Pegasystems Inc. (NASDAQ: PEGA) — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023; filed July 26, 2023. Financial statements are unaudited. Pegasystems develops enterprise workflow automation and decisioning software, with a strategy shifting toward subscription-based arrangements.
Financial performance
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Revenue | $298.3M | $274.3M | $623.7M | $650.6M |
| Gross profit / margin | $202.1M / 68% | $179.2M / 65% | $429.7M / 69% | $467.3M / 72% |
| Operating loss | $(41.3)M | $(85.0)M | $(63.5)M | $(66.4)M |
| Net loss | $(46.8)M | $(286.3)M | $(67.6)M | $(286.7)M |
| Diluted loss per share | $(0.56) | $(3.50) | $(0.82) | $(3.51) |
- Q2 revenue rose 9%, led by subscription services, up 15% to $197.1M. Pega Cloud revenue grew 23% to $115.1M; subscription license revenue was nearly flat. Consulting revenue was $58.4M, while perpetual license revenue declined 30% to $1.6M.
- First-half revenue declined 4%. Subscription services increased 13% to $384.6M, but subscription license revenue fell 30% to $125.7M, primarily reflecting large license contracts recognized in the prior-year period. Consulting declined 7% and perpetual license revenue declined 80%.
- Q2 gross margin improved to 68%, including improved Pega Cloud cost efficiency. First-half gross margin decreased to 69%, with lower subscription-license revenue and consulting gross losses contributing to the decline.
- Operating expenses fell 8% in Q2 and 8% in the first half, mainly from lower selling and marketing compensation following go-to-market workforce optimization and lower legal fees. R&D increased 2% in the first half. Restructuring expense was $3.6M for the first half.
- Reported losses include income tax provisions of $6.6M in Q2 and $11.9M in the first half. The effective tax rate for the first half was negative 21%; management cited valuation allowances on U.S. and U.K. deferred tax assets and U.S. current taxes. Prior-year tax provisions were substantially higher.
Cash, liquidity and capital
- First-half operating cash flow was $113.8M, versus cash used of $5.1M in 2022. Management attributed the improvement primarily to client collections and cost-efficiency initiatives. Non-GAAP free cash flow was $122.5M versus $11.9M, with a 20% margin versus 2%; this measure adds back specified items, including capital expenditures, certain legal fees, restructuring and note interest.
- Cash, cash equivalents and marketable securities totaled $312.8M at June 30, 2023, compared with $297.2M at year-end 2022. Current assets were $737.5M and current liabilities $461.1M. Deferred revenue was $311.3M, down from $325.2M.
- Convertible notes had $502.3M principal outstanding, due March 2025. During the first half, Pegasystems paid $89.0M to repurchase $97.7M principal; it recognized $7.9M of gains on note repurchases. No cash was drawn on the $100M revolving credit facility; $27.3M of letters of credit reduced availability. The facility expires in November 2024 and includes financial covenants.
- The company paid $5.0M in dividends during the first half and stated it intends to continue a quarterly dividend of $0.03 per share, subject to board discretion. The share repurchase program was extended through June 30, 2024, with $60M authorized; no program repurchases were reported for the first half.
Business indicators, outlook and material risks
- Annual contract value was $1.164B, up 13% year over year; constant-currency ACV was $1.159B, also up 13%. Backlog was $1.266B, up 12% year over year, or $1.258B on a constant-currency basis. These are company performance measures, not GAAP revenue.
- Management said current cash, operating cash flow and borrowing capacity should fund operations, repurchases and dividends for at least the next 12 months. The filing provides no specific earnings or revenue guidance. Management cautioned that interim results do not necessarily indicate full-year results.
- Appian litigation: A Virginia jury awarded approximately $2.037B in damages, and the court entered a judgment of approximately $2.060B plus post-judgment interest. Pegasystems appealed; the judgment was stayed during the appeal, secured by a $25M letter of credit. Appellate briefing was complete, but oral argument had not been scheduled. The company said it could not reasonably estimate possible damages and had accrued no litigation losses.
- A securities class action motion to dismiss was denied as to Pegasystems and its CEO; it was granted without prejudice as to the CFO in a July 24, 2023 written opinion. Related derivative litigation and an SEC inquiry into, among other matters, accounting for the Appian litigation were also disclosed. Pegasystems said it was cooperating with the SEC and intended to defend the lawsuits.
- Other stated risks include subscription-model transition, revenue-recognition timing, client demand and retention, foreign exchange, debt covenant compliance, cybersecurity, and ongoing litigation. Management reported disclosure controls were effective as of June 30, 2023.
Important facts for investors to verify
- Appian appeal developments, interest accumulation, possible accounting consequences, and the status of the SEC inquiry.
- Whether Pega Cloud growth, ACV and backlog convert into recognized revenue and cash, particularly as subscription license revenue declines.
- Operating cash generation, deferred revenue trends, and compliance with the credit facility’s liquidity and EBITDA covenants.
- The March 2025 note maturity and the company’s capacity to meet it while sustaining dividends and other commitments.
- Future tax-asset realizability and the effect of the U.S. and U.K. valuation allowances on reported results.