Pegasystems Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Financial amounts below are in millions of dollars unless otherwise noted. Pegasystems develops and licenses business process software and provides related maintenance and professional services. It reports one operating segment. The 2010 comparison includes Chordiant only from its April 21, 2010 acquisition date, affecting year-over-year comparability.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $95.5 | $90.0 | $301.4 | $247.3 |
| Gross profit / margin | $53.7 / 56% | $55.0 / 61% | $179.2 / 59% | $154.7 / 63% |
| Operating income (loss) | $(2.0) | $1.9 | $6.8 | $1.4 |
| Net income (loss) | $5.0 | $3.1 | $12.0 | $(1.2) |
| Diluted EPS | $0.13 | $0.08 | $0.31 | $(0.03) |
- Q3 revenue increased 6%; nine-month revenue increased 22%. Maintenance revenue rose 28% and 46%, respectively, while professional services revenue increased 23% and 27%.
- Q3 software license revenue declined 25% to $25.3 million, mainly due to fewer and lower-value perpetual license arrangements and delays in signing some large deals. Nine-month license revenue was broadly flat at $93.5 million.
- Gross margin declined in both periods. In Q3, lower license revenue reduced gross profit; over nine months, higher maintenance gross profit more than offset lower license gross profit. Professional-services gross margin was 7% in Q3 and 12% year to date, reflecting lower utilization as staffing expanded.
- Q3 operating expenses rose 5%, including higher research and development costs from increased headcount. Nine-month expenses rose 12%, primarily from sales and marketing headcount, commissions, and R&D hiring.
- Q3 net income included a $7.4 million income tax benefit despite a $2.5 million pretax loss. This reflected the estimated annual tax benefit and a $2.4 million discrete benefit from expired statutes of limitation on prior-year tax positions. Management expected an overall tax benefit for 2011.
Cash, liquidity, and obligations
- Cash, cash equivalents, and marketable securities totaled $98.3 million at September 30, 2011, up from $87.3 million at December 31, 2010. Cash and cash equivalents alone fell to $51.6 million from $71.1 million, while marketable securities increased to $46.7 million from $16.1 million.
- Nine-month operating cash flow was $19.6 million, compared with cash used of $9.5 million in 2010. The filing attributes 2011 operating cash generation principally to net income and an $8.3 million increase in deferred revenue.
- Investing activities used $36.0 million, mainly for marketable-security purchases; financing activities used $3.5 million, including dividends and share repurchases. No interest-bearing debt is listed on the balance sheet.
- Current liabilities were $116.5 million and current assets $211.2 million. Current deferred revenue was $67.3 million; total current and long-term deferred revenue was $83.0 million.
- The new Cambridge headquarters lease runs through December 2023 and carries $75.8 million in future rental payments. The company also expected office-related investment of approximately $5.5 million for the rest of 2011 and $7.5 million in the first half of 2012.
- Approximately $24.8 million of cash and cash equivalents was held in foreign subsidiaries. Repatriation could result in U.S. tax, which the company did not estimate.
Changes, outlook, and risks
- Management cited demand for its software and services, expanded solution frameworks and partner alliances, and new-customer wins as growth drivers. It also identified a weak global economy, expansion into industries, and sustaining leadership in business process management and decision management as ongoing challenges.
- Management said current liquidity and 2011 operating cash flow should fund operations and the share repurchase program for at least 12 months. No specific revenue or earnings guidance was provided.
- License revenue can fluctuate with deal timing, payment terms, and the mix of perpetual, term, and subscription arrangements. Management noted a trend toward term licenses, which may spread revenue recognition over longer periods. Existing term-license payments due totaled $84.5 million; other future license payments not recorded on the balance sheet totaled $36.0 million.
- The company began using short-term foreign-exchange forward contracts in Q2 to reduce currency exposure, primarily to the euro and British pound. There were no contracts outstanding at September 30; uncovered Australian-dollar receivables contributed to an approximately $0.5 million net currency loss in Q3.
- In the Chordiant-related Yue litigation, the company settled and paid the assumed liability in April 2011. It said other ordinary-course disputes and claims were not expected to materially affect its financial position or results.
- Restructuring accruals were $1.5 million at quarter-end. A sublease prompted a $0.2 million reduction in Q3 restructuring expense. The company also recorded additional depreciation related to its planned move from its current offices.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. It reported no material changes to the risk factors in its 2010 Form 10-K.
Key facts for investors to verify
- Whether delayed large license deals convert to signed contracts, and how license mix and timing affect recognized revenue.
- Whether maintenance growth and consulting demand can sustain revenue growth while professional-services utilization and margins improve.
- The sustainability of operating cash generation, including the role of deferred-revenue movements and the company’s planned office spending.
- The tax-benefit assumptions, the $18.5 million of unrecognized tax benefits, and any future cash-tax exposure from foreign-subsidiary earnings.
- The full cash-flow and long-term cost implications of the $75.8 million headquarters lease and any future repatriation or currency exposure.