Pegasystems Inc
NASDAQ:PEGA
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Pegasystems Inc
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Good day, everyone and welcome to the Pegasystems' Fourth Quarter 2019 Earnings Results Conference Call. Today's call is being recorded. At this time, I would like to turn the conference over to Ken Stillwell, CFO. Please go ahead.
Thank you. Good evening, ladies and gentlemen, and welcome to Pegasystems' Q4 2019 earnings call. Before we begin, I'd 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 expect, anticipate, intend, plan, believe, will, could, should, estimate, may, target, strategy, intends to, projects, forecasts, guidance, likely, and usually, or variations of such words and other similar expressions, identify forward-looking statements, which speak only as of the date that this 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.
Actual results for fiscal year 2019 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 Q4 2019 earnings, and in the company's filing with the Securities and Exchange Commission, including our annual report on Form 10-K for the year ended December 31, 2019, and other recent filings with the SEC. 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 some events may cause our view to change, except as required by applicable law, we do not undertake and specifically disclaim any obligation to publicly update or revise the forward-looking statements, whether as a result of new information, future events, or otherwise.
And with that, I will turn the call over to Alan Trefler, founder and CEO of Pegasystems.
Thank you, Ken. As seen in the earnings release, we delivered a very strong Q4, which ramped up strong results throughout 2019. In 2019, we made significant progress on our key goals, accelerating growth and moving to a recurring model, beginning to see a pay-off on our go-to-market investment, and creating broader and deeper client engagement and positive business results. I am pleased with how we're executing on our strategy to help clients achieve their digital transformation. And our optimism is validated by clients and prospects, and it's also reflected in our ACV and backlog growth. This is driven by increasing Pega adoption, with both new and long-standing clients. We're very happy to see that ACV growth of Pega accelerated in Q4 to 22% year over year. As we said, we believe ACT is the leading measure and most closely reflects our underlying business momentum.
I want to congratulate the entire Pega team for solid execution in 2019, and I am very confident in our ability to execute. We also know there's so much more we can do to capitalize on the immense opportunity to help clients succeed with their digital transformation initiatives. Now, in 2019, I met with dozens of C-level execs, most recently at Java, and -- that was 2020, technically. But we see a number of key trends affecting our clients, and regardless of industry, a common thread is their ongoing struggle with true digital transformation, and then thinking about how to survive competitive onslaught, and what will take to thrive over the next three, five, or more years with, and especially with the lack of predictability we see in so much of the world and in the economy. So there are three very clear common challenges that are emerging, and they line up perfectly with Pega's capabilities.
First, organizations need to build the right business and technology architecture to support business models that are evolving, and they must pool together capabilities and assets from multiple sources, including outside your organization, to build open platforms that will support these new business models. There were technical challenges involved in weaving together an enterprise-wide an open ecosystem of people, processes, and data, perfectly aligned with what we do exceptionally well.
Second, organizations are dealing with the shift from traditional product-oriented transactional model to a world where everything is offered as a service. The conventional idea of product, something that was bought and owned, is being turned upside down, and organizations are realizing the importance of a shift to this as a service mindset. They're adapting to be more customer-centric, frictionless, easier to engage, and ultimately accountable in different ways. This trends aligns equally well with our ability to enable organizational speech and intelligent automation, and deliver powerful and hyper-personalized customer experiences, which just brings everything together in new ways.
And third, powered by ubiquitous connectivity, mobile computer power, and increased customer expectations, enterprises are shifting from a culture of reactive performance to focus on proactive, and even preemptive engagement. Using analytical principles that leverage information well beyond what's captured in the traditional CRM systems cannot just anticipate the needs, but also to actually preempt potential negative customer issues or interactions. The old adage of "Fix the problem before the customer knows they have it," is finally achievable, whether you're actually making a customer more what we were actually making our customer satisfied, or a preemptive call. These challenges are common across industries. They're expressed in different ways. For example, in telecommunication, the industry's moving from selling phones to selling connectivity and content services. They understand the old style data plan is going to be a race to the bottom, and are looking for ways to better understand the customers wants, and deliver contextual engagements and offers for an expanded portfolio of services and content across channels. And not all know how to do it, but we all know that they need them.
A great example within one of our largest 2019 deals was one of the world's largest telecommunications companies; Mint chose Pega to help them achieve strategic digital transformation of services in the telecom sector becoming more commoditized, their intent of differentiated through superior proactive and preemptive service to deliver those customer experiences increased our revenue and massively got cost out of the business, exactly the type of initiative we have seeded for. They chose Pega because we were the vendor that could best help them meet their multifaceted needs, achieving scale, moving to the cloud, realizing low coast speed of delivery, differentiating customer service, and integrating AI naturally into their customer journey. They expect to generate cases at a 1 billion a year rate in 2021, each able to take the next best action and ensure fulfillment with customers in the moment; this will led to tens of billions of next step action decisions each year.
In the financial services, in many forms, is still organized in silo. The credit card division think it owns its customers, and doesn't talk to the mortgage group, and doesn't talk with the checking and savings, and these silos are going to be shattered by the emergence of open banking. The new staffs of Interbank standards have made it easy for organizations to compete, and will require the organizations to put together a package with multiple products from across their OpEx, as well as some other institutions. This can create better customer loyalty, and the customer's managed from centralized touchpoint environment, but it also opens the banks up [Technical Difficulty]. It's a real driver of forcing organizations to think differently. And the healthcare industry, the final one, has historically been transactional and ultimately incredibly reactive; it snaps to the action around a specific event, whether acute illness or a hospitalization. But the industry is rapidly shifting to wellness and preemptive health outcomes, which means delivering a continuous proactive and nurturing wellness experience, and being able to measure the results.
Common to all of these organizations is that they need a platform on which to build their own business platform, and they need to respond and adapt quickly. With competitors using similar and sometimes identical languages to describe themselves, I want to remind you of the key power, and promise, and differentiation of our solution. We are a modern scalable platform that has both the brain, the intelligence to make brilliant decisions, and the muscle, the ability to get work done in a common architecture. And Pega Infinity is the only software that totally unifies these capabilities. Our architecture, technology, and experience in intelligent automation is miles ahead of alternatives, and we continue to invest, not taking anything for granted.
I find it amusing to see some companies now dredging up terms from the 1990s like workflow. Even as we were the highest-rated company in that segment sector, and we were, I totally found the word ironic, and frankly, sad. Especially in today's era, it shouldn't be about workflow, it should be about work that we do, and that's exactly what Pega delivers. Pega's unique capabilities position us to be the platform of platforms for enterprises that want to create real digital transformation and evolve; never has our client promise, build for change, been more relevant.
To touch again on 2019 accomplishments, we continue to focus on the solutions, markets, and industries that we think will generate the best returns for our business. And we go deep in that commitment to traditionally small markets, while we innovate in newer markets with high potential. We continue to invest in projects to ensure our platform remains best in the industry, providing clients with the most innovative and differentiated capabilities in of the market with the fastest time to value, while building on our very unique model-driven approach that makes it easier to take clients with us, even if we make massive changes and introduce concepts like Cloud Choice. At the core of this offering is Peg Infinity, the single unified, powerful, and intelligent automation platform increasingly adopted by our clients and prospects [ph] as the platform that they want to use to deliver their business platform.
This month, we are releasing the latest version of Pega Infinity with exciting new capabilities in our core areas of one-to-one client engagement, customer service, and intelligent automation. There's some really exciting new features, built-in design thinking concepts, directly incorporated into the software to make low code and highly collaborative development. [Indiscernible] called Peg Express, we will take the development process and guide you step by step to quickly design and deploy their project, ranging from minimum level of project, small quick things, to the traditional projects that can handle the mission critical thinking that drive a business. This lets customers start small but take advantage of Pega [ph] of scale and a full application based on business. We think this capability is going to be especially important as organizations develop new and more platform oriented ways of thinking.
So our net 2019 results; our strategy is working, we saw good momentum, and we continue to develop customer engagement capabilities with new messaging and data visualization. We introduced major AI enhancement to make it easier and faster for clients to develop one application, and we continually went highly in the [indiscernible] and customer engagement, multichannel marketing hubs, real time interaction management, industry awards for CRM customer case management, and customer service. We recently commissioned a report from Forrester that calculated the value of working with Pega on transforming customer engagement. Among clients Forrester analyzed, the average return-on-investment is a whopping 489% over a three-year period, with six months to break even. There is an extraordinary amount of quantifiable value our customer get through driving with us, and you can feel free to check out the Forrester report on our website.
We continue to enhance the Pega platform in intelligent automation without robotic process automation solution. And as I mentioned, introduced the enterprise low code factory to make it possible for citizen developers to create enterprise compliant IT-less, low code solutions. This continued to garner just a recognition by major analysts, and we were identified as being excellent in a number of key categories that are critical to our clients. And we have continued to invest in Pega Cloud to ensure we have awesome cloud solutions, while still supporting Cloud Choice for customers who want to run private or partner cloud. In 2019, we expanded our cloud service guarantee to include amenity support, and we added several important security certifications, high trust, IRAMP, and FedRAMP, making it much easier to do business in healthcare and with the government.
More importantly, as seen in results, the demand for Pega Cloud and Cloud Choice continues to grow. We're thrilled to see it. So, 2019 was the year of quality growth, and we continued to focus on expanding the field organization to better capture the remarkable opportunity in front of us. Of this includes our client success organization, helping us capitalize on the opportunity for expansion within our client base. We also increased engagement, which we judged based on high-quality interactions on the web, or meetings, or email conversations, by more than 30% of our target organization. And we expanded our certified ecosystem by more than 25%.
You may recall that in 2017, we launched our Pega Ventures program to invest in emerging Pega partners and help accelerate the Pega ecosystem. Since then, we've invested in nine companies in the U.S. and EMEA, all of them are doing well and growing. We just had an announcement that we're really pleased to see, that TeleTech, a leading digital global consumer experience technology and services company, just bought one of these partners, [indiscernible]. TeleTech has more than 48,000 employees on six continents focused on delivering transformative customer experiences, engagements, and growth solutions, and the fact that they see an opportunity to grow their business with a Pega-focused practice is exactly the kind of results we were looking for when we established this program, and a great validation.
And then the final topic is PegaWorld because it's a significant event of the year. It's our flagship conference, and it's going to be very, very exciting this year. We have terrific clients signed up to present, over 100. So for example, United Healthcare will be speaking about how they use AI for their next generation customer care. Ford will be talking about how they are harnessing Pega across the enterprise to enable citizen development. HSBC will be talking about how it's rolling Pega out globally, based on the success that they saw in the early regions. And Munich RE will be talking about using Pega to fuel the future of insurance in what they call "insurance in a box." This year, we'll be in our home town of Boston, and we hope you'll be able to join us at what will be the biggest and best PegaWord ever on June 1 and 2.
So in summary, we're very happy with our 2019 performance. I'm pleased to see our license and cloud ACV grow than the way that it has. And in 2020, you can see us operate with an ongoing rhythm of continuous improvement to improve our products and further our ecosystem, investment sales, and marketing to capture the full potential of the opportunity, while being mindful of cost and profitability. I continue to be very positive about how our software is being adopted, and we have really, really excellent visibility to our revenue for next year, and our best guiding to be over $1 billion of revenue. I'm excited to see this milestone and grateful to the entire Pega team that has gotten us where we are today and carries us into future. I'm thankful to our clients and shareholders for continuing to trust us. And with that, I'll turn the call over to Ken.
Thank you, Alan. We've reached an important milestone in the history of Pega's evolution as a business, arriving at the approximate midpoint of our cloud transition. Back in late 2017, we consciously shifted Pega's business model, moving from a company that primarily sold its software on a perpetual license basis, to a much larger company that sells mostly on a subscription basis. We've made great progress on our transition so far. Two of the most important success metrics that we've been tracking to show the impact and progress of our strategic execution during this transition are annual contract value or ACV, and remaining performance obligation, RPO, or sometimes referred to as backlog. Let me first talk about ACV.
Just to remind you, we entered 2019 with the targeted of increasing total ACV by about 20% in 2019. I'm pleased to report that total ACV growth exceeded our expectations. At the end of 2019, our total ACV was $693 million, a solid increase of 22% from 2018's total ACV of $570 million. Pega quality ACV grew 54% from $110 million in 2018 to $169 million in 2019. This impressive result drove this total ACV growth rate up to 22%. ACV growth continues to be our most important metric, reflecting the successful execution of our strategy. Total ACV is the sum of recurring Pega Cloud and client cloud commitments, representing the annualized recurring spend from our clients for cloud term license and maintenance. Another reason that ACV growth is so important is because it's the best leading indicator for our future revenue growth.
Now, let's turn to remaining performance obligation, RPO, also called backlog. This is another important metric. In 2019, Pega Cloud backlog increased by 41%, building from $299 million as of December 31, 2018, to $422 million as of December 31, 2019. Backlog reflects client commitments not recorded as revenue, as of the period reported, providing visibility into where a significant portion of our future revenue will come from. Total backlog increased by $205 million, from $631 million to $836 million, an increase of about 33% when compared to the balance at the end of fiscal 2018. Our robust backlog is another benefit of our cloud transition. Historically, much of our bookings were taken as revenue in the current period, causing variability in our quarterly results. These days, the largest portion of our of our bookings are cloud, most of which goes into backlog, creating a more predictable revenue and cash flow stream.
You could see further evidence of our successful transition to a recurring revenue business by looking at the change in our total revenue nets. Over the past four years, we've moved from a business that was about 50% recurring revenue to a business that's over 67% recurring revenue at the end of 2019. That's a pretty spectacular shift in a relatively short period of time. When you include Pega Consulting, we have almost 90% visibility towards 2020 revenue target. A core element of our strategy continues to be building more valuable business by shifting a greater percentage of our annual revenue to the subscription model. We believe it satisfies demand for our current arrangements, not only enables us to capture a significant lifetime value from existing customers, but also unlocks previously untapped customer segments, which can include business units that would prefer operating rather than capital expenses, or companies whose cash constraints prevents them from making big advance investments. We also enable our clients to start fast and scale, which aligns very well with the subscription-based model.
I want to drive home this point. We will continue to provide flexibility to our clients to see tremendous value in our Cloud Choice differentiator, and our clients continue to invest in Pega on a recurring basis. Our deliberate ongoing transformation to a recurring business model continues to track to plan. As we've discussed in the past, the cloud transition typically takes a software company about four to five years to complete. Today, we're at the approximate mid-point of our cloud transition. If our cloud transition continues at this pace, we will expect revenue and profitability optics to improve noticeably in 2020 and '21, and to normalize during 2022. We continue to adopt the sales capacity and build out our cloud infrastructure to continue to scale this significant growth engine, which in the near term has temporarily slowed our margin improvement. We expect the lag between the business we win and its revenue, and the resulting mismatch between revenue and cost, to diminish over time as we exit this transition. We remain very confident that the long-term benefits of a recurring business model, including a more predictable future revenue and cash flow stream, far outweigh the skewed short-term optics around reported revenue growth and the impact to short-term cash flow EPS margin and profitability. For 2019, we're reporting both GAAP and non-GAAP results. A full reconciliation of all GAAP to non-GAAP measures are provided in the financial tables in the press release issued earlier today, and those are also available on the Investor Relations section of our website.
So, let's turn to a few other details. In 2019, we returned about $74 million to shareholders, comprised of about $9 million of dividends and approximately $65 million in share buybacks and net settlements of equity. And we finished the quarter with just over 5,100 employees worldwide, an increase of approximately 13% from one year ago. More than half of the new hires joined our go-to-market organization. This growth reflects the fact that Pega continues to be seen by Canada as an extremely attractive place to work.
Turning to our fiscal year 2020 guidance. Given our strong ACV growth in 2019, it's clear that Pega's annual revenue will see $1 billion for the first time in the company's history, an important milestone. Assuming that Pega Cloud continues as approximately half of new client commitments, we expect $1.1 billion of revenue, representing total annual revenue growth of about 20% for 2020. From an earnings perspective, we expect to achieve approximately $0.20 of non-GAAP EPS. We believe that the quarterly revenue and cost linearity for 2020 should resemble our quarterly linearity for 2019. We anticipate a slightly better gross margin in 2020 as our cloud business achieves better scale efficiencies. The impact of the cloud shift will be significant to revenue and margins in 2020, as we cross the midway point of this cloud transition.
So, continuing to drive significant ACV growth is a priority, and is the ultimate measure of the successful execution of our strategy. In 2020 and beyond, we're focused on achieving several key goals. First, we aspire to increase our growth rate. The market for digital transformation is huge, and Pega's well positioned for continued success, given our outstanding team, our best-in-class product portfolio, and our proven track record of customer success. Second, we will continue to shift our business to an increasingly recurring model, improving our revenue and cash flow visibility. Third, we will continue to differentiate by offering Cloud Choice to our clients. Fourth, we are focused on building a business that can sustain greater improvement in profitability as we scale, allowing us to make progress running the business under the rule 40 balancing growth in margin while we continue to invest in sales and marketing to capture this massive market opportunity in in front of us.
Before opening the call for questions, I'd like to invite each of you to our annual Investor Day on Monday, June 1 during our annual conference PegaWorld Inspire, which is in Boston, as Alan mentioned. To attend, please send an email to Pega Investor Relations at pega.com. For those who cannot join in person, we'll hold a webcast the day of the event, accessible on the Investor Relations section of our website. And with that, operator, we will open the call to questions.
Thank you. [Operator Instructions] We'll go first to Rishi Jaluria from D.A. Davidson. Your line is open.
Hey, guys. Thanks so much for taking my questions, and nice to see a strong finish to the year. Couple of ones. First, in thinking about the cloud gross margin side, I know we've talked about it, and there's the investments on the cloud infrastructure side. It was down a little bit this year How should we be thinking about the opportunity for cloud gross margin expansion heading into next year and beyond?
So, hey, Rishi. It's Ken. So, it's a great question. We originally had kind of envisioned this cloud margin being much more of a linear scale between 2018 to 2022 as we start to achieve more normalized margins. Reality is that we've talked about -- we made some significant investments in 2019, like our FedRAMP certification, but also getting ahead of some of the accelerated growth in cloud, made sure we had right infrastructure support. I think 2019, we've mentioned before and we firmly believe, is really a trough year for us, and that gross margin will improve in 2020, and '21, and '22 in a fairly kind of linear fashion each year, getting up to where our more steady state margins are. So you will definitely see improvement in cloud margin. Some of that is scale improvement because the cloud is bigger but it's also some specific things that we've done to really run our cloud more efficiently at the end of 2019.
And then on the hiring side, you mentioned the growth in both, total employees and go-to-market; it looks like a head count this quarter is up about 33% versus last year, and it's been accelerating pretty steadily for the past couple quarters. Can you give us a sense for how do you feel you are in terms of sales and go-to-market hires, and when I think should we kind of expect the catch-up curve to be over, and see sale hiring rates maybe drop back in line with ACV growth?
I think the solution to that problem, to be candid, is because the ACV grows up, and if that doesn't happen, then we're going to not continue to accelerate, if we can't get to a high level of confidence that we're going to get to a return. I think what's happened in the last 18 months in particular, to just give sort of a little subjective flavor to it, as we've really deepened our engagements with some of these enormous, enormous companies that we deal with, we're A., finding way more opportunity; and B., it's a reminder that it takes a while to get introduced, reintroduced, and build those relationships. I actually had a meeting at the beginning of 2019 with a very senior executive of one of the world's largest banks who was already a customer. Here is what we did, had a discussion, and he looked at me, and said, "Where the hell have you guys been?" He said, "I can't escape." You can guess what the [indiscernible] can't escape from are. "And what you have is way better than what they have." And frankly, there's business that will be coming from that. Takes a certain critical mass. This is going to be important test year for us to demonstrate that we can get returns and get them more lively, and we're committed to showing that.
All right, thanks. That's helpful. In terms of maybe cash flow used; it did look a little light in the quarter, and just going through the balance sheet it looks that may be a little bit on the receivable side. Can you maybe shed a little bit more light on cash flows. I mean based on guidance, you're talking about somewhere in the neighborhood of 600 basis points of margin expansion on the income statement. But how should we be thinking about cash flow margins next year?
So as you go through a cloud transition, I mean there's some people that talk about it, they refer to this adds up to about financing the transition, right? These are going away from receiving all your perpetual revenue upfront. Not only do you have the revenue troth, you actually do create a natural delay in billing because the billing matches -- really, it just matches the revenue a little bit more closely for our cloud business. We're about halfway through our cloud transition, and we largely funded that through cash that we have on the balance sheet, et cetera. So we are -- we believe that 2020 will be better than 2019, and 2021 will be better than 2020, and 2022 will probably back to normal levels. But naturally, if you go through a cloud transition, there is a pressure there is a pressure on cash flow, just like there is on the optic of top line revenue. But it's nothing unusual, and we're well positioned to get through the transition.
All right. Got it. And then last one from me, and I'll hop. Just in terms of the guidance for next year. I apologize if I missed this. What are you assuming in terms of Pega Cloud as a percent of new sales in 2020 versus what we saw in 2019? Thanks.
So we have assumed a 50% mix of Pega Cloud again because that would seem -- because it seems directionally in line with what we saw in 2019, and also we're trying to -- with Cloud Choice, we really feel that there is a lot choice and a lot of flexibility our clients need and want, and so we believe Pega Cloud will be somewhere in the 50% range again for next year.
All right. Thank you so much, guys.
Thanks, Rishi.
And next, we'll go to Steve Koenig from Wedbush Securities. Your line is open.
Hi, gentlemen. Thanks for taking my questions. I'll just give you two here. Maybe one more for Ken, and one more for Alan. So Ken, apologies. I dropped a couple of times, so sorry if you already answered this. But talk to me a little bit about your ACV expectations. You did 22% year on year in Q4. Was that a result of some large deals coming in, or was it the result of you feel solidly that the hiring you've done is now becoming more productive, and you've got a new baseline for next year, or what would you look to improve upon? Maybe some thoughts on how that could trend.
So yes, Steve. The ACV that we did in 2019, I would not attribute to a small number of deals that skewed the number. We always do scale to size, as everyone probably knows on this call. So there's always a certain amount of our bookings that are with larger transactions. But I wouldn't say that there's -- I wouldn't expect that 2019 was skewed in that direction. In terms of the -- what the -- hopefully the new normal, right, in terms of the ACV number, naturally, we want that number to at a minimum be about 20% because if we can keep it about that, we could really stay close for a longer-term target. However, we're investing in a case in go to market, that we should yield something higher than that. Seeing 22% for fiscal '19 is really promising to suggest that maybe this is the start of an acceleration of that now, but which would then really validate the strategy of increasing go to market.
Look, we know -- it's no secret that we really think that for companies with high quality executing wells, that the right number for growth should be meaningfully above 20% to 22%. It should be in the 30s, I would say at a minimum. And so we are investing in working to do that. The good news is that the pipeline, what would be considered to be a qualified pipeline, actually grew at a faster rate than our ACV growth. So that I think sets us up well and suggests that if we can even convert at the current rate, we should be able to certainly not flip back.
Great, that's really helpful color. Appreciate both you guys weighing in on that. Great. And then for the follow-up, kind of change of pace here. Alan, as you look at your development work on Project Phoenix, how do you expect -- kind of how should we think about the rollout when goes DA, how it goes DA? Does it that replace Infinity? Is it incremental to Infinity? Kind of help us understand the shape of that development as it goes to market.
We announced and had the deep dives with one of the architects of our clients at PegaWorld last year. We did a whole extra day on the Wednesday to really do a deep dive with about 150 clients and architects, and some of the stuff we want to be really clear about is A., this is something that is rolled out in increments, and we have already rolled out some meaningful pieces of Infinity in terms of being able to frankly modernize and interoperate with our client systems, and it is not going to be something we just rip out and replace Infinity with. Phoenix is a project, not a product, and it's a project to really actually take advantage of positive technologies, take advantage of state-of-the-art new user experiences. If you want see an example of what we're talking about, if you go to design.pega.com, you can see an entire new design system we put out, and that -- Phoenix will bring that into the absolutely latest state of the art front end, organized around react. We expect, because we're model driven, we'll be able to take huge amounts of what our customers have already done with us. So this is not a replacement, this is entirely a build for change, built into the architecture plan. I'm really happy with how it's going, and as you can imagine, I'm actually personally pretty close to it.
I could imagine. Great, well thank you very much, guys, and congrats on the Q4.
Thanks, Steve.
And next, we'll go to Yun Kim from Rosenblatt Securities. Your line is open.
Thank you. Congrats on a strong quarter, Alan and Ken. Alan, can you just qualitatively talk about the trend around large deals? I know Steve talked about it in the previous question, but I'm not sure if you guys qualified large deals as $1 million plus deals or not. But has that been trending up, or has that been trending down, or do you move away from the perpetual license business? Just wanted to better understand the overall dynamics there. Or is the large deal activity or the mega deal activity is the one that's been trending down? Thanks.
Yes, I would say that the total contract value, if you wanted to sort of normalize that, is similar frankly a little smaller because we are more open. I mean, we've changed our attitude about a bunch of things. If you think about December of 2017 before we slipped, our sales comp plans and everything else that we did were geared to try to get the salespeople to shove a fifth year on, even if the customer only wanted to go for three. So duration used to be routinely really close to five years. And naturally, a lot of customers had added service business really are more accustomed to signing up typically for a three- or four-year term. And whereas we used to overcompensate frankly, hindsight for the next 50-year commitment, we're now I think doing it much smarter. Installation is going down a little. It didn't have to, but we've been stubborn about some of this stuff. We could have kept it up, but the reality is the fact that duration has gone down to be in the three something sort of range means that our -- I think it's actually two things, and one, I think we're writing better business, and two, the RPO, the backlog, if we had forced like we were duration to be five years, would be at least a third higher, right? So, those numbers, which are already good, would look really terrific. And of course, a bunch of it would have come in as perpetual. We'd rather have the cash upfront, but the pattern of the business is exactly the way we want it to look, and it's not dependent on big deals. I, by the way, don't consider $1 million deal that big. In fact, in many ways with the clients we do business with, that kind of an entree deal that will be -- and instead of working real hard to sell them a $4 million year deal upfront, we want to buy hot $0.5 million or $1 million deal, and then work on being successful and upselling them. I think that's going to be a lot more reliable too.
Great, thanks for that detail. That does really help. And then on the professional services or consulting services line, can you just -- obviously that's been trending down as you try to offload some of that work to your system integrated channel. Is that -- can you just update us on the progress there, and should we continue to expect the revenue trend to trend down in 2020? Thanks.
I'll take that one. I don't suspect the professional services will decline in 2020 like it did in 2019. However, we're also not expecting professional services to grow at the pace that our ACV would be growing because I think, quite frankly, that would be a failure with our ecosystem bill to be able to make sure that we're encouraging lots more people entering the ecosystem to help support Pega Solutions. But hopefully you'll see a decline. And I think we've been thinking about professional services being more of a single-digit grower, right, year over year for the next few years, which then would of course bring the total mix in our favor from -- more towards software related subscriptions.
Okay, great. Thanks for that. And then just quickly, Ken, also on cash flow. What is the size of the billings just being the biggest driver of the cash flow dynamics? Is there any other component that could potentially have an impact in 2020? I mean, do you expect receivables seven impact or any other item?
No, not at all. Our receivables are well in check. We have really -- sometimes the receivables peaked up at the end of the year just because the timing of annual maintenance billings, et cetera, that tend to be more skewed towards Q4. So the AR tends to jump up in a Q4 that kind of deep down through the year. You kind of -- if you look at our last few years, you'll see that trend. There's no DSL or collection issues whatsoever. The real challenge as you go through cloud transition is just going from billing many years upfront to perpetual -- going to billing year by year, and you have to kind of get through that transition to normalize things, and that's just what's going on the billing maybe flattening over the last few years as we get through that transition.
Okay, great, thank you so much.
Thank you.
And next, we'll go to Mark Schappel from Benchmark. Your line is open.
Hi, thank you for taking my question, and nice job on the quarter. Ken, starting with you. During the past 12 to 18 months or so, reducing contract durations has been a focus of the company, or something you've been working on, and I just wondered if you would just give us an update of where you are on your contract durations today. I think you started off 12 months or so ago, about 3.5 years.
Yes, so just one clarification, Mark, just so there's no misunderstanding with that. We aren't dropping duration just for -- and I don't think you're implying this -- just for the sake of dropping duration. It's that what happens is when you push for longer duration, something has to give, and typically you have to give deeper price discounts to get that longer commitment. That's just kind of the way it works in software. And given our retention rate being very high, there really isn't the necessary counter balance -- there's not a benefit for us to really push hard for that five, six, seven-year contract because you're giving up ACV to get that. So what happened is that we pushed more to be more agile and nimble with selling and really not try to force sell, or as Alan said, be stubborn around pushing for a longer duration. It's actually free up market opportunity for us to sell actually higher ACV. But the duration question throughout was -- when we started this journey, we were a little bit north of four years on average duration, and now we're quite kind of closer to just north or just a little bit above three years. So, the great thing about that is we through that and backlog has still grown, and delaying [ph] ACV has still grown. So really -- and we've seen good pricing and unit economics on the deal that we've got. But our duration has come down by somewhere north of four, maybe somewhere north of three, five years.
Thank you. That's helpful. And then Alan, moving on here, it's been eight or nine months since you bought a small little messaging broker vendor. I think it was in the chat. And anyway, I was wondering if you could just give us an update of where their product stands right now that that's kind of a growing and kind of emerging space these days.
Yes, that's an example of bringing in both talent and technology that we tend to do the work upfront to really work to incorporate it into a really sensible coherent platform. And part of our announcement in the next week is worth to highlight really impressive new capabilities that that brings us in this area of what's sometimes referred to as direct messaging, where organizations want to communicate with their customers through chat, but do it personally and effectively. And so that's been a very, very nice add-in. And we're also very pleased with the talent that we got. So I think that's the perfect example of the types of things we're going to continue to do more of that are not very controversial, and I think still allow us to improve what we offer to our clients.
Great, thanks. And then finally, I was wondering if you'd just give us a sense of where you view the demand environment today versus say a year or so ago.
Well, pipeline's meaningfully up, and customers are really interested in having these conversations. You're never sure what the future is going to be, but right now, it's pretty darn good. So I think the demand environment is excellent. We are able to both complement, in some cases, compete with some of the players like the Salesforce and whatever that are out there. We find there's a lot of gap filling that we can do with those organizations. And so companies that had thought that they might go one place for solution realize that sometimes they need a little bit more, and we're having the right conversations with the right people. Go on the website and take a look at some of the video that have been posted in the last six months. What some of these clients are saying -- go look at Commonwealth Bank of Australia. It's mind-numbingly good. So I think that environment's strong.
Great, thank you.
And next, we'll go to Steve Enders from KeyBanc. Your line is open.
Hi guys, thanks for taking the question. Just wondering how the sales ramped that you guys have been implementing over the past couple of years, how those investments and those hires are ramping, and how do you feel about their ability to execute on the strong pipeline growth that you've been seeing.
So, I'll take part of that, and then I'll give the second to Alan. So, one of the things that I think we've been watching closely is as we hire more of our go-to-market team, how fast are they be able to build pipe, what's the quality of that pipe, and then naturally, the next part of that is how quickly convert that pipe into their first, and their second, and their third deal, right? What's the pipe? And we traditionally had a relatively longer ramping for new sales staff, previous to the last couple years. What's really encouraging is that we started this bigger push for sales capacity about 18 months ago, and not only we had good pip build, but we've always seen ACV accelerate above the 20% target that we've been operating at. So that kind of gives us a level of optimism that there is this increased capacity. It certainly helped to drive an accelerated growth. Now, we're not seeing the full yield of that yet because a lot of people are still ramping. So, I'll hand over to Alan on other thoughts.
This is a business where having greater experience, having greater confidence, et cetera can help, and so people do need some time to come off the curve. We've also be putting quite a bit of effort, and we've invested frankly a lot in really improving our enablement, making it so that it is better and more structured. We just had a sales kickoff in January. It was entirely really organized around getting organization, getting account executives to really understand what the strategy is for every one of the organizations, and we pretty uniformly heard that it was the best education, the best training, and the most practical advice that we had ever received. So I think we've really seen things that make me quite optimistic that we will see these grow and frankly, we need to figure out how to accelerate.
Okay. That's really helpful. And just kind of on that same front, how are you thinking about these same kind of sales force investments in the next year, and I guess how do you think about incremental OpEx growth on the sales front?
So, let me make a comment about OpEx in total. So, OpEx will grow at a slower pace than our revenue growth, obviously, because you see the non-GAAP EPS improvement That will be the case in 2021, likely, and the case in 2022 as well. But you will start to see operating leverage over the next three years. If you look at where that OpEx growth is coming from, it will be largely skewed towards those market. And so, we expect -- the increase -- the adjustments that we will do, assuming that we are getting the yield of their return, as Alan mentioned earlier on those investments, we are certainly skewing it that way because even growing at 22% or even 25% in the markets we're in at our scale, there's still a lot more cannibalization we can do for our competitors in those markets, and so we feel like that is an investment worth making.
Okay, great. Thanks, guys.
Thank, Steve.
And next, we'll go to Pat Walravens from JMP Securities. Your line is open.
Hi, this is Mark [ph] for Pat. Thank you so much for taking the question. So just wondering in terms of the market trend, if you see any new CRM or BPM trends in 2020, or if there's any change in competitive dynamic there. Thank you.
So I think it's pretty much as it has been historically. In the process space in the automation space, we're pretty advantaged with our technology. You still see key competitors running around, competitors willing to drop prices, but the drop in prices doesn't deliver outcome. So we've found that we've been able to be quite successful at maintaining a rational price model, and also having clients be successful. I think the biggest competitive dynamic has been the change in our behavior, whereas historically, we were just skewed, and in hindsight, I would say just naturally biased whale deals. We really have an openness and we've really staffed the company with people that understand that the ACV world, in a service world, it's great to eat the whale in lots of bites, and I would say that behavior has meaningfully changed in the last 24 months. And I think that's all for the best. There's lot of noise out in the market. Everyone's talking about stuff, but I'm not seeing a material change.
Great, thank you.
Thanks.
And at this time, I'd like to turn the call back over to Alan Trefler for closing remarks.
Yes. Thank you very much, everybody. I think that we worked hard in 2019. It's nice to have seen it close related with the gig, the way that it did. We're already deeply into 2020, and 2019 actually feels like a long time ago. I will end with a final pitch for PegaWorld. We're expecting what is magnitude over 7,000 people. It should be terrific. There is --awesome presentations are really on the docket with new companies like Procter & Gamble, talking about what they're doing, and existing clients like Sainsbury's, and Unilever, and a whole variety of governmental functions, as has been a good business for us. If you go online to PegaWorld, you can see what they're going to be talking about, and it's not this BS pie in the sky stuff. I will tell you that many of our customers compete with each other, so we're not really allowed to talk about what they do. But when they come to this conference, they'll usually be remarkably transparent, and it's a great opportunity to see how these forward-thinking companies are actually really getting it done.
So, thank you for listening, and hope to see you June 1 and 2 at PegaWorld, and obviously we'll be talking to you before that. Thank you very much.
And that does conclude our call for today. Thank you for your participation. You may now disconnect.