Pegasystems Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Unaudited consolidated results; comparative 2017 figures were retrospectively adjusted for adoption of ASC 606. Dollar amounts below are in millions unless stated otherwise.
Business context and performance
Pegasystems develops and sells customer-engagement and digital-process-automation software, including licenses, maintenance, cloud services, and consulting. Management cited a shift in customer preference toward cloud arrangements and a large term-license deal recognized in Q1 2017 as key influences on reported revenue.
| Metric | Q1 2018 | Q1 2017, adjusted | Change |
|---|---|---|---|
| Revenue | $235.2 | $256.3 | Down 8% |
| Gross profit / margin | $159.6 / 68% | $188.2 / 73% | Down 15%; margin down 5 points |
| Operating income / margin | $7.9 / 3.4% | $65.9 / 25.7% | Down 88% |
| Net income | $12.2 | $53.0 | Down 77% |
| Diluted EPS | $0.15 | $0.65 | Down $0.50 |
| Cash from operating activities | $55.7 | $32.4 | Up 72% |
- Revenue mix: Software license revenue fell 31% to $87.8 million; perpetual licenses declined 39% and term licenses 27%. Maintenance rose 10% to $64.5 million, and services rose 17% to $82.9 million. Cloud revenue, included in services, grew 50% to $15.6 million.
- Margins and expenses: Lower license revenue weighed on gross profit. Operating expenses rose 24% to $151.6 million, including selling and marketing up 27%, R&D up 16%, and G&A up 33%. Management attributed spending increases principally to higher headcount, compensation, equity awards, sales capacity, product development, and related growth investments.
- Annual Contract Value: Total ACV increased 15% year over year to $494.1 million; term and cloud ACV rose 22% to $236.0 million, and maintenance ACV rose 10% to $258.1 million. Remaining performance obligations were $291 million, of which $198.3 million was expected to be recognized before January 1, 2020.
- Cash flow: Operating cash flow was $55.7 million, with management citing $49.6 million from receivables and contract assets, largely reflecting collections and billing timing. Investing used $31.3 million, primarily for $35.2 million of investment purchases, partly offset by maturities. Financing used $23.1 million, including dividends and repurchases. Cash and cash equivalents increased $3.5 million during the quarter.
Financial position and liquidity
- At March 31, cash and cash equivalents were $165.8 million and marketable securities were $89.0 million, totaling $254.8 million, versus $223.7 million at year-end 2017.
- Current assets were $624.2 million and current liabilities $280.1 million; the current ratio was approximately 2.2. Total assets were $1,006.0 million and stockholders’ equity $662.1 million.
- Receivables totaled $498.7 million, including $333.7 million of current and long-term unbilled receivables. Long-term unbilled receivables were $180.1 million. The filing attributes their growth primarily to ASC 606’s earlier recognition of license revenue relative to billing or payment.
- The balance sheet presented does not show a borrowings or debt line; a clear debt balance is not provided in the supplied filing text.
Material changes, accounting, outlook, and risks
- ASC 606 / ASC 340-40 adoption: Effective January 1, 2018, adopted using the full retrospective method. License revenue for qualifying perpetual and term arrangements is generally recognized when control transfers, rather than as payments become due; this increased unbilled receivables. Eligible contract acquisition costs are deferred and amortized, generally over an average five-year benefit period. The standard materially changed reported prior-period revenue and balance-sheet amounts, but did not change Q1 2017 cash flows.
- Tax: The company recorded a $4.2 million income tax benefit, versus $13.6 million tax expense in Q1 2017; the effective tax rate was negative 53%, versus 20%. Management cited stock-compensation tax benefits, the U.S. federal rate reduction, and R&D credits. It expected incremental U.S. tax from GILTI and preliminarily expected not to be subject to BEAT in 2018; tax estimates under the Tax Reform Act remained subject to change.
- Liquidity and shareholder returns: Management said cash, securities, and operating cash flow were expected to fund operations, quarterly dividends, and repurchases for at least the next 12 months. The company paid $2.3 million in dividends and used $20.7 million for repurchases in financing cash flows. Its stated intention was to continue a $0.03 quarterly dividend, which the board may change or terminate.
- Outlook and risks: The filing provides no specific revenue or earnings guidance. Management highlighted uncertainty in license-revenue timing, demand and cloud-mix shifts, international operations and foreign exchange, tax-law interpretation, third-party relationships, cybersecurity, and managing growth. A hypothetical 10% U.S. dollar strengthening was estimated to reduce revenue 4% and net income 13% for the quarter. Management reported no material change to previously disclosed risk factors.
- Disclosure controls were concluded effective as of March 31, 2018; no material change in internal control over financial reporting was reported for the quarter.
Important facts for investors to verify
- How much of the year-over-year revenue and earnings decline reflects the prior-year large term-license arrangement versus ongoing demand and the shift to cloud?
- Whether ACV growth and remaining performance obligations convert to recognized revenue and cash collections on expected timelines.
- Collection and billing trends for the substantial unbilled receivable balance, including foreign-exchange sensitivity and credit exposure.
- Whether investment in sales and R&D produces growth sufficient to offset higher operating expenses and the lower near-term revenue recognition associated with cloud contracts.
- Future tax effects of GILTI and final Tax Reform Act interpretations, and the sustainability of dividends and repurchases alongside operating needs.