Pegasystems Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Unaudited financial statements; amounts below are in millions of dollars unless stated otherwise. Pegasystems develops and licenses enterprise software and provides related maintenance, cloud, consulting, and training services.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $179.8 | $182.8 | $601.0 | $550.7 |
| Gross profit | $110.1 | $122.4 | $395.3 | $373.6 |
| Operating income (loss) | $(14.3) | $5.5 | $18.7 | $26.0 |
| Net income (loss) | $(1.8) | $3.3 | $36.6 | $18.2 |
| Diluted EPS | $(0.03) | $0.04 | $0.44 | $0.23 |
| Operating cash flow | Not provided by quarter | Not provided by quarter | $113.9 | $20.6 |
- Q3 revenue declined 2% year over year, while nine-month revenue increased 9%. Q3 license revenue fell 39% to $41.8 million; maintenance rose 13% to $62.2 million and services rose 29% to $75.8 million.
- Nine-month license revenue decreased 6% to $195.2 million; maintenance increased 11% to $180.8 million and services increased 25% to $225.1 million. Cloud revenue grew 20% to $36.9 million for the nine months.
- Gross margin was 61% in Q3 versus 67% a year earlier, and 66% for the nine months versus 68%. Management attributed the quarterly decline to a shift from perpetual to term licenses and a greater share of lower-margin services revenue.
- Operating margin was -8% in Q3 versus 3% and 3% for the nine months versus 5%. Operating expenses increased 6% in Q3 and 8% year to date, including higher compensation, headcount, and stock-based compensation.
- Nine-month net income included a $18.0 million income tax benefit, primarily reflecting excess tax benefits from stock compensation. Q3’s $12.9 million tax benefit helped limit the reported net loss; management cautioned that such tax benefits may make effective tax rates volatile.
- Operating cash flow rose to $113.9 million from $20.6 million, driven chiefly by $80.6 million from accounts receivable, largely reflecting collections and billing timing. Investing cash use was $12.0 million and financing cash use was $44.0 million.
Liquidity, capital and balance sheet
- At September 30, cash and cash equivalents were $130.6 million and marketable securities were $63.8 million, totaling $194.4 million, versus $133.8 million at year-end 2016.
- Current assets were $438.1 million and current liabilities $267.0 million. Total liabilities were $293.4 million. The balance sheet reports no borrowings or debt.
- Deferred revenue totaled $167.1 million, down from $186.6 million at December 31, 2016. Accounts receivable, net, was $191.2 million, down from $265.0 million.
- Cash used for dividends was $6.9 million and for share repurchases was $3.0 million; an additional $34.1 million was used for shares withheld in equity-award tax settlements. The quarterly dividend was $0.03 per share. Management said it currently intends to continue that quarterly dividend, subject to Board discretion.
- Management believes available cash, securities, and operating cash flow will fund operations, dividends, and the repurchase program for at least 12 months. About $61.1 million of cash was held by foreign subsidiaries; repatriation could result in U.S. tax.
Business trends, outlook and risks
- Annual Contract Value (ACV) was $449.0 million, up 17% year over year; term-license and cloud ACV increased 23%, and maintenance ACV increased 13%. License and cloud backlog was $547.6 million, up 29%.
- Management reported maintenance renewal rates significantly above 90%. Services growth reflected higher billable hours, including a large project that began in the second half of 2016; cloud growth reflected expansion of the client base.
- The filing provides no formal numerical full-year guidance. Management noted that interim results are not necessarily indicative of full-year 2017 results.
- Pegasystems planned full retrospective adoption of ASC 606 beginning January 1, 2018. Management expected earlier recognition of certain term and perpetual license revenue, changes in allocation among performance obligations, earlier recognition of some professional-services revenue, capitalization and amortization of qualifying contract acquisition costs, and related tax effects. The timing of revenue and reported backlog-to-revenue conversion may therefore change.
- Future receipts from unbilled committed license and cloud arrangements totaled $497.0 million at September 30, 2017, up from $376.3 million a year earlier. The company cautioned that amounts shown for 2018 and later may not be recognized in those periods after ASC 606 adoption.
- Risks highlighted include variability in demand and license-revenue timing, reliance on third parties, international operations and foreign exchange, cyberattacks and security breaches, acquisitions, and managing growth. The forward-contract hedging program was discontinued in May 2017; no contracts were outstanding at quarter-end.
- One client represented 10.6% of Q3 revenue and 12.4% of quarter-end gross trade receivables. Management reported no material changes to previously disclosed risk factors and concluded disclosure controls were effective.
Key facts for investors to verify
- Whether license mix and deal timing continue to pressure quarterly revenue, gross margin, and operating profitability.
- Whether service growth and delivery capacity can be sustained without reducing services margins; assess dependence on large projects.
- How much of the reported backlog and future unbilled receipts converts to revenue and cash, particularly under ASC 606’s retrospective adoption.
- Whether operating cash generation remains strong after the substantial receivables-related working-capital benefit in the first nine months.
- The continuing effects of stock-based compensation and related excess tax benefits on expenses, dilution, and tax-rate volatility.
- Customer concentration, foreign-currency exposure without active forward contracts, and the sustainability of dividends and repurchases.