Pegasystems Inc. — Q3 2018 Form 10-Q
Business context and reporting period
Quarter ended September 30, 2018; figures below are in U.S. dollars. Pegasystems develops and licenses software for customer engagement and digital process automation, alongside cloud and consulting services. Financial statements are unaudited. 2017 comparative periods were retrospectively adjusted for adoption of ASC 606.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $203.3m | $191.0m | $635.2m | $633.9m |
| Gross profit / margin | $128.8m / 63% | $121.2m / 63% | $411.4m / 65% | $428.2m / 68% |
| Operating income (loss) | $(17.3)m | $(2.3)m | $(32.5)m | $54.7m |
| Net income (loss) | $(7.6)m | $1.3m | $(5.8)m | $58.0m |
| Diluted EPS | $(0.10) | $0.01 | $(0.07) | $0.70 |
- Q3 revenue rose 6%; subscription revenue increased 4% to $120.3m. Cloud revenue grew 67% to $22.2m, maintenance 7% to $66.0m, while term-license revenue fell 21% to $32.1m. Nine-month revenue was nearly flat: cloud rose 60% and maintenance 9%, while software-license revenue fell 20%.
- Operating expenses increased 18% in both Q3 and the nine-month period, led by selling and marketing, which rose 26% to $87.5m in Q3 and $269.8m year to date. R&D increased 13% in Q3 and 12% year to date.
- Nine-month operating cash flow was $67.1m, down from $113.9m. Investing activities used $49.6m and financing activities used $71.7m, including $64.6m of cash repurchases and $7.1m of dividends. Cash and cash equivalents ended at $106.2m; cash, equivalents and marketable securities totaled $206.0m, versus $223.7m at year-end 2017.
- Current assets were $586.1m and current liabilities $282.3m. The filing reports no debt balance in the presented balance sheet. Total liabilities were $341.8m and stockholders’ equity $620.9m.
Material changes versus comparable periods
- Nine-month operating results shifted from $54.7m operating income and $58.0m net income in 2017 to operating and net losses in 2018. Q3 net results also moved from $1.3m income to a $7.6m loss.
- Q3 gross profit increased 6%, but the nine-month total fell 4% and gross margin declined from 68% to 65%. Management attributed the year-to-date decline partly to a large 2017 term-license renewal and the shift toward cloud offerings.
- ASC 606 changed the timing of license revenue recognition: term and certain perpetual license revenue is generally recognized when the client can use the license. Adoption also increased unbilled receivables and introduced capitalization of qualifying contract acquisition costs. The filing adjusted comparative periods; reported trends should be read on that adjusted basis.
- Annual Contract Value rose 20% to $536.8m at September 30, including term and cloud ACV up 36% to $272.7m and maintenance ACV up 7% to $264.1m.
Outlook, commentary, and risks
- Management expects the revenue mix to continue shifting toward subscriptions, particularly cloud. Because cloud revenue and cash are generally recognized or collected over service periods, while license revenue and cash are often upfront, this transition may slow near-term total revenue growth, gross-profit growth, and operating cash-flow growth.
- Management said cash, marketable securities and operating cash flow should fund operations, quarterly dividends and repurchases for at least the next 12 months. The stated intention was to continue a $0.03 quarterly dividend, subject to the board’s ability to change or discontinue it.
- Remaining performance obligations were $522.3m, of which 60% was expected to be recognized within one year. Cloud represented $263.1m of the total.
- Management cited maintenance renewal rates above 90%, growth in the installed base, and increased cloud demand. It also noted increased sales staffing and product-development investment.
- Key disclosed uncertainties include product and services demand, execution of international sales and growth, foreign-exchange movements, cyberattacks and security breaches, and tax-law interpretation. The company reported no material changes to the risk factors in its 2017 Form 10-K. It expects incremental U.S. tax from GILTI provisions; its preliminary assessment was that it would not be subject to BEAT in 2018.
- The company expects the lease-accounting standard, effective January 1, 2019, to materially increase balance-sheet lease assets and liabilities, with an immaterial impact on operating results and cash flows. No material asset impairments were reported in the first nine months.
Important facts for investors to verify
- Whether subscription and cloud growth can offset continued term- and perpetual-license declines, and the associated impact on reported growth and cash conversion.
- Whether operating expense growth—especially sales and marketing investment—produces improved revenue and operating profitability.
- The collection and billing profile of $324.9m in unbilled receivables, including $168.9m classified as long-term, and progress converting contract assets and remaining obligations into revenue and cash.
- The sustainability of operating cash flow, the pace of share repurchases, and continued dividend payments given the decline in cash and securities during the period.
- Future tax expense and effective tax-rate volatility, including GILTI, stock-based compensation tax benefits, and any further Tax Reform Act measurement adjustments.