Pegasystems Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Financial statement amounts below are in U.S. dollars; millions unless noted. Pegasystems develops and licenses enterprise software for customer engagement, case management, business process management, and related services. It reports one operating segment.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $182.8m | $162.4m | $550.7m | $478.3m |
| Gross profit / margin | $122.4m / 67% | $107.0m / 66% | $373.6m / 68% | $318.1m / 66% |
| Operating income / margin | $5.5m / 3.0% | $10.7m / 6.6% | $26.0m / 4.7% | $27.9m / 5.8% |
| Net income | $2.4m | $6.3m | $15.1m | $15.4m |
| Diluted EPS | $0.03 | $0.08 | $0.19 | $0.19 |
| Operating cash flow | Not separately presented for the quarter | $17.4m | $54.9m |
- Q3 revenue rose 13% year over year; nine-month revenue rose 15%. License revenue grew 17% and 15%, respectively; recurring revenue, as defined by the company, grew 20% and 19%.
- Q3 operating expenses increased 21% to $116.9m, outpacing revenue growth; nine-month operating expenses increased 20% to $347.6m. Selling and marketing costs rose 25% in Q3, and R&D costs rose 15%.
- Q3 net income fell 62%. Nine-month net income was nearly flat despite revenue growth. The nine-month effective tax rate was 38.5%, versus 36.0%; Q3 rate was 56.2%, versus 38.3%.
- Services revenue grew 15% in Q3 and 22% for nine months. Cloud revenue grew 32% and 41%, respectively. Services gross margin improved to 11% in Q3 and 14% for nine months, partly because revenue from projects delayed from prior periods was recognized after most associated costs had been recorded in 2015.
Balance sheet, liquidity, and cash flows
- Cash, cash equivalents, and marketable securities totaled $129.7m at September 30, down from $219.1m at December 31, 2015. Cash and cash equivalents were $66.4m; marketable securities were $63.3m.
- Total assets were $597.0m and total liabilities $269.6m. Current assets were $378.7m versus current liabilities of $237.7m. The filing reports no borrowings or debt balance on the presented balance sheet.
- Nine-month operating cash flow declined to $17.4m from $54.9m, reflecting, among other items, a $17.7m reduction in deferred revenue and $16.7m net cash use from accounts payable and accrued expenses. The prior-year period benefited from a $21.4m reduction in receivables from collections.
- Nine-month investing cash use was $2.9m, including the OpenSpan acquisition and $15.3m of property and equipment investment, partly offset by marketable-security sales. Financing cash use was $39.9m, including $25.8m of repurchases, $10.8m of share withholding for taxes, and $6.9m of dividends.
- Management said available cash, securities, and operating cash flow should fund operations, dividends, and the repurchase program for at least 12 months. Approximately $46.5m of cash was held in foreign subsidiaries; repatriation could incur U.S. tax.
Material changes, outlook, and risks
- License and cloud backlog was $419.8m, up 11% year over year, including $372.5m in commitments not recorded on the balance sheet. Deferred license and cloud revenue was $47.3m, down 15%. Management expected to recognize $26.7m of existing term-license and cloud contractual payments as revenue in Q4 2016, in addition to new arrangements or prepayments.
- License growth reflected term arrangements, including a large arrangement over $10m recognized in full in Q1, and a large renewal whose second year was recognized in Q3. Revenue timing and the mix of perpetual, term, and cloud deals can vary materially. Future payments under noncancellable perpetual licenses were $19.7m; the company expected $3.9m of that amount to be recognized in Q4.
- On April 11, 2016, Pegasystems acquired OpenSpan for $48.8m net of acquired cash. The purchase added $27.3m of goodwill and $24.3m of intangible assets; acquisition-related expenses were $2.6m for the nine months. $7.4m of consideration remained in escrow. A further $0.4m payment tied to an earlier acquisition could be due based on milestones through year-end.
- The company provided no specific full-year revenue or earnings guidance in the supplied filing text. It stated that interim results are not necessarily indicative of full-year results and that it intends, subject to board discretion, to continue quarterly dividends of $0.03 per share.
- Brexit-related sterling weakness slightly reduced reported revenue but had no material impact on results through September 30, according to management. Continued currency weakness could adversely affect future revenue and results. The company uses foreign-exchange forwards for exposure management, not speculation; nine-month forward-contract losses contributed to other expense.
- Key risks include deal timing and product acceptance affecting license revenue recognition, international economic and currency exposure, reliance on third parties, customer-market consolidation, acquisition impacts, and managing growth. Management reported effective disclosure controls and no material change in internal control during the quarter.
Important facts for investors to verify
- Whether revenue growth and the 11% backlog increase convert into recognized revenue and cash on expected schedules, given lower deferred revenue and weaker operating cash flow.
- Whether higher selling, marketing, R&D, and stock-based compensation expenses can be supported by sustainable revenue growth and improved operating margins.
- The quality and timing of large term-license arrangements, including the Q1 contract recognized in full and the Q3 renewal, and the company’s revenue-recognition assumptions.
- OpenSpan’s integration and contribution, the final purchase-price allocation, and any contingent payments or acquisition-related costs.
- The effects of foreign-exchange movements and potential U.S. taxes on repatriated foreign cash; also confirm the sustainability of repurchases and dividends relative to cash generation.