Pegasystems Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unaudited results; amounts below are in U.S. dollars, with financial-statement figures converted from thousands to millions. 2017 comparisons were retrospectively adjusted for adoption of ASC 606.
Business context and key metrics
Pegasystems develops and sells enterprise software for customer engagement and digital process automation, including licenses, hosted cloud services, maintenance, and consulting. Management describes a strategic shift from perpetual licenses toward term and cloud arrangements.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $196.8m | $186.6m | $432.0m | $442.9m |
| Gross profit / margin | $123.0m / 62% | $118.7m / 64% | $282.5m / 65% | $306.9m / 69% |
| Operating income (loss) | $(23.2)m | $(8.9)m | $(15.2)m | $57.0m |
| Net income (loss) | $(10.4)m | $3.7m | $1.8m | $56.7m |
| Diluted EPS | $(0.13) | $0.04 | $0.02 | $0.69 |
| Operating cash flow | Not separately stated | Not separately stated | $75.4m | $85.8m |
- Q2 revenue rose 5%; first-half revenue declined 2%. Q2 software license revenue was $44.8m, maintenance $65.9m, and services $86.1m.
- Q2 license and cloud revenue together increased 2% to $65.0m: cloud grew 61% to $20.2m, term license grew 58% to $31.3m, and perpetual license fell 57% to $13.5m. First-half license and cloud revenue decreased 16%, partly reflecting a $35.3m term-license renewal recognized in Q1 2017.
- Maintenance revenue grew 11% in Q2 and 10% in the first half; consulting and training grew 4% and 8%, respectively. Management cited maintenance renewal rates significantly above 90%.
- Operating expenses rose 14% in Q2 to $146.1m, including selling and marketing expense up 25% to $94.0m. Management linked higher selling costs to expanded sales capacity and headcount. First-half selling and marketing expense rose 26%.
- Cash, cash equivalents, and marketable securities were $243.6m at June 30, versus $223.7m at year-end. Current assets were $600.2m and current liabilities $271.5m. The balance sheet presents no borrowings or debt line item.
- First-half investing cash use was $46.4m, mainly reflecting investment purchases; financing cash use was $45.8m, including $41.1m of cash share repurchases and $4.7m of dividends. Cash and cash equivalents ended at $144.3m, down $18.0m from year-end.
Material changes and notable items
- Despite Q2 revenue growth and higher gross profit, the operating loss widened to $23.2m, principally alongside increased operating expenses. First-half operating income swung from $57.0m to a $15.2m loss.
- First-half net income was $1.8m despite the operating loss, with a $15.1m income-tax benefit. The reported six-month effective tax rate was 113%; management cited stock-compensation tax benefits, U.S. tax-rate changes, R&D credits, and settlement of a foreign tax audit.
- ASC 606 and ASC 340-40 were adopted retrospectively on January 1, 2018. Term and certain perpetual license revenue is generally recognized when control transfers; this increased unbilled receivables and changed timing of reported revenue. The adoption also introduced capitalization and amortization of certain contract acquisition costs.
- Annual Contract Value, a company-defined measure, was $514.5m, up 20% year over year; term and cloud ACV rose 31% to $250.9m and maintenance ACV rose 11% to $263.6m. Contracted revenue not yet recognized totaled $476.7m, expected to be recognized over future periods; this is not a guarantee of future revenue.
- Receivables included $320.7m of unbilled receivables, of which $169.3m was long-term. Management said the allowance for doubtful accounts was not material.
- Management said cash, securities, and operating cash flow should fund operations, quarterly dividends, and repurchases for at least 12 months. The company intended to continue its $0.03 quarterly dividend, subject to board modification or termination.
Outlook, risks, and contingencies
- The filing provides no specific revenue or earnings guidance. Management expects continued growth in term and cloud arrangements, but these revenues are recognized over contract periods, unlike licenses generally recognized at transfer.
- Management expects incremental U.S. tax from GILTI beginning in 2018 and said it did not expect to be subject to BEAT in 2018 based on its preliminary assessment. Tax estimates could change with further analysis or regulatory guidance.
- The company expects most operating leases to be recognized as right-of-use assets and lease liabilities when it adopts the lease standard in 2019, with no material effect expected on results or cash flows.
- Disclosed risks include demand variability, third-party relationships, international operations and foreign exchange, cyberattacks and security breaches, execution of growth plans, and tax-law uncertainty. Management reported no material changes to the risk factors in its 2017 Form 10-K. A hypothetical 10% strengthening of the U.S. dollar was estimated to reduce revenue by 4% and net income by 31% for the six-month 2018 period.
- The board extended the share repurchase program through June 30, 2019 and authorized up to $50m of repurchases during the program period. At June 30, $46.0m remained available under the previously described program authority.
Important facts for investors to verify
- How much of revenue and future growth depends on term and cloud contracts, and how revenue-recognition timing affects comparisons after ASC 606 adoption.
- Billing and collection timing for $320.7m of unbilled receivables, including the long-term portion, and conversion of contracted unrecognized revenue into recognized revenue and cash.
- Whether substantial sales and R&D investment produces revenue growth and improved operating margins, given the first-half operating loss and lower gross margin.
- The sustainability and drivers of the large tax benefit, the company’s GILTI exposure, and any subsequent changes to Tax Reform Act estimates.
- Cash use for repurchases and dividends, and the company’s ability to maintain these while funding operations and growth.