Pegasystems Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Amounts below are in millions of dollars except per-share data. Pegasystems develops enterprise software for customer engagement and digital process automation, including its Pega Platform and cloud offerings. The interim financial statements are unaudited.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $216.7 | $203.3 | $634.8 | $635.2 |
| Gross profit / margin | $135.8 / 63% | $128.8 / 63% | $402.4 / 63% | $411.4 / 65% |
| Operating loss | $(46.8) | $(17.3) | $(133.1) | $(32.5) |
| Net loss | $(30.3) | $(7.6) | $(91.4) | $(5.8) |
| Diluted loss per share | $(0.38) | $(0.10) | $(1.16) | $(0.07) |
| Operating cash flow | Not stated separately for the quarter | $(13.5) | $67.1 |
- Q3 revenue increased 7%, while nine-month revenue was essentially flat. Subscription revenue (term license, cloud, and maintenance) increased 28% in Q3 and 11% year to date.
- Nine-month cloud revenue rose 63% to $94.6 million; maintenance rose 6% to $207.4 million. Perpetual license revenue fell 24% to $43.3 million, and consulting revenue fell 15% to $167.3 million.
- Operating expenses rose 25% in Q3 to $182.6 million and 21% year to date to $535.6 million. Selling and marketing expense increased 26% year to date, which management attributed mainly to added sales capacity, compensation, and deferred sales-commission amortization. Research and development increased 13%.
- Nine-month net loss included an income tax benefit of $43.2 million. Management said the effective tax rate was affected by GILTI, stock-based compensation tax benefits, and U.S. R&D credits.
Balance sheet, cash flow, and liquidity
- At September 30, cash, cash equivalents, and marketable securities totaled $112.6 million, down from $207.4 million at December 31, 2018. Total assets were $917.0 million and stockholders’ equity was $528.8 million.
- Cash used in operating activities was $13.5 million for the first nine months, compared with $67.1 million provided in the prior-year period. Management cited the shift toward cloud contracts, which are generally collected over an average three-year service period, and increased investment in cloud and sales operations.
- Investing activities provided $53.4 million, including $68.9 million of investment-sale proceeds, and included $10.9 million paid for the In the Chat Communications acquisition. Financing activities used $61.9 million, including $54.8 million for share repurchases and $7.1 million for dividends.
- The balance sheet reports no borrowing balance. Operating lease liabilities totaled $72.6 million. On November 6, 2019, after quarter-end, the company entered a five-year, $100 million senior secured revolving credit facility, expandable to $200 million in specified circumstances. It includes a maximum net leverage ratio of 3.5 and minimum interest coverage ratio of 3.5.
- Management said available liquidity, operating cash flow, and borrowing capacity should fund operations, dividends, and repurchases for at least the next 12 months. The company’s stated current intention was to pay a quarterly dividend of $0.03 per share, subject to board discretion.
Material changes, outlook, and risks
- Annual contract value was $634.4 million, up 18% year over year (20% at constant currency); Pega Cloud ACV grew 48%. Remaining performance obligations were $608.6 million, up 17%, with 56% expected to be recognized within one year.
- Management expects revenue mix to continue shifting toward subscription offerings, particularly cloud, and cautioned that this could slow total revenue growth in the near term. It also warned that the mix shift and investment may weigh on gross profit growth and operating cash flow, potentially including negative cash flow in the near term.
- Cloud gross margin was 50% for the first nine months, down from 55%, as the company accelerated infrastructure and service-delivery investment. Consulting gross margin was negative 5% in Q3, reflecting lower billable hours and resource transitions; management also cited increased partner-network leverage.
- Maintenance renewals remained above 90%, according to management. A May 2019 acquisition added In the Chat Communications; the company may issue up to approximately 15,000 retention-based shares subject to milestones.
- Other risks highlighted include foreign-exchange exposure, demand and international-market uncertainty, reliance on third parties and key personnel, cybersecurity incidents, and growth management. The new credit facility adds covenant and repayment risks; covenant breaches or defaults could restrict borrowing or accelerate repayment.
Most important facts for investors to verify
- Whether cloud and subscription growth can offset declines in perpetual licensing and consulting while cloud margins improve.
- Whether operating cash flow recovers as cloud contracts scale, given the nine-month cash outflow and longer cloud collection cycle.
- How elevated selling and marketing costs, stock-based compensation, and other operating expenses affect the path to profitability.
- Whether reported ACV and RPO convert into recognized revenue and cash on the expected schedule; note the substantial unbilled receivables balance of $296.1 million.
- Use of the revolving facility, compliance with its financial covenants, and the sustainability of dividends and repurchases relative to cash generation.