Pegasystems Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Unaudited results; dollar amounts below are in millions unless noted.
Business context and reporting period
Pegasystems develops enterprise software for customer engagement and digital process automation, including its low-code Pega Platform and hosted Pega Cloud services. Management describes an ongoing shift toward subscription arrangements. The filing says COVID-19 had not materially affected results or financial condition through June 30, 2020, but its eventual impact remained uncertain.
Financial performance and liquidity
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Revenue | $227.4 | $205.6 | $493.0 | $418.1 |
| Gross profit / margin | $150.7 / 66% | $128.5 / 63% | $336.7 / 68% | $266.6 / 64% |
| Operating loss | $(51.4) | $(52.3) | $(75.8) | $(86.4) |
| Net loss | $(20.7) | $(32.3) | $(46.1) | $(61.0) |
| Diluted loss per share | $(0.26) | $(0.41) | $(0.58) | $(0.77) |
| Operating cash flow | Not presented quarterly | $(21.2) | $7.7 |
Q2 revenue grew 11%; first-half revenue grew 18%. Subscription revenue (term license, Pega Cloud and maintenance) rose 31% in Q2 and 38% in the first half. Pega Cloud revenue increased 54% and 55%, respectively. Consulting revenue fell 12% in Q2 and 6% in the first half; perpetual license revenue fell 53% and 63%. Management attributed the mix shift to client preference for subscriptions. First-half gross margin improved, while consulting gross profit margin declined to 1% from 7%.
Operating expenses increased 12% in Q2 and 17% in the first half, primarily reflecting higher compensation, headcount and equity compensation in sales and marketing and R&D. Q2 net loss includes a $19.4 million gain from capped-call fair-value changes; the first-half gain was $0.8 million. The first-half income tax benefit was $36.1 million, with management citing stock-based compensation tax benefits and a CARES Act carryback benefit, partly offset by GILTI.
Cash and cash equivalents were $512.1 million at June 30, versus $68.4 million at December 31, 2019. First-half investing cash outflow was $19.4 million, including $19.1 million for property and equipment. Financing cash inflow was $485.3 million, principally from issuing $600 million of convertible notes, net of capped-call purchases and issuance costs. Cash was $468.2 million at U.S. entities and $43.9 million at foreign entities.
Total assets were $1,496.3 million and total liabilities $940.0 million at June 30. Current assets were $969.9 million and current liabilities $356.1 million. The company reported $600 million principal amount of 0.75% convertible notes due March 2025, with a $509.4 million net carrying amount; no principal payments are required before maturity. It had no borrowings on its $100 million revolving credit facility. The company said cash, operating cash flow and borrowing capacity should fund operations and quarterly dividends for at least 12 months.
Material changes versus the prior comparable period
- Revenue growth was led by subscription offerings, especially term licenses and Pega Cloud; perpetual licenses and consulting declined.
- Backlog rose 30% year over year to $817.2 million, and annual contract value (ACV) increased 21%, as reported by management.
- Operating cash flow moved from $7.7 million provided in the first half of 2019 to $21.2 million used in the first half of 2020. Management cited the subscription mix, which generally collects cash over service periods, and increased investment in Pega Cloud and selling and marketing.
- The February 2020 convertible-note issuance added substantial debt and cash proceeds. First-half share repurchases were $43.5 million and dividend payments were $4.8 million.
Outlook, risks and unusual items
No specific quantitative revenue or earnings guidance is provided in the supplied filing text. Management expects the revenue mix to continue shifting toward subscriptions, particularly Pega Cloud, which could slow total revenue growth in the near term. It also cautioned that the shift may restrain operating cash-flow growth or result in negative cash flow in the near term. Management reported Pega Cloud revenue growth of 55% year to date.
COVID-19 reduced travel and consulting billable activity and led to a virtual-only PegaWorld event and remote work measures. Management said the pandemic could delay sales, affect client spending and contract terms, and disrupt clients, vendors or partners; the ultimate impact was not estimable. Q2 selling and marketing expense included a $2.8 million reduction from a favorable settlement of event cancellation fees.
Other risks include the notes’ potential cash repayment obligations, conversion-related dilution, debt covenant compliance, capped-call counterparty exposure, foreign-exchange movements, and the execution and cash-flow effects of the subscription transition. The credit facility has a maximum net leverage covenant of 3.5 and minimum interest coverage covenant of 3.5. Purchase obligations, investment commitments, uncertain tax positions and operating lease obligations totaled $240.4 million. One client represented 11% of receivables at June 30.
Important facts for investors to verify
- Whether subscription and Pega Cloud growth, backlog and ACV convert into recognized revenue and operating cash flow as expected.
- The composition, timing and collectability of $307.6 million in unbilled receivables, including the 11% receivables concentration.
- The effective economic cost, conversion terms, potential dilution and future cash obligations associated with the $600 million notes; the capped calls are subject to a $196.44 cap price.
- Whether COVID-19, reduced consulting activity and continued investment affect demand, margins, cash flow or liquidity beyond the period reported.
- The sustainability of dividends and repurchases given operating cash outflow, contractual obligations and the board’s ability to modify the dividend program.