Pegasystems Inc Q4 FY2020 Earnings Call

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 statements, 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 accelerated Pega Cloud growth, demonstrated by Pega Cloud annual contract value of 57% year-over-year, and Pega Cloud backlog is up 40% year-over-year. Since we began emphasizing Pega Cloud three years ago, we've seen an explosion of Pega Cloud low-code apps with a compound annual growth rate of over those three years of 85%. We also grew total annual contract value by 21%, 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 improved our brand awareness, attracting new talents from leading tech companies including our fiercest rivals. We made significant enhancements to our partner ecosystem strategy, an important long-term accelerator of revenue and margin growth. We continued 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. We maintained technology leadership in key areas that our clients value and continued to gain 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 and clients at the heart of our efforts while expanding our plans and increasing focus on inclusion and diversity. We did all of this while navigating market challenges. Finally, just a couple of fun notes. We'll be ringing the NASDAQ opening bell on Monday, the 22nd, to celebrate our $1 billion revenue milestone. And 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 worth noting we think highly of one of the board members against competitors like Salesforce, Oracle, SAP, and Zoho. Now, in terms of market dynamics, digital transformation has never been more central to the way our clients are thinking; it's fundamental to their continued prosperity, and in some cases, their survival. Reliance here has made it abundantly clear that organizations need to accelerate their digital transformation initiatives, not just to survive, but to compete and thrive in this rapidly changing world. We feel we've never been better positioned to support this need. Our solutions help clients simplify 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 business architecture that puts outcomes and customers at the core. Our prescriptive approach to design thinking brings staff across the organization together to design and deploy innovative solutions in weeks or days leveraging our low-code platform. Our recently launched trademark, Pega Process Fabric, weaves together business processes, 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. At 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 with our free COVID-19 tracking app. In one-to-one customer engagement, we introduced the Ethical Bias Check to help eliminate bias in AI; allowing us to drive customer engagement knowing it is fair. We launched the Value Finder to help customers 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 inquiries. A few weeks ago, we announced the acquisition of Qurious, a developer of powerful AI speech analytics that will assist customer service agents in real time by analyzing service calls and recommending next best actions. In intelligent automation, we launched X-ray Vision, the industry's first self-fueling robotic process automation, and 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 progress on high-impact digital transformation initiatives by introducing a new low-code Pega express methodology built directly into the platform. This offers new ways for customers to get started quickly and improve outcomes, helping clients and partners gain advanced Pega software skills. We established our new Pega Academy with mission-based learning and enhanced the Pega community to facilitate sharing of best practices among clients, partners, and Pega. We look forward to sharing important capabilities with you at PegaWorld iNspire in May. Now, regarding clients and business highlights; our new business continues to be strong across our traditional sectors such as financial services, government, telecoms, healthcare, and insurance, industries less affected by the pandemic, where thankfully, we have a strong critical mass. In 2020, we enjoyed a good mix of new business expansions with existing clients like Anthem, British Telecom, CIBC, Citigroup, National Australia Bank, and government agencies worldwide. We also brought in exciting new logos like Emirates National Bank, Partners Health, and Takeda Pharmaceutical, continuing to see more partner-sourced deals and opportunities we are focusing on in 2021 and beyond. Our clients continue to leverage Pega to cut through complexity in their business systems, allowing for better decisions and productivity. Notably, in the government space, following our successful Census projects, we are quickly becoming a preferred low-code solution, as demonstrated by our recent win with the Internal Revenue Service. We've been able to implement new systems quickly to meet immediate needs and help organizations strategize for the future. There is nothing more rewarding for us than clients willing to share their stories publicly. PegaWorld iNspire will again be held this year as a 2.5-hour interactive virtual event, just around the corner on May 4. We have an impressive list of clients lined up to share their stories. For example, Scotiabank, five years and 70-plus applications into their Pega journey, has built a large catalog of reusable Pega capabilities. They will discuss how they are leveraging these assets to accelerate global rollout and formation of an enterprise Business Center of Excellence to maximize value and standardization in leadership. Vodafone UK will talk about driving transformation by automating business processes, delivering powerful intelligent automation at scale across its businesses, leveraging Pega's agile low-code capabilities, and building and updating applications with unprecedented speed. As an example of practical work needed this past year, we supported StepChange debt charity in the UK, helping over 5.6 million people negatively impacted by the pandemic with an accumulated $10.3 billion in debt who were assisted in applying Pega technologies. StepChange will announce how they used Pega to launch their COVID Payment Plan, a new online service built in a matter of weeks to provide short-term assistance for those who qualify. We are incredibly proud that our technology is being used to transform and improve the lives of millions negatively affected by the pandemic and especially proud that these organizations, among others, are willing to share their stories. 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 understand its impact. However, we have adjusted well over the last year to new ways of working, client requirements, and believe we have delivered strong performance nonetheless. We are well-positioned to continue this as needed. The needs for digital transformation have never been greater, and we are better positioned than ever to respond in unique, forward-looking ways. We remain inspired and are amazed at the continued support and commitment of our staff, clients, and partners, and we are optimistic about this year in our long-term growth agenda. To provide more context, let me turn this back 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. 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 like a mile marker that we hope to far surpass in the coming years. However, there are inherent benefits of scale on our journey to be a Rule of 40 firm. First is operating leverage. You can 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 perform activities more efficiently, which we expect to contribute positively toward our goal of achieving the Rule of 40 as we exit our cloud transition. Items like virtualization and automation can be leveraged more effectively at our increased size. Another benefit is increased brand awareness. We anticipate investing in incremental initiatives to ensure the market is aware of how Pega helps clients manage their digital transformation initiatives. This increased brand awareness can help us reduce sales cycles, decrease customer acquisition costs, and improve sales efficiency; significant value levers for Pega. Third, our increased scale strengthens our ability to attract world-class talent. A prime example is the addition of Hayden Stafford to our team in June 2020 as President of Global Client Engagement. We expect that increasing sales productivity will be one of our most critical value drivers moving forward. Our ongoing growth and scale are not the only multi-year transformations underway at Pega. We are also more than midway through our multi-year cloud transition; it’s worth sharing what we've accomplished and what still needs attention. The shift to recurring revenue for a software company traditionally takes about five years, as I've mentioned previously, following three major phases. First, the company moves from selling perpetual licenses to selling subscription licenses. When we commenced our cloud transition in late 2017, over 60% of our new client commitments were subscription-based. We changed our sales compensation plan to align with annual contract value. By the end of 2018, about 85% of our new client commitments were recurring contracts, which increased to 95% in 2020; we've successfully completed the first phase of this transition. The revenue growth transition is the next phase. During this stage, revenue growth rates tend to decline, particularly during the first few years, because the business shifts from selling perpetual licenses, where revenue is recognized upfront, to selling cloud arrangements, where much of the revenue is recognized gradually. For example, our revenue growth rate dropped from the mid-teens before we transitioned to the low-single digits for several years. Once we passed the midpoint of the transition, revenue growth rates begin improving. For instance, our total revenue growth rate grew to 12% in 2020, even with a significant reduction in perpetual license revenue from 2019 to 2020. In the final two years of the revenue growth phase, growth accelerates, nearing the growth rate of annual contract value by the transition's end. This is why we anticipate revenue growth and ACV growth will both surpass 20% in the concluding years of the cloud transition. A crucial point to note is that our subscription revenue grew by 26% in 2020. When I refer to subscription revenue, I mean the total of all client and Pega Cloud revenue. The cash flow transition comes last. In the final phase, billing to cash collections improves; essentially transitioning from a company that collects most cash billings upfront to a business billing and collecting from clients consistently over time. We expect our free cash flow to accelerate as we complete this cloud transition in late 2022 to early 2023. Given that we are still in the midst of this transition, growth in annual contract value remains the most significant operational metric reflecting our business's underlying growth. Many of our other operational metrics do not accurately reflect the strength of the business when you are partly through a transition like we are currently navigating. In 2020, total ACV grew by 21% year-over-year, reaching $835 million. Currency provided about a 1% to 2% tailwind towards this growth in 2020. Total ACV sums up recurring Pega Cloud and client cloud commitments representing the annualized recurring expenditure from our clients for cloud, term license, and maintenance arrangements. Notably, perpetual licenses decreased from about 10% of new client commitments in 2019 to about 5% in 2020. While this trend negatively impacts near-term revenue results in 2020, it sets us up for more substantial recurring revenue in the future. It is remarkable to see Pega Cloud ACV growth accelerate in 2020, increasing 57% from $169 million in 2019 to $267 million in 2020 due to rising demand for our cloud services. The second most important operational metric during the cloud transition is remaining performance obligations or backlog. Backlog signifies total client commitments Pega has booked that the company has not yet recognized as revenue. In 2020, total remaining performance obligations grew by 28%, an impressive $236 million year-over-year, increasing from $836 million to $1.07 billion. This marks the first time in our company's history that backlog has exceeded $1 billion. It’s also encouraging to see Pega Cloud backlog increase over 40% during this same period. Total current backlog, which is the backlog to be recognized within 12 months, grew by 24% from $493 million at December 31, 2019, to $630 million as of December 31, 2020. This short-term backlog will be recognized as revenue in the next fiscal year, supporting our expectations for total revenue growth of over 20% in 2021. Turning to revenue, Pega Cloud revenue increased by 56%, growing from $134 million in 2018 to $208 million in 2020. As previously mentioned, subscription revenue (including Pega Cloud maintenance and term license revenue) saw an impressive jump of 26% during the same timeframe. Total annual revenue rose by 12%, growing from $911 million in 2019 to $1.02 billion in 2020. To grasp the financials during the cloud transition, it’s vital not to focus on any one metric; you need to consider ACV, revenue, and backlog collectively. For example, ACV growth might rise while the backlog declines; while we haven't effectively communicated this for future planning at this juncture. This situation is further complicated by the cloud transition, which causes deferral effects on reported revenue. This is why we are relying heavily on ACV growth to gauge our business momentum. Together, our financial results in 2020 place us on a strong path toward meeting or exceeding our long-term targets 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, we aspire to grow faster; that's why we have made significant investments in sales capacity, partner support, and customer success. Moving to our fiscal year 2021 guidance; assuming Pega Cloud remains a little more than half of all new client commitments in 2021, we expect total revenue of $1.25 billion, representing an increase of 23% year-over-year. As is typical, we anticipate our bookings to skew toward the latter half of 2021, meaning our revenue will also skew toward the back end of the year, as is customary in enterprise software. Regarding non-GAAP EPS; we project a full-year non-GAAP EPS of $0.25 for 2021. We expect non-GAAP EPS to improve from 2020 because we anticipate our revenue will grow faster than our expenses. Additionally, we foresee non-GAAP EPS rising due to increases in Pega Cloud gross margin, which significantly contribute to our business. In conclusion, like many firms, we are eager to welcome 2021. Our full year results are remarkable considering all the market disruptions from COVID-19; this is the first year in our history that revenue, backlog, and cash collections exceeded $1 billion. We are optimistic that 2021 will demonstrate continued growth in our key metrics. Before we open the call for questions, I invite each of you to our annual customer conference, PegaWorld iNspire, on Tuesday, May 4. This 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 more information about the Investor session during our Q1 2021 earnings call in the spring. With that, operator, please open the call for questions.

Thank you. 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 the cloud mix in Q4 and conversions to cloud? And then, maybe just for our benefit, tie back to Q4 top line results to your previous comments about what happens as your cloud mix changes. Because I would like to tie it back to your initial guidance for the year. And then, how does your view of the year evolve as it went on? Lastly, on that, maybe can you help us with what are some of the variables that could impact fiscal '21? I'm 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 address your questions and hopefully, I capture them all. The first point to consider is the cloud mix for the year; the last three years, Pega Cloud has been about 50% of our new client commitments. In Q4, this number tends to skew a little lower than 50%, and the reason for that, which is speculation on my part, is that clients usually utilize year-end budget funds which may slightly skew toward more client cloud arrangements versus SaaS arrangements; that has been the trend. It hasn't been a significant skew but typically, it’s lower in Q4. Regarding 2021, we believe there is an opportunity for Pega Cloud to become a larger part of our business, but because we've established such a pattern of many clients appreciating the Pega Cloud Choice Messaging and their flexibility in deployment, we don't have a definite forecast indicating that number would be markedly higher than what we've observed in the last few years. So that’s the perspective on the Pega Cloud percentage. I want to discuss Q4 in 2020; the most significant difference we noted in 2020 was the shift away from perpetual licenses toward either Pega Cloud or Client Cloud recurring arrangements. You may wonder if it's term or perpetual; wouldn't it equate to the same revenue? It doesn't, as the revenue recognized in the current period differs when you book an equivalent term or perpetual deal. Thus, the substantial drop in perpetual revenue in 2020 was our biggest factor. Initially, we projected Pega perpetual revenues would remain just under 10%, but it fell lower than we anticipated in 2020. So that’s probably the most significant positive factor behind the change in 2020 and, in Q4. So, that’s the fundamental lever point.

Got it. Okay, thanks for that, Ken. And this one is probably for Alan. Project Phoenix, could you provide a quick update and remind us what functionalities or use cases you believe will benefit most immediately as you innovate around your platform, adopting microservices, etcetera? Where are you taking that in the short term, Alan?

We have an exciting agenda regarding that front. Some of it is visible in the improvements in cloud margins, and as for client cloud, while we prefer Pega Cloud over client clouds, we do believe in client choice. This benefits all our customers financially and allows quicker innovation. We're also experiencing improvements in cycle time and development with the elements that have been broken out as microservices. I would tell you it's working beautifully on that front. Much of what we're doing is reflected in Phoenix based on the release late last year and ongoing work, enabling our clients with new options and an ability to seamlessly integrate Pega into their existing front-ends due to our ability to incorporate app-based technology within our digital experience API, a major part of moving towards an API-centric model. Internally, we are experiencing advances, and many clients who previously criticized our architecture have responded positively to our progress and to our direction for the next 24 months. It has earned us a lot of positive feedback from our customers.

Thanks a lot, Alan. Thanks Ken.

Thank you. I'll 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 commentary on your partner practices in terms of any updates on new logo wins generated from partners or how to expect that to ramp over time?

In the second half of the year, we operated under the guidance of Hayden Stafford; you may recall, Hayden escalated the business at Microsoft in the CRM space to $3.5 billion quite rapidly. We are starting well under $1 billion, and he has a strong partner background from Salesforce. He has truly embraced a push toward partners, pushing for mutual commitments from partners that we will market together. I can report that the number of partners involved and partner-sourced deals has significantly increased in the pipeline, and it is exciting to see that this acceleration began 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; could you elaborate on your comments regarding the government opportunity, especially about being potentially standard for certain use cases? Any thoughts on how under a new administration that might present opportunities for you more broadly?

We believe there were opportunities under the previous administration, and we don't see them diminishing under the current one. The reality is that there is a tremendous amount within government needing efficiency, adaptability, and a reduction in paper waste. The IRS has been public about having over 60 base management systems, and we won competitive bids against numerous other providers to be publicly selected by the IRS; that contract will extend over several years and is already in production. We have a remarkable government story and have been advised by Hayden to double down on our government business; this includes partners as essential participants. Additionally, our government business is thriving not only in the U.S. but also in Australia, the UK, and Germany, where we are observing encouraging progress.

I want to add one more comment on partners. We conducted several partner sales kick-offs this year engaging in working sessions with our partners, and we had numerous partners upsize; I won't mention exact names but they are committing to large commitments focused on driving mutual business between Pega and their practices; something that hadn’t been happening before 2021, just in the last month or so. This is an example of the significant changes in our partner engagement.

That's really helpful. Thanks for taking the questions.

Thank you. We will 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 that you mentioned at the conference last year. Any updates on that, how it is performing, or what initial feedback have you received from customers? Also, how do you see this emerging space of process mining, and what is Pega doing in that regard?

Sure. To address both topics, when we discussed the process fabric last year, it was essential to convey our vision of a center-out architecture, which focuses on work across a large organization. The goal is to avoid creating a massive central system. Instead, we aim to provide a virtual integrated system where work spans multiple systems, incorporating Pega systems among others. We have our first few clients successfully using this model, and we continue to improve while benefiting from enhancements under the Phoenix initiative; it’s incredibly exciting. Imagine an organization harnessing something akin to Google that integrates work safely and securely while delivering that work in a distributed manner. It's generating positive reception and propelling further use specifically within extended, material customers. Regarding process mining, it is a fluctuating trend with periods of high and low popularity, yet we are engaged in interesting work as part of our workforce intelligence and robotics initiatives, allowing us to observe actual processes versus what people claim they do. This represents a complementary technology to our core automation approach, as it helps us understand workflows while avoiding improper implementations of robotic process automation. We want to analyze and derive outcomes without interruptions. I feel confident about our efforts in this space.

Understood, thank you for the details. And Ken, one quick question for you on ACV growth when I look at 20% to 21% around; I think you mentioned a 1 to 2 point currency headwind, so after making adjustments, it seems like it dipped below 19%. I acknowledge it's solid at that scale, but when comparing to a year ago, maybe it was 22% and now possibly sub 20%. Can you highlight what's causing this? Have you seen more impact from COVID in Q4 or is there something to call out?

That's a great question. I wouldn’t say we have seen impacts from COVID, whether positive or negative. It has neither been a tailwind nor a headwind. I believe the year played out directionally in line with our financial expectations where we anticipated ACV growth. The more important question is when do we expect ACV growth to accelerate beyond the 20ish percent growth we've observed for several years, as we're investing in a market opportunity that should yield better growth rates. This percentage fluctuation is less concerning for our long-term strategy. We experience situations where, as I mentioned earlier, ACV fluctuates quarter-over-quarter based on effective dates, which may skew percentages in either direction. My concern isn’t focused on that number; rather, my emphasis is how we elevate it to 25 to 30 percent in upcoming years.

So, thanks for taking my questions as well. I'm just curious if you could provide a lay of the land regarding the automation portfolio. You acquired an RPA vendor a few years back; obviously, you have been a pioneer with your flagship product. Please provide some insight into what you’ve observed regarding the competitive landscape and what you anticipate seeing in the coming years. Some vendors are discussing end-to-end automation offerings across RPA process mining; I think you briefly touched on this. But how do you fit into that space and how do you perceive the merits moving forward? Then I have a follow-up question for Ken.

Sure. The market is saturated with noise and experimentation, and I see a lot of it as fluff. The whole robotic process automation space often witnesses companies calculating the number of customers acquired by various vendors and dividing that into revenue figures. The expected growth rates given the customer numbers indicate a lack of sustainable growth. We believe our approach of emphasizing process automation at the core, with robotics complementing that, is a more effective means of approaching systems lacking APIs. We have received considerable confirmation from prospects that our center-out approach and perspective is the right way to proceed, especially when compared to desktop-oriented methods. I anticipate our strategy will be validated more as we grow and encounter the competitive landscape. You mentioned an additional question for Ken.

Yes. Ken, I appreciate the helpful context about the ACV growth adjusted for FX tailwinds. Your guidance is certainly strong, and your projected revenue growth of 23% seems to align with your CRP growth this quarter. However, in regards to your fiscal '22 targets reiterated at the Analyst Day, could you explain the expected implied acceleration of ACV for fiscal '21 taking those variables into account? You've previously discussed drivers for such growth, particularly regarding sales capacity investments and productivity, but would you outline which of these drivers you think could impact fiscal '21 in the near term versus, for instance, benefiting your performance in the years 2022 and 2023?

To understand the investments we're making, let me outline a few that would potentially yield more immediate results—specifically in 2021— and others that may be more of a mid to long-term nature. 2021's growth will be primarily driven by ramping up sales capacity and getting new team members more seasoned on average compared to 2019 and 2020. When looking at something more long-term, let's consider the investments in partners; these typically take more time to mature and may span 18 to 24 months. One additional aspect is we haven't pushed our client cloud users to transition to Pega Cloud en masse; while this occurs occasionally, it is not part of our core strategy. However, I do see potential for Pega Cloud to increase as the business evolves in 2022 and 2023, propelled further by product advancements and the growing inclination toward cloud services. These factors outline our short-term versus longer-term growth drivers.

Okay, thanks for taking my questions. First, I wanted to ask about the CRM business, particularly in the context of how well the broader category has weathered the pandemic. How has that piece of your business trended over the last year, with a focus on the last quarter?

We’re observing an uptick in interest in CRM, particularly concerning an omnichannel approach to CRM. Part of our investments has included bringing exceptional leadership into the primary areas of CRM, intelligent automation, and one-to-one engagement. This focus ensures we double down on those areas that encompass everything from the full contact center desktop to omnichannel priorities, which utilize common process flows and decision-making across mobile, web, and service desktops, which we feel enhances accessibility and accelerates benefits for customers.

Great, thank you. I had one modeling question on ACV growth; exiting the year at 21% and then the revenue guidance at 23%. I understand that during the transition period, you can see revenue growth potentially outpacing ACV growth in 2021. Can you tie that connection together?

Typically, the rules work as such. When assessing the effect of professional services, I know this can skew numbers somewhat. If we think about ACV growth, let’s use a round figure. An ACV growth of roughly 20% indicates that as we approach the end of our cloud transition, we can expect subscription revenue to begin matching and eventually outpacing ACV growth, especially towards the back end of the year. We anticipate that revenue growth in 2021 will accelerate beyond ACV growth as we catch up from the earlier slow phase of transitioning, which is why you may observe growth trends improving in the latter part of the cloud transition. Therefore, the expectation in '21 is that while they may differ, ACV growth and revenue growth will align more closely as we push toward the end of our transition.

Hey guys, it's Rishi Jaluria. Alan and Ken, good quarter. Nice to see continued strong results. I wanted to start with the impressive cloud gross margins, showing improvement as the year has progressed. How should we approach future cloud gross margin expansion? Ken, you’ve mentioned in the past the potential to exceed 70%; could you clarify how we should expect that and any focus areas for improving infrastructure efficiency?

One thing to note is that I’ve managed the Pega Cloud business since December 2019, aiming to run this as a P&L and drive margin expansion, with the team making significant headway. You might question how we can go from mid-60s or approaching mid-60s to a target of 70-75%. Scalability serves as a pivotal factor, not just in client numbers, but also in the scale of expenditures in Pega Cloud that allows for over-indexing costs. For example, as client spending increases, there’s a combination of variable and fixed costs that can be leveraged. Similarly, moving to principles like virtualization within cloud environments enhances efficiency across client deployments. Clients who transition to Pega Cloud with Pega Infinity represent a growth lever; that expansion contributes to our investment capacity across our operations. It’s about scaling, evolving our new products and applying consistent methodologies that yield efficiency improvements while maintaining a focus on running our business effectively as a SaaS venture.

Got it, that’s really helpful. I’d like to understand the sustainability of trends you’ve seen as a result of COVID-19. Assuming an optimistic outlook for the back half of this year normalizes, what should we expect regarding recurring emphasis on digital transformation and cost savings? Considering how travel restrictions have improved margins; how likely is it that these savings persist post-pandemic?

Predicting future trends is challenging, but I expect there will be sustainable cost savings since I believe behavior has fundamentally changed. It's far more convenient to conduct meetings via video than conjoin group travel efforts; this method likely persists beyond 2021. However, while remote implementations are effective, physical interactions will still occur when necessary. I’m optimistic this will be feasible in the second half of 2021 or by year-end. Additionally, the ongoing Project Phoenix—part of our lower-level initiatives—offers significant potential for sustained cost savings and operational scalability in the future. I’m confident in that trajectory.

Hi, good evening. Thank you for taking my question. Can you provide additional insights on how your business is progressing in Europe, specifically in the UK?

The UK has certainly faced challenges, particularly with Brexit alongside the pandemic. However, in assessing the situation, UK financial institutions have shown considerable interest in cloud-based solutions, despite being conservative historically. Furthermore, significant governmental entities have become increasingly aware of the need for transformation amidst current challenges. I feel grateful for the activity occurring in the UK, even during uncertain times.

To clarify, while Q4s typically include more renewals than average, as we grow, renewals will progressively distribute across the year, leading to less impact than previously. The primary reason Q4s are larger is due to heightened new business activity; that is the major driver of ACV growth in Q4. As we look at RPO and backlog, lumpiness can distort the total amounts reported whereas the next 12-month forecast remains stable. Thus, we focus on these numbers over others to validate upcoming revenue expectations, comparing year-over-year trends effectively.

One more note – with our shift to subscriptions, we have diminished incentive towards long-term deals, alongside a notable transition in our renewal structure to better align with current market patterns. I expect to see continued fate fluctuation in RPO, but a tighter relationship with ACV will remain significant in our reporting.

I believe we've reached the top of the hour. I sincerely thank everyone who joined us for the call. It has certainly been a challenging year, but we must acknowledge our team’s hard work and the support of our clients. We would like to express our appreciation to our investors; know that we are working diligently for you. Please stay safe as we enter the new year, and we genuinely feel optimistic about the direction we're heading. Thank you again!

Thank you. That concludes today's conference. Thank you all for your participation. You may now disconnect.