Pegasystems Inc
NASDAQ:PEGA
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Pegasystems Inc
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Good day and welcome to the Pegasystems' Fourth Quarter and Full Year 2020 Earnings Results Conference Call. Today's conference is being recorded.
And now at this time, I'd like to turn the conference over to Mr. Ken Stillwell, Chief Financial Officer. Please go ahead, sir.
Thank you. Good evening, ladies and gentlemen and welcome to Pegasystems' fourth quarter 2020 earnings call.
Before we begin, I would like to read our Safe Harbor statement. Certain statements contained in this presentation may be construed as forward-looking statement, as defined in the Private Securities Litigation Reform Act of 1995. The words expects, anticipates, intends, plans, believes, will, could, should, estimates, may, targets, strategies, projects, forecasts, guidance, likely and usually, or variations of such words or other similar expressions, identify forward-looking statements, which speak only as of the date 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. The actual results for fiscal year 2021 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 the forward-looking statements are contained in the company's press release announcing its Q4 and full year 2020 earnings and in the company's filing with the Securities and Exchange Commission, including its Annual Report on Form 10-K for the year ended 12/31/2020 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 subsequent 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 these forward-looking statements, whether as the result of new information, future events, or otherwise.
And with this, I will turn the call over to Alan Trefler, Founder and CEO of Pegasystems.
Thank you, Ken. The highlight is strong and we feel good about what we've accomplished and where we landed in 2020. We adapted well to an extraordinarily difficult situation bringing on new ways of working with each other, our clients, and our partners. We introduced new solutions and enhanced our industry-leading low-code software to help our clients manage the short-term challenges, while building for long-term success. And we made substantial progress in our transition to a recurring revenue model. You can see clear signs of this progress in our full year results.
We completed the move of our Pega Cloud clients onto our next-generation cloud platform, setting us up for long-term margin improvements. We accelerate as Pega Cloud growth is demonstrated by Pega Cloud annual contract value of 57% year-over-year, and Pega Cloud backlog, up 40% year-over-year. Since we really began emphasizing Pega Cloud three years ago, we've seen an explosion of Pega Cloud low-code apps with a compound annual growth rate over those three years of 85%. And we also grew total annual contract value by 21%, we delivered record revenue that crossed the $1 billion milestone and grew backlog to more than $1 billion for the first time.
We also invested in key sales and marketing initiatives and start to improve our brand awareness, and attracted new talents from leading tech companies including our fiercest rivals. We made significant enhancements to our partner ecosystem strategy, an important long-term accelerator with revenue and margin growth. And we continue to advance our solutions in one-to-one customer engagement, customer service, and intelligent automation with innovative capabilities improving functionality, productivity and speed-to-value. We drove deeper into long-term clients and added exciting logos to our growing breadth [ph].
We maintain technology leadership in key areas that our clients [indiscernible] and continue to get recognition by influential industry analysts in more than a dozen reports covering CRM, robotic process automation, low-code, customer engagement, digital process automation, decisioning and real-time interaction management. We stayed true to our values, culture and commitment to keeping the well-being of our staff, our clients of the extended Pega community, their hearts and minds still expanded planned the efforts, their increased focus on inclusion the diversity; and we did all of this while including markets.
Finally, just a couple of fund notes. We'll be leaving the NASDAQ opening now on Monday, the 22nd, to celebrate our $1 billion revenue milestone. And up the Layer Cakes, a band made up of Pega staff recently won the top award in a battle of the bands sponsored by one of our key CRM influencers. It's right to know we think one of the Board members against the likes of Salesforce, Oracle, SAP and Zoho; and one of the bands where we get them to [ph].
Now, in terms of the market dynamics, digital transformation has never been more central to the way our clients are thinking; fundamental to their continued prosperity, and in some cases, their continued existence. Reliance here has made it abundantly clear that organizations need to accelerate their digital transformation initiatives, not just to survive, but to really compete and thrive in this wildly changing world. And we feel we've never been better positioned to support this need. Our solutions help clients crush business complexity enabling better decision-making, saving time, and helping them get work done. Our software is exceptionally powerful and adaptable with a scalable and unique centered our business architecture that puts outcomes and customers at the core. And our prescriptive approach to designed thinking brings staff across the organization together to together design and deploy innovative solutions in weeks or days leveraging our low-code platform. In our recently launched trademark, Pega Process Fabric, leaves together business processes, hence management and workloads to streamline the customer experience and improve employee productivity across the enterprise.
As I mentioned, we continue to enhance our solutions to meet our clients' long and short-term needs. In the beginning of the pandemic, we quickly rolled out a set of industry-focused solutions, specifically built to help manage some of our customers' most pressing needs like managing surges in unemployment claims for our free COVID-19 tracking app. In one-to-one customer engagement, we introduced the Ethical Bias Check to help eliminate bias used in AI; so we can drive customer engagement knowing it's going to be fair. And launching the Value Finder to help customers deal with and serve underserved segments with meaningful empathetic offers. In customer service, we launched the SaaS Unified Messaging Edition to help agents' better handle increasing volumes of service enquiries. And just a few weeks ago, we announced the acquisition of Qurious, a developer of powerful AI speech analytics that will help customer service agents in real-time by analyzing service calls, and recommending next best actions and via right proactive and pre-emptive customer service.
In intelligent automation, we launched X-ray Vision, the industry's first self-fueling robotic process automation; and we introduced the industry's first RPA Auto-balancing feature, which uses AI to help clients reduce robotic process automation costs. We made it easier for clients to make progress on high impact digital transformation initiatives by bringing a new low-code Pega express methodology and built it directly into the platform with a new set of ways for customers to get started fast and improve outcomes, and to help clients and partners gain an advanced Pega software skills. We introduced our new Pega Academy with mission-based learning and enhancing the Pega community to make it easier for clients, partners and Pega to share best practices. We continue to work on these enhancements and look forward to sharing some important capabilities with you at PegaWorld iNspire in May.
Now, in terms of clients and business highlights; our new business continues to be strong as in our traditional areas such as financial services, government, telecoms, healthcare, insurance; industries less hard hit by the pandemic where thankfully, we have had strong critical mass [ph]. In 2020, we had a good mix of new business expansions in existing clients like Anthem, British Telecom, CIBC, Citigroup, National Australia Bank, and at government agencies around the world. We rather also brought in some exciting new logos like Emirates National Bank, Partners Health and Takeda Pharmaceutical, and continue to see more partnered source deals and opportunity we were focused on in 2021 and beyond.
Our clients continue to leverage Pega to cut through the complexity of the business systems, so they can actually make their decision and get work done. And you know what's interesting in the government space is, on the heels of our successful Census projects, we are quickly becoming a preferred low-code solution for government as demonstrated by our recent Internal Revenue Service win and continued success in this market. We've been able to stand up new systems quickly to meet the immediate needs, and help organizations think deeply about their future, and there is nothing more awarding for us than clients who are willing to tell their stories publicly. PegaWorld iNspire, will again, this year be held as a tune of half hour interactive virtual event and it's just around the corner on May 4. We've already had impressive list of clients lined up to tell their stories; for example, 5 years and 70-plus applications into their Pega journey, Scotiabank has built a large catalog of reusable Pega capabilities, they're going to talk about how they are gaining leverage from these assets to accelerate the global rollout, and with the formation of an enterprise Business Center of Excellence to maximize value and standardization and leaders.
Vodafone UK, will talk about driving transformation by automating business processes delivering powerful intelligent automation at scale across its businesses leveraging Pega Agile low-code delivered capabilities, building and updating applications with unprecedented speed, and have a new automation platform that enables multiple used cases, radically simplified operations, and reduces costs. And as an example of work so incredibly needed this past year, is the product and the program we supported for StepChange debt charity in the UK where more than 5.6 million people who'd been negatively impacted by the pandemic with an accumulated $10.3 billion in debt have been helped by being able to apply the Pega technologies. StepChange will announce how to use Pega to launch their COVID Payment Plan, a new online service built in a matter of lease to provide short-term assistance through up to a year for those who qualify. We're really proud that our technology is being used to help transform and improve the lives of millions of people who got hurt by the pandemic, and especially proud that these organizations and others are willing to step forward and speak probably [ph].
Well, in summary, we know the challenges of the pandemic will be with us for some time, and it's going to take a while for the world to sort through its impact but we've adjusted well over the last year to new ways of working in client requirements, and feel that we delivered strong performances, nonetheless, and surely are well positioned to continue to do with that as required. I will tell you that the needs of digital transformation has never been greater, and we are better positioned than ever to respond to that need in ways that are truly future-looking. And I think we're in further position to help our clients as well about the short-term and the long-term problems that they face in ways that we believe are unique. We remain inspired and are just amazed at the continued support and commitment of our staff, our clients, and our partners, and are optimistic about this year in our long-term growth agenda.
To provide some more color, let me turn this over to Pega's Chief Financial Officer, Ken Stillwell. Ken?
Thanks, Alan. I'm going to start by recognizing a milestone but also one that I'm not going to dwell on too much either. But our - by our count, there are more than 1,600 publicly-traded software companies worldwide, and less than 4% of those firms exceed $1 billion in revenue. With our 2020 full year results, Pega joined this group with total revenue, a little more than $1 billion. We view this milestone as interesting, but more of a mile marker; we hope to far surpass in some type of endpoint. However, there are some inherent benefits of scale on our journey to be a Rule of 40 firm.
First is its operating leverage. You could see Pega realizing the benefits of scale in our expanding Pega Cloud gross margin increasing from 51% in 2019 to 63% in 2020. As we grow in scale, we can clearly perform activities more efficiently, which we expect to positively contribute to our goal of achieving the Rule of 40 as we exit our cloud transition. Things like virtualization and automation can be leveraged more effectively at our increased size. Another benefit is scale has increased brand awareness. We anticipate investing in some incremental initiatives to ensure the market is aware on how Pega helps our clients to manage their digital transformation initiatives. This increased brand awareness will help us reduce sales cycles, decrease our customer acquisition costs, and improve sales efficiency; all big potential value levers for Pega. Third, our increased scales strengthens our ability to attract world-class talent. A great example is the addition of Hayden Stafford to our team in June of 2020 as President of Global Client Engagement. We expect that increasing sales productivity will be one of our most critical valued lives.
Our ongoing journey to increase the scale of our business is not the only multi-year transformation underway at Pega. We're also more than midway through the multi-year cloud transition; I believe it's important to share about what we've accomplished and where we have more work to do. Our transition to recurring revenue for a software company normally takes about five years, as I've mentioned previously, and follows three major phases. First, the company moves from selling perpetual licenses to selling subscription licenses. When we started the cloud transition in late 2017, for example, over 60% of our new client commitments were subscription. We changed our sales compensation plan to focus on annual contract value. As said, a total contract value in 2018, and our client's prospects and sales teams jumped onboard. By the end of 2018 about 85% of our new client commitments were recurring contracts that increased to 95% in 2020; so we've done a solid job of completing the first phase.
The revenue growth transition is next. During the second phase, revenue growth rates declined, especially in the first few years; this is because the business is moving away from selling perpetual licenses, where the revenue is recognized upfront to selling cloud arrangement where much of the revenue is recognized overtime. For example, our revenue growth rate dropped from the mid-teens before we started the cloud transition to the low-single digits for few years. Once the midpoint of the transition is passed, the revenue growth rate starts to improve. For example, our total revenue growth rate grew to 12% in 2020, and that growth was even in the face of significant reduction in perpetual license revenue from 2019 compared to 2020. In the final two years of the revenue growth transition, growth accelerates approaching the growth rate in annual contract value at the end of the transition; that's why we expect revenue growth at ACV growth will both exceed 20% in the final years of the cloud transition. A very important point to highlight is that our subscription revenue grew by 26% in 2020. When I say subscription revenue, I mean the total of all client and Pega Cloud revenue.
The cash flow transition comes last. During its final phase, billing to cash collections improved; in other words, a company has completed the transition of moving from a company that collected most of its cash billings from new client commitments upfront to a business that builds and collects cash billings from clients consistently overtime. We expect our free cash flow to accelerate as we finish the call transition in late 2022 to early 2023. Given that we are still in the middle innings of this cloud transition, growth in annual contract value remains the most important operational metric that reflects some underlying growth of our business. Many of our other operational metrics don't properly reflect the underlying strength of the business, when you are part way through a transition like we had embarked on.
In 2020, total ACV grew by 21% year-over-year, reaching $835 million. Currency was about a 1% to 2% tailwind to this growth in 2020. 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 arrangements. It's notable that perpetual license decreased from about 10% of new client commitments in 2019 to about 5% of new client commitments in 2020. While this dynamic has a dampening impact on near-term revenue results in 2020, it sets us up for even greater recurring revenue in the future. It's remarkable to see the Pega Cloud ACV growth accelerated in 2020 increasing to 57% - increasing 57% from $169 million in 2019 to $267 million in 2020 as cloud demand for our customer - from our customers continue to grow.
The second most important operational metric during the cloud transition is remaining performance obligation or backlog. Backlog represents the total client commitment Pega has booked the company, have not taken into revenue yet. In 2020, total RPO grew by 28% or an impressive $236 million year-over-year growing from $836 million to $1.07 billion. This is the first time in our company history the backlog has exceeded $1 billion. It's also great to see Pega Cloud backlog increase over 40% in the same period. Total current backlog, which is the backlog within - to be recognized within 12 months increased by 24% from $493 million at December 31, 2019 to $630 million as of December 31, 2020. This is the short-term backlog as I mentioned, it will come into revenue in the next fiscal year which supports our expectations for total revenue growth of over 20% in 2021.
Turning to revenue, Pega Cloud revenue grew by 56%, increasing from $134 million in 2018 to $208 million in 2020. And as I mentioned earlier, subscription revenue, which includes Pega Cloud maintenance and term license revenue jumped an impressive 26% in the same period. Total annual revenue increased by 12% going from $911 million in 2019 to $1.02 billion in 2020. To really understand the financials of the business during the cloud transition it's important to not just look at any one measure, instead you need to look at ACV revenue and backlog. For example, if ACV goes up, the backlog goes down; while we haven't done as good a job as these appealing ourselves for the future. And this is further compounded by the cloud transition which has a deferral effect on reported revenue, which is why we're looking so much to ACV growth to measure our business momentum. Taken together, our financial results in 2020 put us on the right track to meet or exceed our long-term targets that were set in 2017 of $1.3 billion in total ACV and $1.6 billion in total revenue by the end of 2022. Even though we are on target with our plan, we aspire to grow faster; that's why we've made major investments in selling capacity partner support and customer success.
Turning to our fiscal year 2021 guidance; assuming that Pega Cloud continues to be a little bit more than half of all new client commitments in 2021, we expect total revenue of $1.25 billion, an increase of 23% year-over-year. As typical, we expect our bookings to be skewed towards the backend of 2021 which means that our revenue will be skewed more towards the backend of 2021, as usually is the case in enterprise software. Moving to non-GAAP EPS; we project 2021 full-year non-GAAP EPS of $0.25. We expect non-GAAP EPS to improve from 2020 because we anticipate that our revenue will grow faster than our expenses. We also anticipate non-GAAP EPS will improve due to the increases in Pega Cloud gross margin which is becoming a bigger impact on the business.
In conclusion, like many companies, we are happy to welcoming 2021. Our full year results are very impressive, given all the market disruption from COVID-19, this is the first year in our history that revenue, backlog and cash collections each exceeded $1 billion, and we're optimistic that 2021 will show continued growth in our key metrics. Before opening the call for questions, I'd like to invite each of you to our annual customer conference, PegaWorld iNspire, on Tuesday, May 4. The event will be virtual again this year, and you can register at www.pega.com/pegaworld. We plan to hold our Annual Investor session shortly after on Thursday, June 3. We will release additional information about the Investor session during our Q1 2021 earnings call in the spring.
And with that, operator, please open the call to questions.
Thank you. [Operator Instructions] We'll take our first question from Steve Koenig with SMBC Nikko Securities. Please go ahead.
Great, thanks guys for taking my questions. The first question is going to be for Ken here. Ken, can you give us some color on cloud mix in Q4 and conversions to cloud? And then, maybe just for our benefit, ties - if you tie back to Q4 top line results to your bridging to your prior commentary about what happens as your cloud mix changes. Because I could tie - I'd like to tie it back to kind of your initial guidance for the year. And then, how your view of the year evolves as it went on? And then lastly on that, maybe can you help us with what are some of the variables that could impact fiscal '21? I'm a little - maybe a little surprised that you didn't as a baseline assume your cloud mix would be more significantly higher than 50%. So, thanks for that. And then I've got one quick follow-up.
Sure, Steve. So, I'll hit on your questions and hopefully, I catch them all. So, the first point that I think is important is to think about the mix for the year which - the mix for the last three years, Pega Cloud has been about 50% of our of new client commitments. In Q4 of the year, that number tends to skew a little bit lower than 50% in Q4, and the reason for that, and this is speculation on my part, but the reason for that is that clients tend to use year-end budget money which may have a slight skew to more client cloud arrangements versus SaaS arrangements; that has been the trend. It hasn't been a significant skew but it's typically a little bit less than Pega Cloud in Q4 and the other three quarters typically end up being a little bit more than Pega Cloud percentage of bookings. Now, in terms of 2021, we believe there is an opportunity for Pega Cloud to be a much bigger part of our business, but we also feel that because we've had such a pattern of so many clients really enjoying the Pega Cloud Choice Messaging, and their flexibility in how they deploy, that we really don't have a crystal ball to suggest that that number would be noticeably higher than what we've seen for the last few years. So that's kind of on the Pega Cloud percentage.
I want to talk about Q4 in 2020; the biggest gap that we saw in 2020 was the movement away from perpetual licenses into either Pega Cloud or Client Cloud recurring arrangements and that - you may think, well, if it's term or if it's perpetual, wouldn't it be the same amount of revenue; it's not. The same amount of revenue does not come in the current period when you book an equivalent term or perpetual deal. Perpetual does have more revenue and you can see the big drop in perpetual revenue in 2020. So that was our biggest factor. When we originally modeled, we thought that Pega - excuse me, perpetual would still stay kind of something just south of 10% but not go as low as it actually did in 2020. So that's probably the biggest lever point in terms of what changed in 2020, and then - and in Q4. So that's kind of the biggest factors that I would say is positive; I mean we're super happy that that happened, don't get me wrong, but that was a variant from the original model that we have built up for 2020.
Got it. Okay. Thanks for that, Ken. And this one is probably for Alan, here. Project Phoenix [ph], maybe a quick update there and kind of remind us what functionalities or used cases do you think are going to benefit most immediately as you innovate around your platform, and adopt micro services, etcetera? Where are you taking that in the short-term, Alan?
Well, you know, we have a really interesting agenda in that front. You see some of it pretty directly in the improvements in cloud margins, and obviously, for client cloud - we love Pega Cloud or rather do a Pega Cloud than a client cloud, but we're in the client cloud business too, we believe in client choice. I think this helps all of our customers in terms of their ability to save money, our ability to save money, and our ability to innovate faster. We've also been able to improve around cycle time and development for the things that have been broken out as micro services; and I would tell you it's working beautifully in that front. And a lot of what we're doing that we've talked about that you'll see in Phoenix [ph] based on the release late last year and where we're going here is being able to allow our clients many new options and ability to in fact inject Pega up into their existing front-ends because of our ability to incorporate app-based [ph] technology as part of our digital experience API, which is a big part of moving to this API-centric model.
So we're seeing internal advances, we're seeing customers who years ago used to think that our architecture was bigger, perhaps heavy, saying the we really like what we're doing architecturally; whereas architect sometimes would be pretty critical, anybody who looks at this architecture is responding positively to both, what we've accomplished, and where we're going to continue to go over the next 48 months - 24 months, I mean. So, I think it's gotten us a lot of positive flight [ph] with our customers.
Thanks a lot, Alan. Thanks Ken.
Thank you. I'll then move on to our next question from Jack Andrews with Needham.
Well, good afternoon and thanks for taking my question. I'm wondering if you could provide some more commentary in terms of just how your partner practices are progressing in terms of - just any commentary you can provide in terms of just new logo wins that are being generated from partners or how should we expect that to ramp overtime?
So in the second half of the year, we under the offices of Hayden Stafford; and you may remember, Hayden builds the business at Microsoft in the CRM space to $3.5 billion, quite rapidly. We're starting well under $1 billion, and also has the - I think strong partner experience from sales force in his background. He really has embraced major push towards partners and getting significant mutual commitments from partners that we're going to really go to market together. So as Ken talked about, we're investing in sales and marketing, and a big part of it is making sure that the partner ecosystem is front and center in how we go to market. I can tell you that the number of partners involved and partner-sourced deals is materially up in the pipeline. And it's pretty exciting to see really that the big acceleration only happened when we started in the second half of last year.
That's great, thanks for the color around that. And just as a follow-up; I want to ask you about if you could flush out some of your comments on the government opportunity, in particular, you mentioned becoming potentially a standard for certain use cases. Any thoughts in terms of how under a new administration that might provide opportunities for you more broadly?
Well, I think there were opportunities under the previous administration and we don't see them abating under the current one. And you know, the reality is that is a tremendous amount in government that needs to be made more efficient, that needs to be made more easy to change and needs to get rid of a lot of the paper and the waste. The IRS has been public about how they have over 60 base management systems, and we won head-to-head competition against numerous, numerous other providers to be selected and publicly available by the IRS; and that's worth - that's going to go on over years and how as already lagged through its initial production years. So, I think we've got a terrific government story, and I'll tell you that Hayden has - in fact, said we should double-down on our government business; and that by the way is another place where partners obviously are our key.
I'll also tell you what's exciting, that our government business not just in the U.S. is going so well, but if I take a look at Australia, at the UK, at the German government, we're really seeing a nice push there and a nice community of government using [indiscernible].
One addition - I'll make one additional comment on partners. We did our first several partner sales kick-offs this year where we actually engaged in a working kind of session with our partners, and we've had numerous partners up-size; I won't mention the exact names that are really committing to sign-up for very large commitments to drive neutral business between Pega and their practices, that has - that didn't happen prior to say at least, 2021 just in the last month or so. So that's an example of a number of big changes in our engagement with partners.
That's really helpful. Thanks a lot for taking the questions.
Thank you. And I'll take our next question from Mark Murphy with JP Morgan.
Okay, thank you. This is Benjamin sitting in for Mark, thanks for taking the questions. Alan, quick question on the process fabric for that you're talking about in the conference last year. Any updates on that, how that has been doing or what is the initial feedback from customers? And then, I'm curious to hear how are you thinking about this hot space that's emerging around process mining and what is PEGA doing around that.
Sure. I'll touch on both of those. So when we talked about process fabric whilst middle of last year, it was very much to make people understand when we talk about a center out architecture, where you really want to think about the work across would might be a very large organization. The thing you want to do is not have some big massive system bunkering in the middle of there, you want to have the illusion of a virtual integrated system where the work and actually within multiple system and the process of multiple systems including some places on Pegasystems which need to be able to be part of that work. We now had our first couple of customers using it quite successfully. And we're continuing to enhance have been growing under the offices of Phoenix and it's enormous exciting. I mean imagine an organization, just to draw an analogy, think of in-effect having Google tied into all of the work into your company but done in the way that's safe and secure, and managed - and being able to provide access and deliver that work in a distributed world as if it was all small and imminent [ph]. I think it's extremely exciting and build on the Phoenix work that we've been doing and it's getting a lot of positive reception and it drives not just the positive fabric system, but it drives the further use of kind of particularly in large material customers.
Now you asked about process mining, process mining is one of those things that now it's very popular and sometimes it's not so popular, very popular. It's not too popularity again and we've been doing some really interesting work, it's part of our workforce intelligence and robotics initiatives that allow us to watch in mind the processes of what people are really doing as opposed to what they tell you that they are doing. And I think that that's one of those examples of complementary technology to our core or automation because you really want to give is understand what people are doing but then very possibly not do it in the exact same way, that's on the state robotic process automation done incorrectly. People are kind of the screen scraping and annualizing key strengths. We take that, I mean with the mining work in some of the other work we're doing with [indiscernible] going to pull that in and then really figure out how to drive and send outcomes without having [indiscernible]. And I will tell you that's a much more sustainable, a much stronger and a much more resilient way to handle these sorts of things. So we feel good about what we're doing there as well.
Understood, thank you for the details. And Ken one quickly for you on the ACV growth rate when I'm looking at 20% to 21% around, I think you said one to 2 points of currency headwind, so if I adjust for that, it seems like it might have dipped below 19%. I mean, don't get me wrong, it's still good at that scale, but if I compare it to a year ago, maybe it was 22% and now maybe sub 20%. And can you leave out what is causing that, have you seen actually more impact from COVID in Q4 or anything that to call out?
Yeah, good question. So, there is no impact that we've seen from COVID, I would say positive quite frankly positive or negative certainly hasn't been of tailwind. I don't believe it's been a headwind either. I mean I think where the year landed is directionally in line from an ACV growth standpoint to where we thought the year would land, the question really is, I think the more important question is when do we expect to see the acceleration of ACV growth beyond kind of the 20ish percent growth that we've seen now for the last number of years because we're certainly investing in a market opportunity that should yield better growth. So I think that's kind of more of the angle that we're looking at, which is why and when do we expect the acceleration in our ACV growth.
Our percentage movement in ACV growth one way or the other is to be honest not a noticeable change in the longer-term strategy. We also have situations where and I mentioned this a little bit before, over the years. Well also in situations where ACV moves in and out of a quarter depending on effective dates and that could easily be a percentage skewed one way or the other as well. So I don't focus too much on that number being any real now, 2021, 2022, even '19 in that range is to me kind of our historical, it's really the focus for us is how do we get that number up to 25 to 30 is something that is beyond where we've seen the growth rate.
Understood. Thank you.
Thank you. We will move on to our next question from Mohit Gogia from Barclays.
So, thanks for taking my questions as well. So I don't know just wondering if you give us sort of like the lay of the land in terms of the automation portfolio, right, so you acquired an RPA vendor a few years back, obviously you have been a pioneer or your flagship product [indiscernible]. So just give us little land as to what comparative landscape have you seen and what do you expect to see in the next few years? I mean there has been, sort of like some vendors talking about this end-to-end automation offering across RPA process mining quarter, I think you briefly touch on that. But those windows or maybe in the IPO pipeline, so there is going to be more investor noise on that. So just help us understand how you fit into that space and how you fit into merits [ph]? And then I have a follow-up question for Ken.
Sure. So when we think about, there's a lot of noise in the market and a bunch of experimentation, and I think there's a tremendous amount of BFs in my view here. The whole robotic process automation somebody does a little math and takes the number of customers that are declined by some of these vendors and divide that into the revenue. You see that a lot of what's going on here with experimentation and is not game changing for the customers. Well frankly be a lot more revenue and a lot more consistent growth. So we think the approach we have which is still really think about process automation of the core and then be able to have robotics is a really powerful way to deal with systems, but you not yet have APIs is the right way to do it. And we're getting a lot of reinforcement from customers and prospects that our way of thinking the center, our way of thinking as opposed to kind of like pace of the desktop where you're thinking is the right way to do it. So I think we will be vindicated in that view and I'm showing work that makes me more confident though we have the competitive landscape and the competitive we were. You said you had another question for Ken.
Yes. So Ken, really helpful color on that ACV growth adjusted for FX tailwinds, but I mean your guidance, obviously strong right, I mean you're guiding for 23% revenue growth, which also in line somewhat with your CRP growth this quarter, but at the same time I'm assuming that if we also look to your fiscal '22 targets that you've reiterated at your Analyst Day that I mean there will be an implied acceleration ACV for fiscal '21 if I look at all of those variables right? And you have discussed drivers for that previously along sales capacity investments and productivity, but help us understand which of those drivers do you think we'll have a more near-term impact in fiscal ' 21 versus maybe for example to be higher penetration in your customer base, maybe more of a long-term? So give us an overview of those drivers in which of those we think we already start to show up in fiscal ' 21?
So the way to think about the investments that we're making, so I'll give you kind of the ones that I think have, I'm going to say more near term meaning 2021 and more mid-term. Let's just call that '22 into '23. '21 is going to be driven by the ramping of the sales capacity and those individuals becoming more seasoned on average in 2021 and in 2020 or 2019. When you think about something, I'd be more of an 18 month to 24 months, it's probably some of the investments that we're making in partners, right, because those things tend to mature over not, they not typically, they're kind of not a kind of a one quarter kind of turn on those investments. And I think there is another aspect of that we're thinking about as well. We haven't noticeably and Steve mentioned it early on and we actually try to give them to intentionally skirt this part of this question but I will highlight it now.
We are not to date nor is it part of our core strategy to just move all of our client cloud people want to Pega Cloud, it happens from time to time as clients want to move, but I do think as we get out in the 2022 and '23 with processed fabric with the evolution of the product with Pega Cloud being our primary go to market with everybody really looking to move to the cloud, there is the potential that Pega Cloud will accelerate as percentage of our business. So those are kind of some things that I don't think, I think it's going to happen in Q1 or Q2 of '21. There certainly is that potential for it to happen out into the end of '21 into '22. So that kind of gives you almost like productivity, more people buying Pega Cloud partners playing a bigger role. Those are kind of the 24-month levers.
Perfect. Thanks guys.
Thank you. We will hear next from Chris Merwin with Goldman Sachs.
Okay, thanks very much for taking my question. I think, first off, I just wanted to ask about the CRM business that, just give us the broader category that CRM fits very well, pandemic started to just curious how that piece of your business is trending over the last 12 months in particular, the last quarter. Then I had a follow-up.
So we're seeing a lot of interest in CRM, particularly in the sort of Omni channel approach to CRM and as part of some of the investments that we've done, what we've done is we've actually bought some very strong leadership into each of the sort of three general areas of CRM, intelligent automation and one to one engagement. And so we're really doubling down on all of those, remember across the year, I'm - everything from the full contact center desktop on all the way to the Omni channel a priority has a common process flows and common decision making across mobile, web, service desktop et cetera. And I think that's actually a much better story, when people who are coming in and just trying to sell that. It easier for customers to get started and frankly for them to get benefits faster with the styled approach that we've got. So, I think that all falls into CRM that is important to our business. It will be going forward as well.
Okay, great. Thank you. Then one just modeling question, if I look at the ACV growth exiting the year. It is 21%, right. And then the revenue guidance is 23%, I know that as you get through the transition, I think there is growth, which you're going to converge overtime that you're outpacing the ACV growth with revenue growth in 2021? I just wanted to tie that together if I could. Thanks.
So the revenue growth, so the latest typically work, and I think we're a little bit skewed by the percentage of business that professional services, but I know that kind of screw with the numbers a little bit, but if you think about ACV growth, I'll just use a number used 20 to make around. ACV growth of 20% when you get to the back end of the cloud transition you should expect that your subscription revenue lines that connect ACV, we'll will start to action we outpace your ACV growth because you're catching up, you had almost an easier compare in some cases, which is why you kind of, I don't want the hockey stick with the slope kind of slopes upward in the back end of the cloud transition. So the revenue growth does actually grow a little faster than your ACV growth, that's what you're seeing happening in '21, it will happen in '22. So there isn't a direct connection between ACV growth and revenue. So really, you get to the end of the transition, so grow slower in the beginning that it accelerates kind of catches up weeks them being more closely aligned when you exit the transition that's what you see happening in '21.
Got it. Thank you.
Thank you. You will hear next from Rishi Jaluria with D.A. Davidson.
Hey guys, it's Rishi Jaluria. Alan and Ken, good quarter. Nice to see continued strong results. I wanted to start by looking at the cloud gross margins, it's been really strong this year and improving as has gone on. How should we be thinking about the opportunities for future cloud gross margin expansion from here? I know, Ken, you have said in the past there is overtime, it might be able to get above 70%; maybe we speak how we should expect that and any areas where you think there is more opportunity for better infrastructure efficiency or to just get better margins out there? And I've got a follow-up.
Sure, Rishi. So one thing that probably most of you know is that I kind of took responsibility for our Pega Cloud business in December of 2019, so it's been about a year. And one of the reasons why Alan and I decided that that was a sensible move was because of the importance of really running this as a P&L and driving the margin expansion, and the team has done an amazing job in terms of driving that over the last year. So really good progress; you might say, okay, well, so you're in mid-60s now or approaching mid-60s, how do you get to 70, 75 and one of the levers? First off, scale is a big lever, right. Scale, not only in the number of clients, but the size of the client spends in Pega Cloud because as that goes up, there is some variable and some fixed costs, and you're able to leverage people over a larger pool of clients and a larger pool of ACV. So some of this is just typical operating leverage, we see that happen, in honestly, any business model. But technically speaking, when we start leveraging at scale things, like [indiscernible], right to create virtualization in the cloud environments which all of our clients are deploying on some version [indiscernible] in terms of driving efficiency, it's really virtualization in the cloud as I'm sure you know, that is a big lever for us.
In addition, clients that are adopting to Pega Cloud on Pega Infinity is actually another lever point because the expansion that they have on the application really becomes kind of a larger spend pattern and really create us - ability for us to make certain investments in those stepper breakpoints so that we can actually create essentially more efficient cloud environment for our clients. So it's really about scale, it's about the new product - Pega's new product, which is Pega Infinity, right, the product that is a net new generation. And about leveraging from very common tools like people having said lots of - all of our clients, quite frankly, and our competitors and other companies are leveraging to build that level of efficiency. So those are kind of the - some of the key tenants of getting there. But to be honest with you, it's really driven by a business P&L mindset of running our business like a SaaS business, like an Azure service business for our clients, and we're starting to really see some great pick-up in our results from that focus.
Got it, that's really helpful. And then a follow-up, I wanted to maybe get your sense on the sustainability of some of the trends that you've seen out of COVID, going forward, and let's say optimistically back half of this year starts to look a little bit more normal. And so from that I'm talking; A) kind of acceleration of digital transformation projects and efforts from customers, even if that hasn't been a driver on the revenue side just yet, but sustainability of those tailwinds. And then on the cost saving side as well, because not having travel clearly helping on the margin side; I mean, if you look at the growth rate of just your sales and marketing, it's dramatically lowered this year than it has been historically, I think even half of 2019 to growth rate. So how should we think about the sustainability and those cost savings going forward post-pandemic? Thanks.
Well, I'll tell you - it's obviously hard to predict, but I think there will be sustainable cost savings because I think behavior has changed. It's easy to do a video meeting or otherwise you would have had to arrange a trip to show people that you expected them and trying to make sure you're in the right place at the right time. I think a lot of that is going to persist, I think a lot of implementations where we've learned to do things remote, will not be entirely remote, people are still going to want to get in and do a physical walk-through and get together on the conference table. And I'm optimistic that that's going to be possible in the second half of the year or by the end of the year but I think there will be some sustainable cost savings there. Certainly the improvements - this whole project Phoenix which has been part of our move [indiscernible], it's part of a lot of the other changes that we've been doing is - has a lot of runway, as we think of what we can do to create sustainable cost savings and sustainable tactical scalability in coming years; so I also feel really good about that.
Thank you. We'll take our next question from Mark Schappel with Benchmark.
Hi, good evening. Thank you for taking my question. I was hoping if you could just provide some additional commentary on what you're seeing in Europe, and particularly, your business in the UK?
So, it's interesting. Obviously, the UK has undergone some confusion, that's the whole Brexit thing happened on top of the COVID thing. I would tell you that, as I think about it, the UK and particularly areas like some of the big UK financial institutions with some cases very, very big interest in moving things to the cloud, but historically, they have been more conservative on. But also some of the large governmental entities has been - I would describe has been powerful and intelligent. So, I'm feeling pretty good about the UK at a time when it's really hard to appreciate it, you know, what was going to happen as a result of some of the Brexit stuff on top of the COVID. So there is a tremendous amount of activity there. I guess, wish I could go back there in sometime [ph].
And then, Ken, a question for you. The December quarters are typically big renewal quarters for the company and also big revenue quarters; seasonally, how should we be thinking about your Q4 as with respect to ACV growth and RPO growth seasonally?
So the - let me clarify one thing; so Q4s do have more renewals than - on average than other quarters. However, as we've gotten bigger, the renewals do start to spread across quarters in the year, and across years, such that it isn't as big of an impact as we - as more of its Pega Cloud and as the company grows. The reason why Q4s are typically bigger because there is more new business activity in a Q4, more selling activity; that's actually a bigger factor for Q4, and that's really the only factor for ACV growth because our renewals, unless there is an upsell, there isn't really any change to the ACV. Now in terms of RPO in backlog, that is really - that is a tough one because market does become - it does become - there is definitely lumpiness around RPO in terms of the total amount, where it's not as lumpy is in the next 12 months number, right. And that number - that's why I focus on that number because that really is a validation of how much of the next year's revenue is already kind of baked, and kind of in the backlog to be able to come into revenue. So if you're comparing a Q4 over Q4, ACV is a very valid measure, and the next one year is a very valid measure. When you look at the gross amount of RPO, then you get into differences where get a renewal hit with that was four years versus three years and the cycle of renewals is not linear in terms of that. So that's kind of where it kind of screws with you a little bit, not so much on revenue, not on ACV at all, and really not much on that next 12 months number; so if that helps. That's the kind of the way to think about a Q4.
I think that the only thing that's happened, and we've talked about this a little is; when we did the flip to recurring, we massively reduced the incentive for long deals. The incentive used to be frankly, a little out of whack throughout total contract value, and that is massively reduced. So yes, I think you're going to continue to see less lumpiness in RPO, and the real measure I would say is ACV coupled with RPO; that's always what I look at.
Thank you.
I think we're getting to the top of the hour. So, operator, if it's okay with everyone, I'm going to just say to folks that it was obviously tough and hard [ph] year; we need really to thank the whole team for just what we've done and doing tremendous work, thanks our customers are standing by us. And I want to thank our investors; you should know we're working hard for you. And I wish all of you stay safe and let's work through this. We're actually feeling like we're moving into the light this year.
Thank you very much, everyone. Take care.
Thank you. That does conclude today's conference. Thank you, all for your participation. You may now disconnect.