Good day, welcome to the Pegasystems fourth quarter and fiscal year-end 2022 earnings results conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Kenneth Stillwell. Please go ahead.
Thank you. Good evening, ladies and gentlemen, and welcome to Pegasystems Q4 and full year 2022 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 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 the 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 2022 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 2022 and full year earnings, and in the company's filings with the Securities and Exchange Commission, including its annual report on Form 10-K for the year ended December 31st, 2022, 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.
With that, I will turn the call over to Alan Trefler, Founder and CEO of Pegasystems.
Thank you, Ken, and thank you to everyone on today's call. I'm proud of how our team adapted, leveraged our strengths, and executed in 2022, demonstrating exceptional resiliency. We ended the year at 16% ACV growth, right where we said we were, despite multiple significant distractions and challenges. We're making progress to become a Rule of 40 company, which will drive greater value for our shareholders and opportunities to further invest in our business, our technology, and our people. Our results reinforce the effectiveness of our strategy to target customers where we know we have tremendous opportunities for growth. Ken will discuss in more detail later in the call. You know, the market dynamics here I think are very positive for us in some key ways.
Digital transformation continues to be a driving force for our clients. We expect it to be even more important in 2023, given the economic indicators. In the type of uncertain environment we're in and, well, we're gonna continue to be in, enterprise automation is top of mind for clients who are looking to optimize their investments, increase efficiency, and improve effectiveness. According to IDC's 2022 Worldwide CEO Survey, the number one skill CEOs think will be most critical to their success over the next three years is digital know-how. At the same time, there is a growing scarcity of developer skills, which helps drive increasing use of low-code and no-code solutions. According to the latest forecast from Gartner, the worldwide market for low-code development technologies is projected to total $27 billion in 2023, an increase of nearly 20% from 2022.
IDC projects that by 2025, 60% of all application developers worldwide will be low-code or no-code developers. This theme is consistent with what we're hearing from clients. I recently came back from Davos, where I met face to face with CEOs of some of our largest and most strategic customers. They told me they are focused on digital transformation as key to success, and it's gonna be especially true in what they expect will be a challenging year. They know they need better and faster ways to do things, driven by the economic environment and scarcity of resources. Pega is perfectly positioned to leverage these dynamics. We have a long history in this space and a clear strategy to focus us this year and beyond. Our strategy is very much vested in our technology.
Pega technology provides the most powerful and scalable low-code platform for AI-powered decisioning and workflow automation. It's designed to help clients maximize value, simplify service, and boost efficiency, freeing them to adapt to change. Our product leadership is broadly recognized by industry analysts and has led to dramatic successes with many of the world's most recognized and sophisticated organizations and their partners. Pega Cloud innovation has accelerated adoption, and we've made tremendous progress on modernizing our clients who now more than ever are able to make use of our latest advancements. We are strengthening deep strategic relationships with our clients and their trusted partners, and we believe that they are more likely to consolidate their technology choices with proven and trusted providers in this uncertain environment.
Driving accelerated value for these clients will translate directly to significant growth for us. We are building a healthy, agile, and efficient organization so that we can work closely with our clients and inspire innovative ideas and creative solutions to their biggest challenges. Now, though I'm feeling good going into the year, we do expect it will be a tough year based on all the economic indicators, and we've taken steps and planned accordingly. As we announced in early January, that means having had to make some tough decisions to help set us up for both long-term and short-term success. These changes were focused on our go-to-market organization, where we're driving alignment to further improve our go-to-market operating model to drive role clarity and accountability, enable greater efficiency, and sharpen our client focus, especially where our historical investment outpaced our growth.
Nearly all of the changes have been completed, though there are some markets that we're working through evaluations, in adherence to local regs and processes. I know this is a challenging time for many whose roles are changing, or being eliminated, as well as those saying goodbye to colleagues we care deeply for. We're working to take great care to support those who leave Pega with transition support in keeping with our values. Like many other companies, we're planning for more conservative growth in 2023, which Ken will talk about more later in the call. Our overall approach and strength will continue to serve us well as we go beyond this year and into future years where we will continue to adapt.
We're in a position where whether our clients are focused on rapid go-growth or whether our clients are focused on efficiency and cost-cutting, we've got the technology and the approach to do either, as we've shown over the years. I'm also excited to see that our subscription transition is coming to completion, and you can see the related impact in our financial results and projections. Combined with the organizational changes we are making, we are well-positioned to be a more significant cash generator over time, which gives us the flexibility to invest in growth opportunities for the business. Pega, I think, has always had a focus on innovation, and providing the most innovative and effective solutions for our clients has, I think, been central to our success.
In 2022, we continued to enhance Pega Infinity to give clients the best low-code platform in the industry. Some of the highlights included launching a new version of Pega Infinity, which lets organizations develop apps faster, create smarter workflows, and improve experiences for customers and employees. We continue to focus on Pega Cloud and have significantly increased adoption. We're also finding that our Global Operations Center, which uses extensive workflows built on Pega Infinity, can bring automation, availability, reliability, and scale to our own cloud operation. We're seeing this as a reason where clients are choosing Pega Cloud over running on their own cloud because they can see how well we can do it. We introduced new low-code templates, courses, and services to help organizations improve productivity while reducing strain on IT teams, all while still maintaining good governance.
With the demand for professional developers exceeding talent availability, organizations want to be able to tap citizen developers to get work done. Citizen development can also create silos and increase risk and costs if there isn't proper governance or if the tools are not sanctioned or supported by enterprise IT. Many of the lower-end low-code tools in the market today are contributing to that challenge. Pega's low-code factory approach empowers citizen developers while providing technology-supported governance to automate the enforcement of best practice, ensuring security, scalability, and maintainability. We've also enhanced our robotics capabilities to make it even easier for users of any skill level to quickly build robotic automations, that help make business processes more efficient when robotics makes sense.
We acquired Everflow to add intuitive process mining capabilities to create what we believe is the industry's most complete hyperautomation solution, enabling Pega clients to uncover and fix hidden process inefficiencies that would otherwise bog down an organization's operations. There's also a lot of interesting tech developments we're tracking. For example, we're looking carefully at the latest generative AI technologies and how they can position themselves inside our offering to make them better. We're looking at model-driven approaches that help pragmatically tackle business problems. All of this, I think, plays on historical strengths of Pega. Pega is terrifically positioned to take advantage of these trends. We see lots of potential to provide more value to our clients and enhance their relationship with customers. I expect we'll have some very exciting news to share at PegaWorld in June as a result of this work.
We also announced Pega Launchpad, a new cloud-based low-code application development platform designed to empower users to build and monetize new business-to-business SaaS applications. This has the potential to provide new revenue streams and an interesting new market for us. Our goal was to sign up several early adopters during 2022 in anticipation of launching in 2023, and we're right on track with where we want to be. I'd like to touch on some client highlights because ultimately that's what this is from our point of view, all about. For us to be successful and grow our business, we need to make sure our clients are successful. You know, innovation for innovation's sake has never been our strategy. Whether homegrown or acquired, we've always thought first about how a new feature or technology or product would support our clients' goals and contribute to their success.
That's why we continue to see impressive results from our clients and why so many are willing to talk publicly about how they are leveraging our software. For example, a number of our banking clients recently won awards for their use of Pega software, including NatWest, named Best Banking Tech Provider for their use of Know Your Customer and Pega Client Lifecycle Management Solutions. Lloyds Banking Group, awarded Best Use of IT in Retail Banking for its automation and streamlining of processes for customer credit cards, all built on Pega Cloud. More than 40 clients have signed up to share their success stories at PegaWorld iNspire this year in June, including Roche, Wells Fargo, Virgin Media, and the FDA, just to name a few. We're so excited to be going back to Las Vegas for our first in-person PegaWorld in four years.
In addition to the many clients we look forward to joining us there are already more than 30 major partners signed up as sponsors, including Accenture, EY, Capgemini, and others. They'll be demonstrating their services and solutions along with our latest technology in our Innovation Hub. Please check out the PegaWorld website, register, and join us live to hear these stories and see the amazing technology firsthand. I'd also like to note that it's been really exciting in this new in-person world again to see a steady stream of our clients coming from Amsterdam to from Australia visit our new executive briefing center in Cambridge for in-depth, highly strategic conversations. In summary, I think we've again shown our resiliency and ability to execute in challenging times.
I'm excited to see our transition to a subscription business coming to completion and the positive effect it's having on our results. We are on pace to be a Rule of 40 company as we exit 2024. We're the right space with the right heritage and the right capabilities and the right strategy, and at the right time to leverage a significant opportunity in front of us. We have the right team to deliver on that opportunity. To provide more color on the financial results, let me turn it back to you, Ken.
Thanks, Alan. Nothing brings more stability to revenue profitability and cash flow than our recurring business model, especially in times of economic uncertainty. That's the major reason we embarked on our subscription transition five years ago. Our execution has been strong thanks to the hard work and resiliency of our team in close collaboration with our clients and our partners. Over this five-year transition period, we've achieved a nearly 250% increase in our annual contract value. More than doubled our subscription revenue, which in 2022, I'm happy to say, topped $1 billion. Now the subscription revenue represents 81% of Pega's total revenue, up from just around 50% a few years ago, with the majority of the remaining revenue coming from professional services.
Our subscription model helps us build a more resilient business and improve profitability at scale through operating leverage, especially with our high client retention rates and massive client expansion opportunities. Growth in annual contract value is the key growth metric to measure our business momentum. During the transition, we almost exclusively focused on ACV because of its critical importance. Let's talk about our ACV results. In Q4 2022, annual contract value increased 16% year-over-year in constant currency and 13% as reported, reaching $1.1 billion. Our ACV growth was driven by our go-to-market strategy, where we focus heavily on cross-selling and upselling to our existing clients. Pega Cloud ACV reached $455 million, an increase of over $90 million. Over 60% of our new client commitments were from Pega Cloud deals in 2022.
Another important metric to measure our success during our subscription transition is growth in remaining performance obligation or backlog. Total backlog reached $1.36 billion as reported. As we highlighted last year on our earnings call in Q4 of 2021, our subscription license backlog was unusually high, resulting in a tough compare this year. Focusing just on subscription services, which includes Pega Cloud and maintenance, backlog grew 13% year-over-year, in line with our reported ACV growth rate. We are currently in the final months of our subscription transition, and our 2000 to 2022 results demonstrate that we exited the year with improved profitability as we expected we would. Let me give you a few examples. First, our non-GAAP EPS reached $0.72, an increase of over 200% year-over-year.
Our non-GAAP EPS performance was primarily driven by more disciplined expense management, especially in sales and marketing. In fact, total sales and marketing costs were down slightly year-over-year. You'll hear a little later that we expect to see another significant increase in profitability in 2023. Second, Pega Cloud gross margin improved approximately 300 basis points to 70%. The improvement in Pega Cloud gross margin was driven by increased scale as well as innovation in our cloud architecture that helped increase automation and further drive efficiency. When the subscription transition is complete in 2023, free cash flow generation will start to normalize, a critical step on our path to become a Rule 40 company as we exit 2024.
As a reminder, we define Rule of 40 as the combination of ACV growth and free cash flow margin, which adjusts for other items outside the ordinary course of business. The reason I say we will become a Rule of 40 company as we exit 2024 is because our bookings are skewed toward the end of the year, so our cash collections tend to bridge to the following year. Once we exit 2024, our cash collections should be more normalized. That said, you should expect to see significant improvements in free cash flow in 2023 and in 2024. Moving to our fiscal year 2023 guidance. To start, I want to remind you of our guidance philosophy and approach. It's our practice to provide annual guidance at the beginning of the year. We do not typically update guidance.
For the last several years, we invested aggressively in sales and marketing to accelerate our ACV growth rate, and our guidance philosophy reflected our belief that our incremental investment in sales and marketing would result in significant ACV growth acceleration. As we thought about our 2023 guidance approach, we looked at the world events. We believe 2023 will be a tougher and less predictable year for everyone. Our 2023 guidance is informed by this view. We know from experience that during uncertain times, focus is more important than ever. We believe the changes we made to our go-to-market strategy will work extremely well in the current environment. In January, we announced a 4% reduction in our global workforce.
We expect that action to result in over $75 million of net savings versus our original spending plan, and we're focused on improving our sales efficiency by further selling into our existing client base, which is made up of the largest and most respected global brands. We are pursuing new clients selectively. We often land new clients because a buyer from an existing client takes a role with a new prospect, or because a partner recommends Pega as part of a major digital transformation project, or because an industry analyst firm recommends Pega. Obviously, there's a reasonably high amount of uncertainty in this market, and we assume that there's risk that enterprise software companies, including Pega, could experience longer deal sales cycles, lower close rates, and deal value compression. Given these risks, we've decided to factor this into our guidance.
Let's get into guidance numbers for full year 2023. Total ACV will grow 11%-13% year-over-year. We're driving our execution to achieve the Rule of 40 SBX at 2024. We think of any such slowing of our ACV growth rate is reflective of the overall economic environment in 2023 and not indicative of the scale of the opportunity or our ability to accelerate growth efficiently in future years. We will be hyper-focused on efficiently accelerating our growth with our Rule of 40 focus. We believe total revenue will be approximately $1.4 billion. We expect non-GAAP earnings per share of about $1.50 per share. Given our focus on increasing cash flow, we've added a new guidance metric this year, free cash flow.
We project free cash flow of $150 million in 2023. From where we stand today, these are our best estimates of what we will deliver to our shareholders in 2023. A reconciliation of our GAAP and non-GAAP guidance is contained in our earnings release. We also thought it would be helpful to provide additional guidelines as to how people should think about modeling our business in 2023. I'll share a few of those thoughts. First, we believe Pega Cloud will represent between 60%-70% of new client commitments in 2023. A 1% shift in the projected Pega Cloud mix would impact recognized revenue for the full year by approximately $3 million. Second, 2023 is a more typical year in terms of renewal volume.
As it was in 2022, our renewal portfolio in 2023 is skewed to Q4 of 2023. This dynamic will likely result in a more significant portion of our ACV growth and revenue to occur in the second half of the year and a larger amount of our collections to straddle Q4 of 2023 into the beginning of 2024. In Q4 of 2021, term license backlog was unusually high at $172 million, and you saw that backlog significantly impact revenue in the first quarter of 2022.
Given we did not have that dynamic happen at the end of 2022, we expect term license revenue for Q1 of 2023 to be more consistent with the pattern of historical first quarters of a year. In other words, the seasonality of term license revenue in 2022 was unusual. We expect it to return to a more typical seasonality for 2023. We see Q1, Q2, and Q3 having a similar level of activity. Q4, as usual, is expected to be significantly greater. When you are focused on selling to your existing clients, naturally, clients are likely to make incremental buy decisions commensurate with a contract renewal event.
We expect our sales and marketing expenses to be higher in the first half of 2023 because of PegaWorld, our annual customer conference being held in person in 2023. Irrespective of the seasonality of our business, we think the first half of 2023 likely be the slower part of the year due to the expected economic softness and having fewer renewals. Our annual Investor Day, which will be held during PegaWorld 2023, is scheduled for Monday, June 12th at the MGM Grand in Las Vegas, Nevada. Please mark your calendars for this event. We'd love to have you join us in person after so many years away from PegaWorld. The agenda will include updates on our go-to-market strategy, our technology, and our financials, including our long-term model.
We will also host a Q and A section during this event. In conclusion, we're driving toward becoming a Rule 40 company, which will result in a significant increase in free cash flow generation, as well as provide opportunities to further invest in our best-in-class technology, our clients, and our people. I look forward to seeing many of you in early March, as there are a number of investor conferences in the coming weeks. Operator, please open the line for questions.
Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, star one to ask a question. We will go first to Kevin Kumar with Goldman Sachs.
Thanks for taking my question. You know, pretty solid results here, particularly on ACV. I guess, you know, how much of that resiliency is just a function of kind of the sales reorg that you did last year? You know, are you seeing the efficiency improvements that you're hoping for?
Kevin, I'll take the first part of that. I think that. I think it's not a surprise that we would expect to start to see better engagement with our target organizations, our existing clients, because there's so much more focus and capacity in the company around those clients.
Those clients are precious to us, not only because they actually we get, you know, $1 billion of ACV from them, but also because there's, you know, tens of billions of dollars of opportunity within those clients for the future. I do think that that was helpful, that recalibration to the, you know, the core of our client base. I don't, I don't think I would necessarily claim victory on efficiency and go-to-market at this stage, you know, if it's still early. I would say we do see a connection between efficiency and engagement with those exact orgs. Alan?
Yeah. We're very much still in the midst of the process of, you know, having the changes take root. The good news is the changes have been architecturally made. The allocation of resources to the organizations, the reallocation of resources to roles that we think make the most sense in this environment, those things have been announced as part of the kickoff of the year. You know, we spent a good chunk of last year figuring out exactly what we wanted to do because this was, I think, a pretty material change to the go-to-market. I'm seeing the evidence, both from the increased engagement that some of our staff is having, but also from the response from clients that this is all very, very positive. And I think it's gonna lead to the results we expect.
That's great. Just a question on the license, term license revenue in the quarter. I think that number was quite a bit higher than kind of where Street was at. You know, anything to call out in terms of pull-forward deals? Was that just kind of a return to kind of a natural cadence of Q4-type dynamics? Thank you.
Yeah. Good question. I think the last point you just made is absolutely true. At year-end, there tended to be in Q4 a little bit of a higher client cloud versus Pega Cloud mix. I think that that's definitely a factor. We also, as I mentioned, last year, we had a number of our deals go into backlog at the end of the year, which then carried into revenue of Q1 of 2022. This year, the timing of some of those deals just happened to be that the revenue came in in Q4 versus Q1 of 2023.
I do think the mix was not unexpected, and I think the timing of it was just some, you know, depending on whether a deal hits on, you know, December 31st or January 1st, sometimes is a difference between whether it comes into revenue or it goes into backlog.
Great. Thank you both.
Sure.
We'll go next to Steve Enders with Citi.
Okay, great. Thanks for taking the question here. I guess I just do wanna clarify a little bit on what you are seeing on the outlook, particularly with regards to macro. Yeah, if I'm interpreting it right, it seems like, you know, maybe to date you haven't really seen much of the impact in terms of deal cycle slowing down and those sorts of things that I think you typically think about in a tough macro, but it seems like it's being embedded in the guide. I guess, is that fair to say, and I guess how should we kinda think about, you know, some of the other underlying assumptions that you're thinking about there?
Well, I, you know, I think they're reflected in the selection of 11%-13% as kind of the guideposts. It's a bit schizophrenic, you know, candidly, because, you know, clearly there are impacts. I would tell you that the mood, talking to other CEOs, is kind of a little bit dour, but, you know, not about us. Particularly for the ones that we're most worried about, which is the, you know, very large and candidly more sophisticated companies. I think that the market impact and the economic impact is going to be way more pronounced on the SMB-type market, which we so, you know, As we entered last year, we did a conscious re-pivot away from that market, which we had pivoted towards, sadly, I think wasting a lot of money.
We re-pivoted away from it, and that, you know, was a re-pivot that even began before the Ukraine action. I think that's gonna be what gives us a lot more resiliency than many other firms in this market.
I would also add just one additional point, which is, I'm sure you've heard this from other companies like Pega. When you have time periods where budgets may be compressed, there is a tendency for client spend to concentrate with known vendors or known value propositions in terms of the investment of that incremental budget. That plays into our strategy as well if that occurs.
Okay. No, that's helpful context there. I guess maybe, you know, competitively, have you kinda seen any change in any kind of market dynamics, you know, out there? I know that, you know, one of your competitors has been, you know, putting out some more negative news out there. Just trying to understand what impact that's, you know, potentially having at this point with some of the recent changes there.
Yeah. I'm not going to rise to that bait, as tempted as I might be. The reality is. I think the competitive dynamics are pretty much as we've seen them. There is belief I'm seeing in particularly larger companies, that they have a lot of risk of creating a new generation of technical debt with low-code and no-code approaches that are kind of, you know, these little standalone things. This idea of an enterprise app factory and the idea of having an architecture that can empower citizens, but can do it in a way that it looks sane to the folks in technology who are going to have to possibly maintain it a long time. There's a lot of appetite for that level of, I would describe it as selectivity and sophistication.
I think that that positioning helps us enormously and is really competitively advantageous compared to, you know, all the companies who use this language. The fact is, we've been talking about doing this as an enterprise capability pretty uniquely for the last couple of years. I would say the competitive dynamics are gonna be much worse for organizations that are I would describe as kinda more low end or more ephemeral, as opposed to organizations that are capable of doing really, you know, you need to be able to, and wanna be able to do easy things, but are also capable of doing the more challenging things too.
Okay, great. Thanks for taking the questions.
We will move to our next question from Rishi Jaluria with RBC Capital Markets.
Hi, this is Richard on for Rishi Jaluria. Thanks for taking my question. I guess one just on the on some of the expansion with existing logos. As we look forward to next year, how should we kinda think about that mix? On top of that, you know, what are some of the upsell drivers that you're kinda encouraged by or that you see kinda driving that growth as we head into next year?
I'll take the first part of that, and I'll let Alan take the upsell drivers. The first part of that is you're absolutely right that, you know, a few years ago, we were getting 75%-80% of our ACV growth from existing logos. If you go back and look at the last couple quarters and then project out what we think that number will be in 2023, that number will be, you know, well in excess of 90% of our ACV that will come from our existing clients. That doesn't mean that we won't get new logos. It doesn't mean that we won't even decide that new logos are an opportunity that we wanna, you know, push the accelerator on in the future.
For 2023, the new logos that we get will be very targeted, and in many cases, not the average deal size of some of the upsell and expansion of our existing clients. Think about that number being in excess of 90%. Alan, talk, you know, talking about some of the ways that the opportunities we see there are examples.
Yeah, you know, what's interesting about talking about quote logos is, you know, we don't really generally consider it a new logo, even when we go into an entirely distinct division of one of the major companies that we do business with.
What I'm seeing, which is encouraging both for the strategy and I think for what we can do, in what might be a tough economic time, is the level of engagement with very significant companies of, you know, picking up despite travel restrictions in some cases and wanting to come into Cambridge for, you know, having a company come into from Australia for three days in the Cambridge office so we can work to help them redesign how we can spread into other areas of their business, is exactly the type of thing that we wanted to have happen and was frankly not really happening as much.
Now we're seeing that, and it's, I just think a conscious result of the, increased focus, the increased depth of understanding and really working to be more trusted advisors with these clients, which is, an investment of a lot of energy and a much more consultative approach as opposed to a transactional approach. We're seeing that response, from clients and makes us, you know, believe this is working and will work.
Got it. That's very helpful. Just as a follow-up, with some of the ISV and global system integrator partnerships that you've had, it seems to be picking up a bit in, you know, recent quarters. I know Pega Launchpad has been a good driver there, but just kinda as we think about the relationships there and kinda what your strategy is on a go-forward basis with some of the partner ecosystem, is there any update there?
What's interesting is that I think that the change of relationship with our partners regarding the new strategy has actually played to the way a lot of them are working, which is a lot of them are concentrating on what they call their sometimes they call them their diamond customers, you know, their customers, which whom they have the most significant relationships. What we have stressed, it is the responsibility of our on-the-ground account teams to meet and to know and to be really face-to-face with the key partner at a major organization. Think a top telco or top bank. They need to build those direct relationships as opposed to thinking of that as something that comes through some sort of third party there.
That I think is very, very positive, I'm seeing a real enthusiasm from partners as well as from of our staff from having taken that responsibility on directly. I hope that makes sense to you in terms of, you know, saying it's the person on the ground, you know, at Citibank that's going to be responsible for making sure that the partners who work there have direct relationships and can build a sense of trust. Relative to ISVs and Launchpad, you know, I just want to be clear that, you know, we're not expecting Launchpad to be a significant revenue producer in 2023, we are really excited about what the potential is there and the uptake.
We are getting interest from, a lot of companies, a lot more companies than frankly we're in a position to be able to service. We didn't tee up any Launchpad revenue in any material way for any of the numbers that we've got here. That I think is really something we hope to be able to talk a lot about in 2024.
Got it. That's very helpful. Thank you.
We'll move on to our next question from Pinjalim Bora with J.P. Morgan.
Hey, guys. Thank you for taking the questions, and congrats on the quarter. Ken, just one question on the ACV growth guidance. Can you help us understand maybe your approach to building that guidance? I'm trying to understand what kind of assumptions you're baking in. Are you kind of taking the pipeline entering and using kind of the close rates you saw in Q3, Q4, flowing that through the year? Are you taking a step down in those close rates? Maybe you're thinking some of the expansion rates ticking down. Just help us understand some of those levers.
Sure. There's a few factors that we typically look at. Naturally, we do look at pipe. We also look at pipe in the organizations that we're focused on in terms of coverage. Is it an existing client? We look at the pipe connected to events like renewals, for example, because naturally.
ladies and gentlemen, please stand by while we work to reconnect the speakers. Thank you.
Pinjalim, can you hear me?
Yes.
Sorry. Right. We dropped again. Let's try that one more time.
Listen, I want to be clear. Ken is not dropping the mic.
Yeah.
We're happy to sit here and answer whatever other questions you've got.
We're not sure why our phone line dropped, but there's no power issue or anything. We look at pipe. We look at renewal events because renewal events tend to tie to higher quality pipe. We look at where that pipe's coming from. Quite frankly, some of this, you know, we don't have. We have enough clients that we can actually look at the specific pipe and probability adjust the pipe as opposed to using broader level statistical analysis on close rates, et cetera, across a bigger population.
There's a bunch of factors that play in, and then there's another factor with it, which is basically a little bit more of the nuanced feeling of who or how many AEs, what are the tenured AEs, what are the orgs we're covering, what's the momentum with those. There's a quantitative measure that we use, and then there's also some qualitative factors that we use to kind of triangulate on what we think that number would be. It is not, we're not using historical close rates or Q4 close rates. It's very specific to the orgs and the pipe that we see.
I see. Okay. Thank you. Thank you for that color. Can you talk maybe, help us about the changes that you made with the RIF in the sales org going into this year? Apart from that, obviously in Q4, I see as you were pointing out, the S&M was down. What how where are you seeing that efficiency beyond the RIF?
There was some cost calibration that we did in the middle of the year that you may recall in the July timeframe. In Q4, you really saw that come in to some of our savings. Maybe many people weren't expecting to see it at the level that it came in in Q4. Then you have the adjustment that we did to the, you know, the reduction that we talked about, which had its impact. That did not impact Q4. That would have impacted Q1 and beyond in terms of savings because none of those actions happened until Q4 was closed out. To your point on.
Yeah
...where are we seeing the efficiency, the biggest efficiency driver, the biggest efficiency driver in sales and marketing that we're focused on is the ratio of non-primary quota carriers to primary quota carriers on our key organizations, on our target organizations, excuse me. That ratio had expanded when we did things like what Alan said, like where we actually were going after new logos. We actually had partners trying to drive pipe, et cetera. We really focused on our account executive being the quarterback, so to speak, for the account and the right level of support for that organization, and then tying the yield that we expect to get from that cost build-up that we make around the organization. Really focus...
That is where we're going to drive efficiency because it's going to tie our productivity to the investments that we make around regions, orgs, verticals.
If we're in a position where we have account execs and account teams who are focused on, you know, a very, very specific target organization, that's a very different, and candidly, a tremendously more efficient model when you already know people in that organization, to get to know more people and to have the trusted credibility in that organization than the alternative which we had much more of what I would describe as a lead response approach, where we would be looking for people in often new organizations, you know, who had the classic qualification activity of, you know, BANTs. They have budget authority, you know, need and a timeline. We're not in that business. We're now in the business of building and deepening critical relationships with, you know, think Fortune 2000 companies.
Yep. Understood. Thank you very much.
I hope we haven't lost you again.
Thank you. We'll go to our next question from Steve Koenig with SMBC Nikko.
Hi. Thanks, gentlemen, for taking my questions. Both kind of financial questions here. First one is a little bit in the weeds, but, kind of parse out based on the commentary you've offered, is there a mix shift a little bit to cloud this year 'cause you're forecasting 6% revenue growth, but 12% ACV growth?
No. Good question, Steve. That really relates to the amount of backlog that we had at the end of 2021 that rolled into 2022 in Q1 of last year. That actually kind of makes the optics a little bit weird because of the timing of revenue.
Mm-hmm. That makes sense, actually. Okay. That's great. Thanks. The other question may be a little bit more.
Yep.
open-ended. You haven't updated your fiscal 2025 model. You know, you talked about the investor session that's coming up in June. Maybe just a couple questions around that. You know, maybe your thought process on waiting to update that model, you know, why later? Then in terms of, like, some of the numbers, I know you're offering guidance. You're not offering that long-term guidance right now, but, you know, you look at the kind of the base case, 19% ACV growth that you had, which looks pretty questionable now. Conversely, you should probably be able to do much better on free cash flow. Can you give us any thoughts directionally on that? Kinda lastly, tied to all this, why not Rule of 30 this year? Is that potentially feasible, and what would need to happen to make that happen?
Yeah. We're not gonna preview Investor Day in terms of our long term.
Okay. Uh-huh. Yep.
We will have some commentary on that, so look forward to talking about that in June.
Yeah.
I think your comment about Rule of 30, Rule of 40-
Yeah.
I think that if we were in a normal kind of growth year in 2023, I think that was kind of the track that we were on. I still think we will, directionally, I think we'll be on our way there. The way the math might work, we'll have to see how we land on free cash flow. Keep in mind that free cash flow in 2023, remember we booked a lot in Q4, we bill a lot in Q4, and some of that cash leaks into Q1 of 2024. If you use that measure only, there is a little bit of a back-end loaded billing and collection, and that kind of puts that...
You know, until we've normalized our free cash flow model, that's one of the reasons why I talk about exits of years.
Mm-hmm. Mm-hmm. Just maybe the last follow-up on that. Do you... By mid-year, do you... In what ways might you have better visibility, you know, into the longer-term model or into fiscal 2024? Like what, you know, the first... Are there things in the first half of the year that you'd be looking for to inform, you know, that long-term model?
I think one thing that will definitely be more interesting to see after we get a few months into this year is to see how the economy shakes out in the coming months. You know, we're in February right now. I think we know a little bit more now than we knew in November, and I think we'll know a little bit more in, you know, every month that we get through the year. That will definitely inform whether 2024-
Mm-hmm.
could be a return to some level of normalcy of growth or our normalcy for growth, or whether 2024, you know, may be, you know, a continuing-.
Mm.
You know, challenged year like we think 23 will start. I think we're, you know, we're not... I think we're seeing signs that this may not be, you know, you know, maybe a 2023 beginning of the year kind of situation, but we'll have to see how that goes.
Got it. Okay, great. Hey, thanks a lot. Appreciate being able to ask questions.
Thanks, Steve.
we'll go next to Joe Mearus with Truist.
Hey, guys. Nice quarter. Thanks so much for taking the questions. I appreciate it. We hear a lot from companies in the space about this theme of vendor consolidation. We've been hearing about it for, I think, a few years now, but it doesn't ever seem to have any specific examples behind it. I'm curious if, like, the first part of the question is, have you seen any, like, actual evidence of that? If not, do you think it's still on the come and can provide some upside to the guidance for 23?
I think the clearest manifestation of vendor consolidation is the reluctance to introduce new vendors. Which, I think you actually, if you look, you'll see it. Which is, you know, not great for folks who aren't in the places they want to be. That I think, you know, candidly, you've seen that historically as well, and I think you'll see that more now.
Yeah, I think I've heard that. I've heard the same thing you've heard, Joe, for a number of years, you know, predating my joining Pega. I think the reality is, what I think supply chains are really trying to say is, you add a vendor, you drop a vendor, right? You don't actually go out and just keep, like, proliferating vendors, software vendors, and really end up with, like, six systems that do the same thing. I actually think supply chain and budget owners are thinking about that. I don't know that they can actually. You can't force an ERP vendor to do a CRM or force CRM to do ERP. I mean, you are limited with that.
I do think there's a focus on not having this constant creep of new technologies that actually do the same thing as other technologies.
And we are seeing people who are interested in consolidating, for example, different workflow systems into, you know, that's one of Pega's core strength. We're, you know, retiring things that weren't able to scale the way they wanted or that, you know, have turned into, you know, technical debt. You know, that's a positive for them. I suppose I would put that under the vendor consolidation, but it's I think a little closer to what Ken's saying. You know, it's, you know, it's not like the number of vendors is gonna go down by 35%.
Got it. That's great. That's all helpful. Just as a follow-up, I think last quarter you had mentioned that $1 million purchases were higher than Q2 or Q1. I'm just curious how $1 million purchases trended in the fourth quarter. Thanks, guys.
That was a fairly typical quarter in terms of the number of deals that we engaged with over $1 million. It was not a whale kind of quarter or, quite frankly, a whale kind of year. I think the deals were dispersed around a lot more engagement in a broader engagement with our clients. We didn't get there on any one or two deals.
Makes sense. Thanks, guys.
With that, I think, I'm.
Thanks, Joe.
I'm sorry to say that the time is up. I really do apologize for some of the technical difficulties. I am sure you will shake down our Waltham office quite rigorously. We are always available to talk to you guys, informally as I think many of you know. I want to reiterate the importance of coming to PegaWorld, June 11th-13th. We're gonna have a lot of very cool new stuff to show. I'd like to thank all of you for, you know, joining us on this call and let you know we're all working hard to drive a successful business. Have a great evening. Thanks.
Thanks, everyone.
This concludes today's call. Thank you for your participation. You may now disconnect.