Pegasystems Inc. — Q1 2017 Form 10-Q
Business context and period. Unaudited results for the three months ended March 31, 2017, compared with Q1 2016. Pegasystems develops and licenses enterprise software and provides maintenance, cloud, consulting and training services. It reports one operating segment.
Financial results and liquidity
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $223.2 million | $178.9 million | +25% |
| Gross profit / margin | $155.2 million / 69.5% | $122.3 million / 68.4% | +27% |
| Operating income / margin | $31.2 million / 14% | $14.1 million / 8% | +121% |
| Net income | $27.0 million | $10.4 million | +160% |
| Diluted EPS | $0.33 | $0.13 | +154% |
| Cash from operations | $32.4 million | $10.0 million | +$22.4 million |
Revenue comprised software licenses of $92.4 million (+35%), maintenance of $59.0 million (+11%), and services of $71.9 million (+25%). Recurring revenue was $123.5 million, up 7%, and represented 55% of total revenue versus 65% a year earlier; the prior-year proportion was elevated by a large three-year term license recognized in full.
At March 31, cash and cash equivalents were $83.8 million, marketable securities $63.9 million, and combined cash, equivalents and securities $147.8 million, up from $133.8 million at year-end. Current assets were $441.6 million and current liabilities $279.6 million. The balance sheet does not list borrowings or debt. Operating, investing and financing cash flows were +$32.4 million, -$3.7 million and -$16.0 million, respectively. Financing outflows included $2.3 million of dividends and share repurchases/stock-award net settlements. Quarterly dividend declared: $0.03 per share.
Material changes and management commentary
- Perpetual license revenue increased 176% to $38.7 million, while term license revenue declined 1% to $53.7 million. Management attributed the term-license comparison to the unusually large prepaid arrangement recognized in Q1 2016.
- Consulting revenue rose 26%, driven partly by a large project begun in the second half of 2016. Services gross margin improved to 17% from 14%; management said Q1 2017 included revenue on a delayed project whose costs had been recognized in 2016.
- Maintenance growth reflected installed-base expansion and renewal rates well above 90%; cloud revenue grew 27% with the client base.
- License and cloud backlog was $513.1 million, up 32% year over year. Of this, $451.6 million was unbilled contractual commitments; timing of receipts may differ from revenue recognition. Management expected to recognize $78.2 million of term-license and cloud commitments and $16.0 million of perpetual-license commitments during the remainder of 2017, in addition to new arrangements or prepayments.
- Operating expenses rose 15%, including higher sales and R&D headcount and stock-based compensation, which increased 40% to $12.5 million. Management said selling capacity was being expanded across existing and new industries and geographies.
- The effective tax rate fell to 15.0% from 22.9%, mainly due to excess tax benefits from stock compensation and a more favorable mix of earnings. Management cautioned that stock-compensation tax benefits may make future effective rates volatile.
Outlook, risks and unusual items
- No specific full-year revenue or earnings guidance is provided. Management said current cash, securities and operating cash flow were expected to fund operations, dividends and the repurchase program for at least the next 12 months; the dividend may be modified or terminated by the board.
- Management cautioned that as recurring revenue grows, profit and EPS may not grow as quickly as historical trends because more license revenue is recognized over longer periods. Results also depend on license mix, deal timing, customer acceptance and revenue-recognition timing.
- ASC 606 adoption is planned for January 1, 2018 using full retrospective adoption. Management was still quantifying the effects; expected changes include earlier recognition for certain license obligations, revised allocation of contract consideration, changes to contract-modification accounting, capitalization and amortization of certain contract acquisition costs, and related tax effects.
- Foreign exchange is a key market risk. Brexit-related pound volatility may affect currency transaction gains and forward-contract losses. Forward contracts are not designated as accounting hedges; Q1 2017 reported a $0.3 million contract loss and $0.7 million foreign currency transaction gain.
- About $40.2 million of cash was held by foreign subsidiaries and may incur U.S. tax if repatriated. The filing says the potential tax was impractical to estimate. OpenSpan acquisition consideration included $7.4 million held in escrow through October 2017.
- Management reported no material change to the 2016 Form 10-K risk factors, no material change in internal control over financial reporting, and effective disclosure controls as of March 31, 2017. Interim results are not necessarily indicative of full-year results.
Investor verification points
- Check whether license and cloud backlog converts to recognized revenue and cash on the anticipated schedule, especially the unbilled commitments.
- Assess sustainability of perpetual-license growth, recurring-revenue trends and the unusually strong Q1 services margin.
- Monitor operating-expense, headcount and stock-compensation growth relative to revenue and earnings.
- Review the quantified financial and tax effects of ASC 606 when disclosed.
- Track foreign-exchange exposure, foreign cash repatriation considerations, and the board’s continuation of the dividend and repurchase program.