve and then architect the actual workflow for you so that you can then load that into Pega and you might be 5x its down the highway further than where you actually started that journey. Now what's really interesting is, as you think about the evolution of Blueprint, it can ingest things like process models, screen shots, right? It can look at things and be able to tell what the system did. So that just continues to make it easier from a user experience to be able to get yourself to be further down the path. What we're hoping comes out of that is the client say, "I can assess more of my legacy applications. I can move faster on digital transformation, and I'm going to do it with Pega." And so that's the outcome that we want. So we don't charge for Blueprint. The outcome we expect to get is more applications and more volume through Pega faster, helping our clients move faster on their transformation.

Okay. And so maybe as we think about the monetization potential with Blueprint. And is there any way to maybe articulate kind of the time line you're expecting there? Or how you're expecting this kind of impact deal cycles or anything like that?

So if I just think about how Blueprint would play out and then we kind of play that into when might we see some impact from that. Blueprint -- the first step in Blueprint is to insert it into a selling process. Now that could be a pipeline deal that's already well seasoned in the pipe. It could also be a brand-new opportunity. So the key is to leverage Blueprint as applicable in the selling process. What that should do is bring more pipe in, bring more opportunities into the pipe, accelerate the opportunities that are in the pipe and have a higher win rate. Because when you're actually accelerating those opportunities, you should be in a more sole-sourced position because you're actually using Blueprint, and Blueprint is -- naturally it's tied to Pega. So when I think about it, if we started that right now, like, say, in the last couple of months, you would expect pipe to start to be impacted in this quarter in Q4. You would expect to see deals closing from Blueprint involvement in probably Q4 into 2025. We've already seen deals close with our partners where they've used Blueprint. So our partners are actually using Blueprint and building actually models and building use cases. So we've already had -- we actually had a partner in our office a couple of weeks ago, where they actually closed 2 deals with clients to actually start projects on Pega leveraging Blueprint. So we're already starting to see the early stages of pipe being built, transactions being driven that are connected to Blueprint. I think that will probably still be somewhat subdued in 2024. And going back to your -- one of your questions earlier about growth rate for the quarter and how that plays out for the year. I'm not prepared to start to say that we think our growth rate is going to be something different than what we guided back in February. It's not our style to do that. We have a lot of business in Q4. What I would tell you is where we are in the year and where we are with Blueprint certainly gives us increased confidence in the numbers that we had put out for the year. I think you'll start to see Blueprint in a bigger way impact our growth rate into '25.

Okay. All right. No, that's good context there. Maybe just talking about -- I think you talked about a little bit around like your expected adoption curve, but maybe you can talk about some of the use cases that are coming out of Blueprint so far? And maybe how are those different than the traditional use case that you tend to see coming from customers using Pega?

So to be honest with you, a lot of the use cases are the same or similar. I think it's -- what it's -- what you're seeing is there is an opportunity to evaluate homegrown deep legacy applications in a much faster way with Blueprint. So I'm not sure I would put that into the use case category. But I would say that that's a little bit of a -- if you think about an addressable market opportunity, those are typically not the easiest ones to go after. Something that's running on a mainframe that's been around for 20 years that isn't broke, may not be the first thing that a client goes after to digitally transform. But it does give us an opportunity to bring those into site more. So I would think that's probably one of the bigger opportunities. Not a use case, but more of a demographic of the types of applications, which are homegrown applications or custom applications. And I'm generalizing saying mainframe. It doesn't need -- it's not just mainframe. It could be old ERP adjacent applications. Those are the ones I think that Blueprint is really suited perfectly for.

Okay. Maybe staying on the AI topic, but I want to talk a little bit about maybe the risk or where we hear skepticism sometimes from investors, So, maybe we can just start on the competitive dynamics in the market and what you're seeing there. I think it feels like every company has an AI strategy. Everyone is talking about it and increasing the spend to value for developers. I guess with Microsoft out there with Power Platform and what they're doing with GenAI, what ServiceNow is trying to do and what they're focusing on the AI landscape. How does that maybe change -- I guess, where do you see the risk? Or how does it maybe change where Pega fits within this ecosystem?

Sure. So I don't know that I would maybe necessarily call this a bold or provocative comment, but I would say that if a strategy for a vendor is to use GenAI to help clients write more code, I think that's a losing strategy. I think there is a value proposition to leveraging GenAI to write code that you would otherwise have to write, but I don't think the strategy is to go try to build more applications with custom code. And I think anybody that's doing that and there's not many people that are thinking about that. But that is -- I think that is not the best use case for GenAI. It is a use case, it's not the biggest value prop. The second piece of that is that a lot of the GenAI stuff that you see -- and you should be skeptical of what Pega says around that, too. But a lot of the stuff that you see around these GenAI use cases around existing applications is, quite frankly, a lot of BS, right? These are not big value proposition changes. They are slight tweaks to things that would otherwise have to have some manual interaction. They're helpful but not needle moving. That's maybe the way to say it. But I think that because the market is so frothy around GenAI, it forces companies to want to talk about all these things that they're doing. I just don't think a lot of it is, quite frankly, enterprise scale, scalable. I think it's little helpful things around the edges. So I think that's -- so then you go to the competitive dynamic. At the end of the day, the way that we are going to win more legacy transformations is to make those transformations happen faster with more certainty for less cost. That is a reality. If we can do those things, if you have the best technology in the world, but it's super costly and takes forever to implement, you're going to only get a small piece of the pie. If you can actually help clients do enterprise scale transformation with certainty with not being resource dependent, you're going to win a lot more. And we believe we have the best platform. So if we can do that, we have the best product, and we're helping our clients. So we feel really strongly that's the way to really get differentiated competitive advantage. Well, I'm not worried about the piece part kind of GenAI stuff. I mean that is -- we need to make sure we are tracking to that, but I do not believe that is actually going to be what wins in the market.

Okay. All right. That makes sense. I think the other thing we've heard is that maybe people are a little skeptical of Blueprint or think it maybe it's just fancy templating or something like that. And there wasn't that big of a change there. How would you maybe push back against that view? Or maybe asked differently, what does Blueprint enables for Pega that's different than before?

I would -- anyone that's skeptical of Blueprint, I would say, go use it. Go to the website, see for yourself. You can go to pega.com, you can find Blueprint, you can do on yourself, you don't need to be trained. You don't have to do anything -- I mean, it's simple. And if you want to see the power of it, I mean, put in a use case that you know, don't even -- make one up, right, and see the result that you get. And I think you'll see the content that you get is powerful. What's more powerful than the content is the structure that it organizes the work in. It actually tells you exactly how the work needs to be done, the data fields that need to be in there, the users that are going to touch the system, the integrations that you might need to consider. -- and actually reports. And actually, in the newest version of Blueprint, you could actually see the screen of the application rendered as you're actually going through the props and discussing it. So to me -- that's for the skeptics. I would say that's one way to see that it is certainly not a templating exercise. What it is, is it's leveraging GenAI and the content library to be able to tell you what your use case should look like and build the application.

We have a mic coming. We'll get it to you. Yes.

Perhaps you could just go through an actual use case for a long-time customer that's adopted it and is relatively early in a cohort, so to speak, of usage and really proving it out and seeing the ROI?

Sure. So I'll use an example. Let's say that a client had a loan origination system, a bank had a loan origination system that was maybe a little outdated and they needed to modernize it, and some of it was like compliance changes they needed to make, but also like the whole loan of like the way that mortgage loans or warehouse, et cetera, was different. And so they could go and try to customize the code of that homegrown system of that or they could build new. So what they would do is they would go to Blueprint. They could put us a brief description in the box of what they're trying to do. They could actually load content that could be architecture diagrams, manuals, et cetera, from the old application. They can also load screen shots in that would actually show anything that -- schematics, anything that they might have because they probably have something from that. And they could actually go through a couple of other props to help to build, that would build kind of stage 1 of what that new workflow might look like. Then they can go through and actually look at each one of the steps and stages and make any additional changes. For example, if there was a core credit report stage and it talked about the different ways that it would pull and they said, well, we don't actually use all 3 credit agencies. We only use 2 or we have a different way to calculate, they could actually put that text into the description as an example. At the end of that process, which I would say, realistically might be, if you did it really fulsome, it might be an hour or 2 of actually working in Blueprint. You would at the end of that get depending on what you wanted the output to be, you could have a PDF or you could actually have a file that actually could be -- in the new version of Blueprint, you don't even need to file. But what -- right now, you get a file and that file gets loaded into a Pega system, and it creates actually the application. In the new version, that you won't even need to do that. Blueprint will actually be inside of a Pega app. So when you click it, it will open up a prompt to the screen of essentially Pega App and Dev Studio, which is where you actually built, and it would say, here's your application that's built. That application could be 50% of the way done, 75% of the way done. It isn't going to be 100% because, of course, you're going to do other things. It gets with everything, UI, mobile UI, desktop, different operating systems, browsers, et cetera, all that is out of the box. So then the client would take that and they would say, okay, now I've decided I'm going to modernize this application I've got an application that in a previous world may have taken a year to get to that point. And now I've done it in, I'm being aggressive, a day, right? Let's call it a week, right? It's still something significantly less than what it have been.

It was huge savings there. Where would that have been done? In the offshore or outsourced?

So the land would have been done as you would have typically went to Pega or a system integrator or the employees of the client because they might have a center of excellence of skilled people. And they would say -- they would basically say, here's a project, and they would just start. They'd start whiteboarding out the work flow and they look at documents and they basically create Gantt charts and Visio diagrams, and excel list of all the -- and then they would go into Pega and they'd start creating like stages and steps and the script. And then they would run and they go figure out all the data elements and create the screens and then they go. So they will just the -- that would be the typical way that you would build an application.

Do you cannibalize any revenue? If a lot of this would have been done with Pega anyway?

So the revenue that is -- the effort that is cannibalized is the upfront preproduction effort is going to be reduced. So sometimes that's -- so we do that a little bit. That's implementation work. SIs do that implementation work. Clients certainly wouldn't view that as cannibalizing because they need less resources to do the project. But what is maybe not a commonly known thing is many -- much of that work that is done by SIs, they're not able to charge for, right, because that's business development efforts. So you're actually taking time that might be free work for Accenture, E&Y or one of the partners and you're turning that in to a template they could start with. That's why our partners are now some of the biggest users of Blueprint because we've created a Blueprint library where partners can create their own proprietary blueprints, stored in our library, completely anonymous and separated from other partners and Pega, we can't even see what their blueprints are. And they then use those to differentiate themselves when they talk to clients about doing it. So the cannibalization is the cost of implementation, but some of that is actually work that SIs wouldn't charge for anyway.

So how should we think of the net delta in revenue to Pega perhaps in percent in that use case or that customer?

In the model where Pega is not doing anything around the implementation at all, there would be no -- there the revenue would be exactly the same, just higher win rate, faster pipe, faster time to production. So ultimately, more revenue because we'll be doing more. But on that transaction, we would actually get the same amount of revenue naturally just faster because we go to production. Size might get slightly less -- if they get less business development costs, which is a positive, they might have less implementation. But quite frankly, they actually can do more projects for the client. They can probably fix price the projects and that actually is a big advantage for the SIs because they can actually get more embedded with the clients to help more digital transformation, which is why our partners are pretty excited about adopting Blueprint. The reality is the system integrators know that GenAI is going to commoditize a lot of the less skilled work that was done anyway. So this is a way for them to capitalize on that trend as opposed to be a victim to it.

Maybe to follow up on that line of questioning. I guess from a -- I think we kind of already talked a little bit around custom development and some of those initiatives out there that GenAI is impacting. But does it maybe change how customers would be thinking about putting something custom code versus going to somebody like Pega or another kind of low-code vendor?

So you're saying Blueprint or GenAI?

With Blueprint and the ability to accelerate that, would that maybe change how customers think about writing custom code versus using a low-code vendor?

I think there will always be a bias with some engineering teams to want to write custom code, right, and not always, but certainly in the next 5 to 10 years. because it's a self-preservation, right? Like, so I think there's just going to be some of that's just a reality. But the answer is, would people be more inclined to use development platforms like Pega versus Java? 100%. If you can get further down the highway without using any fuel using that analogy, you're going to have -- there's going to absolutely be faster adoption of platforms.

Okay. That makes sense. Maybe shifting gears away from the AI discussion unless there's any more questions in the room here. I want to ask about go-to-market and the changes that have kind of gone on there. I think you've made some changes in '22, '23 a little bit. Can you maybe walk us through what's changed and maybe how productivity rates trended since you've made those changes?

Sure. So we did 2 changes to our go-to-market team. One was at the end of 2022, and one was toward the end of 2023. It was kind of right as Q3 went into Q4. And the first change that we did was we resized the amount of organizations that we were going to cover, which then carried into us needing less sellers. So that was the -- and by the way, we don't take these changes lightly because naturally, we -- these people are impacted, our teams are impacted. So we tried to be as thoughtful as we could about that impact. But sometimes you have to make those difficult decisions. That was the first step, which was total scale of how many orgs we covered and the account. As we kind of -- as that got anchored into '23, we then realized that was a great opportunity to centralize selling -- parallel selling units that may have been going in. So you might have had a primary seller and then a specialty seller and a partner seller and so we really kind of, I don't say collapsed, but like combine that in to focus on like kind of a quarter back, so to speak, of the selling team, which was the account executive so that we would actually get some efficiency there. So those were 2 changes that we made to the go-to-market. If you ask me, so how is that going so far? I would say, we have 40% more ACV -- incremental ACV in the first 6 months of 2024 with about 20% less cost. So that would be like my elevator pitch, so to speak. So it's working. Now I think what we've got to do is we've got to continue to bring that out. We've got to look at new logos and make sure that we're being very selective with how we grow new logos, so we don't lose that efficiency momentum.

Okay. And so I guess, maybe what are the learnings that you had from -- I think you kind of put your foot in accelerator 3 or 4 years ago to try to build out that new logo motion. What are kind of the learnings from then that you're kind of applying now for maybe where it makes sense for who to target or how you kind of go about that go-to-market motion?

Our product market fit is not built for a territory model. We have to have a target model. We have to know the vertical, know the org, and understand the use cases. It doesn't even matter what order, what vertical. We just have to know that, like, we -- our solutions are not commoditized such that you don't have to understand the businesses. And when you sell in a territory model, you're selling to 10 different verticals, all in the same week, right? You just really -- it's very different. You can do that with an expense management system. You can't do that with an enterprise platform. So that's one thing. The second thing is you can only tolerate so much scaling of new logos without you get -- without getting overwhelmed, distracted with onboarding, with enablement, with management, you have to be really thoughtful about how fast you could scale the orgs that you target. I'm not saying you can move faster than we've moved in the last 2 years, but you may have to be thoughtful if not, you're going to end up with a lot of confusion and a lot of inefficiencies. So I think that's the second one. Third one is if you're going to pick new logos, you should go where you know you should be in the verticals that you know you should be in the common use cases. It's just -- it's like more of an obvious statement. And then I would say maybe another one is you have to think about the scale of the size of the company and make sure -- Pega is a business that does not sell once and leave. We sell and then we help those clients for decades. So if you're targeting an org, you got to make sure that org has either the capacity to need us or the growth trajectory that they would need us over time. And it's -- and sometimes you'll get a small company, but you know they're going to be big. And sometimes you get a big company that just you know there's more use cases. Just being -- that's a commercial comment, right? Like -- so it's not a technical one. I just think that those are things we learned that we really need to -- that quite frankly, we should have already known some of those things and shame on us for not like staying true to who we are. But we, like other companies during COVID, we got a little fast and loose with how fast we hired and we had to fix that. And I think we've learned from that a lot.

Okay. You have a $2 billion ACV goal in 3 to 5 years, you're at $1.3 billion today. Can you maybe -- what does the road map look like to get from here to there? What contribution is new logos? What's coming from the expansion? And how do you think about how much more room there is to run within the current accounts that you have?

So majority of that growth will come from logos that we already do business with right now. However, we have to add new logos over that 3- to 5-year period to make sure because we will get some growth from that. And we want to make sure because there's -- we don't -- Pega doesn't cease to be a business in 3 to 5 years, So we want to make sure we're thinking about the next hill to climb. So I think that the majority will come from existing. Pega Cloud will be a helpful accelerant to that, not just with clients moving to Pega Cloud, which some will, but also Pega Cloud is a different selling motion. And we think there's a lot more opportunity. If you look at the TAM inside our existing logos, it's like the companies that we already do business with. I mean, if we're 25% to 50% penetrated in any of our clients, I think that's probably the highest. And I would say most clients were single-digit penetrated. So we have tremendous opportunity with even our largest clients, which we have clients that spend tens of millions of dollars with us. You could look at those clients and say, what did they spend with Salesforce? What do they spend with ServiceNow? What do they spend with Adobe? What do they spend with Microsoft in the solutions that we sell? And it just highlights that there's a tremendous amount of opportunity in the existing client base. So I think that there is no TAM shortage, and I think new logos aren't needed at all to get to the $2 billion. right? We will leverage them because we want to continue to keep the flywheel going, so to speak.

Makes sense. We have about 5 minutes left here. So just going to see if there's any questions in the room. I'm going to ask about free cash flow. I think you've seen a pretty impressive ramp up here in the past couple of years. I think it's about 25 points in 2 years or so. So pretty impressive and rapid growth there. What's been the biggest area of leverage for you so far? And where do you see kind of the most incremental opportunity?

Well, so just being very honest, some of the free cash flow change was coming out of the subscription transition, and we knew it was going to happen. So that's like we were going to generate a couple of hundred million dollars in cash flow just because of the movement to the subscription business. But then there's that next one, which is, okay, that's great. That gets you into the 20s. How do you get to 30 plus? Gross margin for Pega Cloud. When we first started this journey, our gross margin for Pega Cloud was 37%. And then we said our target was 65%, then we set it for 70%, then we set it for 75%, now it's 80%. Now you're starting to see like, well, we're obviously going to get to 80%, we're at 78% or whatever we are now. So -- but I don't know how much further we can get -- can we get to 85%? I don't -- maybe not. Can we get the low 80s? Yes, probably. So there's a little bit of operating leverage there. Sales and marketing, we still spend quite a bit for sales and marketing compared to the size of the business we are. So I think there's a good bit of leverage there. There's probably 5 to 10 points of leverage there in terms of percent of revenue. G&A, I mean, we spent 4-plus percent in G&A. I mean, I don't find another company that spends that amount, that's pretty low. And if you look at engineering, we're at like 17% to 18% kind of in that range, and that's probably about the right number. Maybe you could go a little lower than that. So I think it's gross margin just scaling the business larger with the sales and marketing organization that doesn't grow at the same pace and you're above 30% free cash flow margin. So that's -- I mean, that's the easy way to think about it.

So you've had a lot of focus on Rule of 40. It seems like there's a bit of a shift towards how you're thinking about free cash flow and free cash flow per share. Can you maybe kind of walk through some of the shift that's going on right now? And maybe now why is the right time to start focusing on free cash flow per share?

Well, I mean, if you think about we, as investors, I'll put myself in the same category as all of you. And we, as investors, think about a discounted cash flow model and then dilution, right? We've always thought about that, right? So the discounted cash flow multiples -- the discounted cash flow and the multiples on free cash flow have always been connected to free cash flow growth and then with an assumption of a certain dilution level, right? So naturally, if you can put those 2 together, which is free cash flow per share and look at that model, you can make some assumption about buyback or not and figure out like what is the actual net what is the -- an owner of a share get and the growth in that. So that, to me, is a very like -- being a finance major, it's very like logical, that's kind of the right way to think about the value of the business. But I think what is not obvious in that is what is the company's intention of buying back shares and what do they want to do with their free cash flow. Some companies don't buy back shares and they try to buy revenue, do an acquisition, right? That's one strategy. At the end of the day, either one that you do, you can actually look at 2 companies that have 2 different strategies, and you can get to a free cash flow per share growth in both of those models. And so for us, we just -- we think that it's pretty easy to say, here's what we think our free cash flow is going to grow and we're going to use our free cash flow to buy back shares at some certain ratio. And we haven't built that framework at the sophistication level that even I'm talking about now, but we're at that point where we're ready to do that. We wanted to get through the cash flow ramp and stabilize the business, generating a certain amount of cash flow and know that we are through the sales transformation until we really started to think about this, and we're kind of at that stage.

So does this kind of maybe suggest a shift in how you're thinking about capital allocation plans then?

Yes. You will see -- obviously, we have the convert out there, $500 million. So a lot of our free cash flow was earmarked to be able to make sure we could satisfy that convert if we so choose to. But after the convert is paid off, we're generating hundreds of millions of free cash flow. We're going to be buying back shares, right, obviously, at any reason it will multiple -- certainly at the multiple that we're at now. But -- so that's -- that is a change. We just weren't ready to do that because we weren't through the subscription transition, but it's definitely a part of our capital allocation now.

Well, I think we're out of time here. So I think we'll leave it there. But Ken, I want to thank you so much for being here and the rest of the Pega team.

Thanks, Steve.

And thank you, everybody in the room.