Pegasystems Inc. — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. Pegasystems develops enterprise software for workflow automation and AI-powered decisioning. Unless noted, financial amounts below are in millions of U.S. dollars.
Financial results
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Revenue | $270.7 | $256.3 | $921.4 | $895.5 |
| Gross profit / margin | $177.7 / 65.6% | $172.0 / 67.1% | $645.0 / 70.0% | $644.3 / 71.9% |
| Operating loss | $(77.2) | $(65.3) | $(143.6) | $(62.5) |
| Net loss | $(93.5) | $(56.5) | $(380.2) | $(25.8) |
| Loss per diluted share | $(1.14) | $(0.69) | $(4.65) | $(0.32) |
- Revenue mix: Q3 subscription services were $174.9 million, including Pega Cloud revenue of $97.4 million, up 24% year over year. Subscription license revenue was $31.1 million, down 12%; consulting revenue was $55.5 million, down 2%. Nine-month Pega Cloud revenue rose 28% to $281.2 million.
- Cash flow: Nine-month operating cash use was $13.4 million, compared with $5.3 million a year earlier. Investing activities provided $10.1 million; financing activities used $43.5 million. Cash and cash equivalents declined $52.3 million during the period.
- Liquidity and debt: Cash, cash equivalents, and marketable securities totaled $275.7 million at September 30, versus $362.8 million at year-end 2021. Convertible notes had $600 million principal, mature March 2025, and were not eligible for conversion at quarter-end. No revolver borrowings were outstanding; $27.3 million of letters of credit reduced availability.
- Backlog: Remaining performance obligations were $1.148 billion, up 11% year over year, or $1.222 billion and up 18% at constant currency.
Changes and management commentary
- Total revenue grew 6% in Q3 and 3% for the first nine months. Management attributed the pattern to the shift toward subscription arrangements, which recognize revenue over contract terms rather than generally upfront as with perpetual licenses. The company expects to complete this transition in 2023.
- Management said the stronger U.S. dollar reduced revenue growth by approximately five percentage points in both reported periods. Subscription license revenue declined partly because several large licenses had been recognized in 2021; maintenance revenue also reflected foreign exchange and migration to Pega Cloud.
- Operating expenses rose, notably research and development and general and administrative costs. Nine-month G&A expense increased $36.9 million, including $24.0 million of additional legal fees and related expenses from proceedings outside the ordinary course of business.
- Nine-month net loss included a $191.9 million valuation allowance against U.S. and U.K. deferred tax assets, recorded in Q2. The company said uncertain economic conditions and insufficient objectively verifiable evidence of future taxable income supported the allowance. It expects to maintain a full allowance for those assets until realization is better supported.
- Nine-month results also included a $56.4 million non-operating loss from fair-value changes in capped call transactions, compared with a $7.5 million loss in 2021. The capped calls’ reported fair value fell to $3.6 million from $60.0 million at year-end.
- Management believes cash, operating cash flow, borrowing capacity, and access to capital markets will be adequate for operations and known requirements for at least 12 months. The credit facility requires at least $200 million of cash, investments, and borrowing availability through year-end 2022; leverage and interest-coverage covenants begin in Q1 2023.
Risks, contingencies, and unusual items
- Appian judgment: A Virginia court entered a $2.060 billion judgment against Pegasystems in September, including the jury award, attorneys’ fees, and costs, with post-judgment interest. Pegasystems appealed; the judgment was suspended during the appeal after the court approved a $25 million letter of credit. The appeal could take years. The company disputes the allegations and says it cannot reasonably estimate possible damages. It reported no accrued litigation losses at September 30.
- Pegasystems also has a separate lawsuit against Appian; the court narrowed issues on summary judgment and set a January 2023 trial date. A securities class action against the company and two executives seeks unspecified damages; Pegasystems says it will defend the claims.
- The company warns that an adverse outcome in the Appian judgment matter could require financing the judgment and interest, and could affect its debt obligations. Other stated risks include subscription-transition execution, economic and geopolitical uncertainty, foreign exchange, cybersecurity, intellectual property disputes, and debt covenant compliance.
- No specific financial guidance for future periods is provided in the supplied filing text. Management stated that COVID-19 had not materially affected results or financial condition as of September 30, 2022; direct financial exposure to Ukraine, Russia, and Belarus was described as not material.
Most important facts for investors to verify
- Developments in the Appian litigation and appeal, including the status and potential financial consequences of the $2.060 billion judgment.
- Whether subscription growth, especially Pega Cloud, can offset declines in license and maintenance revenue while the transition continues through 2023.
- Cash generation, liquidity headroom under the $200 million covenant, and the impact of the $27.3 million letters of credit and 2025 note maturity.
- Whether future evidence supports releasing any portion of the $191.9 million deferred-tax valuation allowance.
- Operating expense and legal-cost trends, along with the effects of foreign exchange and capped-call fair-value changes on reported results.