Pegasystems Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Unless otherwise indicated, dollar amounts below are in millions. The company develops and licenses enterprise software and provides maintenance, consulting, training, and cloud services. Its reportable segment is Digital Enterprise Business Solutions.
Financial performance
| Metric | Q3 2014 | Q3 2013 | First 9 months 2014 | First 9 months 2013 |
|---|---|---|---|---|
| Revenue | $137.6 | $122.0 | $421.1 | $355.6 |
| Gross profit / margin | $91.2 / 66% | $83.9 / 69% | $282.1 / 67% | $241.9 / 68% |
| Operating income / margin | $5.0 / 3.6% | $13.8 / 11.3% | $21.8 / 5.2% | $33.8 / 9.5% |
| Net income | $1.9 | $8.7 | $13.2 | $22.5 |
| Diluted earnings per share | $0.02 | $0.11 | $0.17 | $0.29 |
| Cash provided by operating activities | Not reported separately for the quarter | Not reported separately for the quarter | $98.3 | $83.4 |
- Q3 revenue grew 13%; nine-month revenue grew 18%. Q3 license revenue increased 8%, maintenance 24%, and services 7%. For the first nine months, those categories rose 21%, 23%, and 12%, respectively.
- Operating expenses increased 23% in Q3 and 25% year to date, outpacing revenue growth. Research and development expense rose 44% in Q3 and 36% year to date; selling and marketing expense rose 14% and 18%, respectively.
- Services gross margin declined to 5% from 16% in Q3 and to 7% from 15% year to date, reflecting higher employee and subcontractor costs, projects whose revenue had not yet qualified for recognition, and weaker European utilization. Total gross margin also fell.
- Foreign-currency transaction losses were $2.8 million in Q3, versus a $0.7 million gain a year earlier. Nine-month losses were $2.5 million versus $1.7 million.
Balance sheet, liquidity, and capital
- At September 30, cash and cash equivalents were $136.5 million and marketable securities were $92.0 million, totaling $228.6 million, up from $156.7 million at December 31, 2013. Current assets were $366.4 million and current liabilities $211.8 million.
- Accounts receivable, net, was $103.4 million, down from $165.6 million at year-end. Management attributed increased operating cash flow primarily to strong collections.
- Total liabilities were $270.9 million; the balance sheet lists no borrowings or other debt balance. Deferred revenue totaled $148.9 million, compared with $144.9 million at year-end.
- Nine-month investing cash outflow was $22.5 million, including $5.8 million of property and equipment investment and $2.6 million for acquisitions, net of cash acquired. Financing cash outflow was $17.4 million, including $12.3 million in share repurchases and $4.6 million in dividends.
- The company declared dividends of $0.03 per share in Q3 and $0.075 per share in the first nine months. Management said it currently intends to pay a quarterly $0.03 dividend, which the board may modify or terminate. About $58.7 million of cash and equivalents was held in foreign subsidiaries; repatriation could result in U.S. tax.
Material developments, outlook, and risks
- Revenue growth included higher maintenance from the installed base and renewal rates, and higher cloud revenue as the client base expanded. License-contract value executed rose year over year; management cited a perpetual license arrangement exceeding $10 million in Q2 2014. License revenue timing varies with contract mix, payment schedules, and acceptance or other recognition criteria.
- At September 30, contractual future cash receipts from existing license and Pega Cloud arrangements were approximately $265.3 million, versus $248.4 million a year earlier. Management expected to recognize $7.1 million from specified perpetual-license payments and $21.3 million from term-license and cloud arrangements in Q4 2014, in addition to new agreements or prepayments. These are contractual receipts and expected recognition, not a full-year revenue forecast.
- Management said current cash, securities, and operating cash flow should fund operations, dividends, and the share-repurchase program for at least the next 12 months. No formal earnings or revenue guidance was provided in the filing.
- Acquisitions included MeshLabs in April and Profeatable in July 2014. Profeatable provides Firefly co-browsing technology; MeshLabs adds social listening and text analytics capabilities. Ultima IT was acquired on October 31, after quarter-end, for $3.1 million in cash consideration, with potential additional milestone payments. Antenna, acquired in October 2013, was integrated into operations; its acquired intangible assets contribute ongoing amortization.
- Management identified demand variability, timing of license-revenue recognition, global market uncertainty, consolidation in financial-services and healthcare markets, reliance on third parties, and managing growth as risks. It reported no material changes to the risk factors in the 2013 Form 10-K.
- The company had not entered into foreign-currency forward contracts since February 2014 while reassessing its hedging strategy. Exposure is primarily to the British pound, euro, Australian dollar, and Indian rupee.
- Other notable items: the company recorded $0.2 million of Q3 restructuring expense related to Antenna-associated facility space; stock-based compensation was $13.7 million for the first nine months, up from $9.7 million; and the two-for-one stock split effective April 1, 2014 is reflected retrospectively in share and per-share figures.
Important facts for investors to verify
- Whether revenue growth, particularly license and maintenance growth, continues while operating expenses grow faster than revenue.
- Whether services utilization and margins recover, especially in Europe, and whether deferred project costs convert to recognized revenue.
- The timing and collectability of the $265.3 million of contractual future receipts, and the variability of license revenue recognition.
- The source and sustainability of operating cash flow, including the contribution from receivables collections and the effect of future working-capital changes.
- Foreign-exchange exposure and the company’s hedging approach, along with the possible tax cost of repatriating foreign-held cash.
- Acquisition integration, potential milestone payments, and ongoing amortization and restructuring costs.