Pegasystems Inc. — Q3 2023 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2023. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted. The interim financial statements are unaudited.
Business context and performance
Pegasystems develops enterprise software for workflow automation, customer engagement, and decisioning. The company is shifting toward subscription-based offerings. Subscription revenue accounted for 82% of revenue in both Q3 and the first nine months of 2023.
- Q3 revenue was $334.6 million, up 24% year over year. Nine-month revenue was $958.4 million, up 4%.
- Q3 subscription services revenue increased 15% to $201.6 million; subscription license revenue rose 139% to $74.3 million. For the nine months, subscription services grew 13% to $586.2 million, while subscription license revenue declined 5% to $200.1 million.
- Pega Cloud revenue grew 21% in both periods: to $118.0 million in Q3 and $341.0 million for nine months. Management attributed growth primarily to expansion of the hosted client base.
- Annual contract value (ACV) was $1.169 billion, up 12% year over year, or 10% at constant currency. Backlog was $1.265 billion, up 10%, or 7% at constant currency.
Financial results and liquidity
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Revenue | $334.6 | $270.7 | $958.4 | $921.4 |
| Gross profit / margin | $240.9 / 72% | $177.7 / 66% | $670.5 / 70% | $645.0 / 70% |
| Operating loss | $(10.8) | $(77.2) | $(74.3) | $(143.6) |
| Net loss | $(7.3) | $(93.5) | $(74.9) | $(380.2) |
| Diluted loss per share | $(0.09) | $(1.14) | $(0.90) | $(4.65) |
- Nine-month cash from operations was $137.9 million, compared with cash used of $13.4 million a year earlier. Free cash flow, a non-GAAP measure defined as operating cash flow less property and equipment investment, was $123.6 million versus negative $35.7 million.
- At September 30, cash, cash equivalents, and marketable securities totaled $336.3 million, compared with $297.2 million at December 31, 2022. Total current assets were $776.5 million and current liabilities were $472.8 million.
- Convertible notes had a carrying value of $498.8 million and principal outstanding of $502.3 million, due March 2025. The company repurchased $97.7 million principal for $89.0 million during the first nine months, recognizing a $7.9 million gain. No cash borrowings were outstanding under the $100 million revolving facility; $27.3 million of letters of credit reduced availability.
- The company declared quarterly dividends of $0.03 per share. Management stated that available cash, operating cash flow, borrowing capacity, and access to capital markets should fund operations and planned capital returns for at least the next 12 months.
Material changes and management commentary
- Gross margin improved in Q3, with management citing improved Pega Cloud hosting efficiency as the business scaled. Nine-month gross margin remained 70%.
- Selling and marketing expense declined 10% for the nine months, primarily due to lower compensation costs associated with reduced headcount and go-to-market optimization. Restructuring expense was $21.5 million for the nine months, including $17.8 million in Q3.
- Consulting revenue fell 5% for the nine months, which management attributed primarily to lower consultant realization rates in the Americas. Perpetual license revenue declined 75%, consistent with the subscription transition.
- Nine-month results included a $10.9 million increase in venture investment value and the $7.9 million gain on note repurchases. Prior-year comparisons included a $56.4 million loss on capped calls and a $190.2 million income tax provision. The 2023 nine-month tax provision was $15.4 million; management cited U.S. and U.K. deferred-tax valuation allowances and projected U.S. taxable income as key factors.
- Management noted that the operating results for interim periods do not necessarily indicate full-year results. The filing provides no specific revenue or earnings guidance.
Risks, contingencies, and unusual items
- Appian litigation: A 2022 Virginia court judgment totaled approximately $2.06 billion, plus post-judgment interest. The judgment was suspended during Pegasystems’ appeal, with oral argument scheduled for November 15, 2023. The company disputes the claims and said it could not reasonably estimate potential damages. No litigation loss was accrued at September 30, 2023.
- Other legal matters: A securities class action and consolidated derivative litigation remain pending; the company said it could not reasonably estimate potential damages. The SEC has requested information, including about the accounting treatment of the Appian litigation; Pegasystems said it is cooperating.
- Debt and liquidity covenants: Through December 31, 2023, the credit agreement requires at least $200 million in cash, investments, and facility availability, as well as specified year-to-date EBITDA. Further leverage and interest-coverage covenants begin in Q1 2024. The filing does not clearly state covenant headroom.
- Other cited risks include foreign-exchange exposure, client retention, demand variability, cybersecurity and intellectual-property claims, and execution of the subscription transition. The company also expects continued legal costs.
Key facts for investors to verify
- Appeal developments and any resulting change in the Appian judgment, potential exposure, or accounting treatment.
- SEC inquiry developments and status of the securities and derivative lawsuits.
- Progress on recurring revenue and growth in Pega Cloud, ACV, and backlog, including constant-currency trends.
- Restructuring costs, operating cash flow, tax valuation allowances, and compliance with debt covenants.
- Ability to meet the March 2025 note maturity while maintaining the dividend and funding operations.