Pegasystems Inc. — Q2 2022 Form 10-Q
Reporting period: Three and six months ended June 30, 2022. Pegasystems develops enterprise workflow automation and AI decisioning software and is transitioning toward subscription sales, a transition expected to continue through 2024.
Financial performance
| Metric | Q2 2022 | Q2 2021 | First half 2022 | First half 2021 |
|---|---|---|---|---|
| Revenue | $274.3 million | $325.7 million | $650.6 million | $639.2 million |
| Gross profit / margin | $179.2 million / 65% | $241.2 million / 74% | $467.3 million / 72% | $472.2 million / 74% |
| Operating income (loss) | $(85.0) million | $1.2 million | $(66.4) million | $2.8 million |
| Net income (loss) | $(286.3) million | $37.3 million | $(286.7) million | $30.7 million |
| Diluted EPS | $(3.50) | $0.43 | $(3.51) | $0.36 |
- Q2 subscription services revenue rose 13% to $171.8 million, including Pega Cloud growth of 28% to $93.5 million. Subscription license revenue fell 60% to $41.6 million, mainly reflecting large license contracts recognized in Q2 2021; perpetual license revenue declined 82% to $2.3 million.
- First-half revenue increased 2%. Subscription services grew 16% to $341.9 million, while subscription license revenue fell 17% to $179.1 million. Consulting revenue increased 9% to $119.9 million.
- Q2 gross margin declined to 65%, primarily due to lower subscription license revenue. First-half Pega Cloud gross margin improved to 68%, which management attributed to cost efficiencies as the business scales.
- Operating expenses increased, notably R&D (up 15% in Q2) and G&A (up 71% in Q2), including higher legal fees. The company reported $28.0 million of legal fees and related expenses in the first half and expects additional litigation costs in 2022.
Cash, liquidity and debt
- First-half operating cash flow was $(5.1) million, versus $19.4 million provided in the prior-year period. Cash and cash equivalents declined $50.7 million from year-end to $109.3 million. Cash, cash equivalents and marketable securities totaled $296.9 million, compared with $362.8 million at December 31, 2021.
- Management said available cash, operating cash flow, borrowing capacity and access to capital markets should fund operations, repurchases and dividends for at least 12 months. The company reported no borrowings under its $100 million revolving credit facility.
- Convertible notes had a $592.2 million net carrying value ($600 million principal), mature March 2025, and bear 0.75% coupon interest. The credit facility requires at least $200 million of cash, investments and availability through year-end 2022. A July 25, 2022 amendment increased certain facility sub-limits.
- Current assets were $740.2 million and current liabilities were $435.5 million at June 30. The company paid $4.9 million in dividends and repurchased $24.5 million of shares under its repurchase program during the first half.
Material changes, outlook and risks
- A $191.9 million valuation allowance against deferred tax assets drove a $186.2 million Q2 tax provision and substantially explains the reported net loss. Management cited uncertain economic conditions and concluded that backlog and other evidence were insufficient to support recovery of those tax assets.
- Backlog (remaining performance obligations) was $1.126 billion, up 9% year over year on a reported basis and 15% at constant currency. The filing provides no specific financial guidance; management said results may fluctuate during the subscription transition, which it expects to complete in 2024.
- In Appian’s Virginia case, a jury awarded $2.037 billion for trade-secret misappropriation and $1 for a computer-crimes claim. Post-trial motions were pending; Pegasystems said it would appeal any judgment and could not reasonably estimate the ultimate loss. No litigation loss was accrued at June 30. Appian also sought approximately $22.6 million in attorneys’ fees, $4.2 million in costs and post-judgment interest.
- A separate Pegasystems suit against Appian and a securities class action were also pending. The company warned that an unfavorable final judgment could require financing and could trigger debt acceleration if not timely satisfied after appeal rights expire.
- Management identified broader risks including subscription-transition timing, global economic and geopolitical uncertainty, foreign exchange, client demand and retention, cybersecurity, and litigation. COVID-19 had not materially affected results or financial condition as of June 30.
Important facts for investors to verify
- Subsequent court rulings, final judgment, appeal prospects and potential financial exposure in the Appian litigation.
- Whether subscription services and Pega Cloud growth can offset lower upfront license revenue while sustaining margins and cash collections.
- Future operating cash flow, liquidity covenant compliance and the effect of the 2025 convertible notes under adverse litigation or business outcomes.
- Whether changes in operating performance and backlog support realization of deferred tax assets, and whether the valuation allowance is maintained or adjusted.