Enterprise workflow software provider Pegasystems (NASDAQ:PEGA) reported results ahead of analysts' expectations in Q3 FY2023, with revenue up 23.6% year on year to $334.6 million. Turning to EPS, Pegasystems made a GAAP loss of $0.09 per share, improving from its loss of $1.14 per share in the same quarter last year.
Pegasystems (PEGA) Q3 FY2023 Highlights:
- Revenue: $334.6 million vs analyst estimates of $296.8 million (12.8% beat)
- EPS (non-GAAP): $0.44 vs analyst estimates of $0.01 ($0.43 beat)
- Free Cash Flow of $23.8 million, down 44.8% from the previous quarter
- Gross Margin (GAAP): 72%, up from 65.6% in the same quarter last year
Founded by Alan Trefler in 1983, Pegasystems (NASDAQ:PEGA) offers a software-as-a-service platform to automate and optimize workflows in customer service and engagement.
Founded to offer business process management (BPM), the company originally analyzed workflows and implemented changes to increase quality and reduce inefficiencies. Over time and with technological advances, Pegasystems began offering broader software products to enable automation of the business processes the company once improved. Low-code application building was then added to the platform to empower a customer’s non-technical workers.
A customer problem that Pegasystems solves is how to manage customer interactions across multiple channels. With Pegasystems' software, businesses can create a unified view of customer interactions across email, phone, and social media. This enables businesses to provide more personalized and effective service, which can lead to happier customers. Pegasystems’ flagship product, Pega Platform, is a low-code platform that allows businesses to build custom applications. Whether it is a customer-facing healthcare portal to manage doctors appointments or a back office application for reconciling customer bank balances, this platform allows those who cannot write code to build functional applications.
Pegasystems generates revenue through the sale of software licenses and professional services to ensure customer success. The company’s customers include financial institutions, healthcare providers, and government agencies whose business processes tend to be complex and sometimes regulated.
The whole purpose of software is to automate tasks to increase productivity. Today, innovative new software techniques, often involving AI and machine learning, are finally allowing automation that has graduated from simple one- or two-step workflows to more complex processes integral to enterprises. The result is surging demand for modern automation software.Competitors in productivity and automation software include ServiceNow (NYSE:NOW), salesforce.com (NYSE:CRM), and private company BMC.
As you can see below, Pegasystems's revenue growth has been unimpressive over the last two years, growing from $256.3 million in Q3 FY2021 to $334.6 million this quarter.
This quarter, Pegasystems's quarterly revenue was up a very solid 23.6% year on year, above the company's historical trend. On top of that, its revenue increased $36.4 million quarter on quarter, a strong improvement from the $27.2 million decrease in Q2 2023. This is a sign of re-acceleration of growth and very nice to see indeed.
Looking ahead, analysts covering the company were expecting sales to grow 7.59% over the next 12 months before the earnings results announcement.
What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Pegasystems's gross profit margin, an important metric measuring how much money there's left after paying for servers, licenses, technical support, and other necessary running expenses, was 72% in Q3.
That means that for every $1 in revenue the company had $0.72 left to spend on developing new products, sales and marketing, and general administrative overhead. Despite improving significantly since the last quarter, Pegasystems's gross margin is still lower than that of a typical SaaS businesses. Gross margin has a major impact on a company’s ability to develop new products and invest in marketing, which may ultimately determine the winner in a competitive market. This makes it a critical metric to track for the long-term investor.
Cash Is King
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. Pegasystems's free cash flow came in at $23.8 million in Q3, up 350% year on year.
Pegasystems has generated $91.5 million in free cash flow over the last 12 months, a decent 7.73% of revenue. This FCF margin stems from its asset-lite business model and gives it a decent amount of cash to reinvest in its business.
Key Takeaways from Pegasystems's Q3 Results
Sporting a market capitalization of $3.25 billion, Pegasystems is among smaller companies, but its more than $336.3 million in cash on hand and positive free cash flow over the last 12 months puts it in an attractive position to invest in growth.
We liked seeing that the company beat Wall Street's estimates for revenue and EPS. The devil is in the details, however, and what drove the revenue beat was actually license revenue, which is less exciting than a subscription revenue beat. Additionally to temper excitement, ACV (annual contract value) slightly missed. Zooming out, we think this was still a good quarter that should have shareholders pleased. The stock is up 1.24% after reporting and currently trades at $38.5 per share.
Is Now The Time?
When considering an investment in Pegasystems, investors should take into account its valuation and business qualities as well as what's happened in the latest quarter.
We cheer for everyone who's making the lives of others easier through technology, but in case of Pegasystems, we'll be cheering from the sidelines. Its revenue growth has been very weak over the last two years, and analysts expect growth to deteriorate from here. And while its strong free cash flow generation gives it re-investment options, the downside is that its customer acquisition is less efficient than many comparable companies. On top of that, its gross margins aren't as good as other tech businesses we look at.
Pegasystems's price to sales ratio based on the next 12 months is 2.2x, suggesting that the market does have lower expectations of the business, relative to the high growth tech stocks. While we have no doubt one can find things to like about the company, and the price is not completely unreasonable, we think that at the moment there might be better opportunities in the market.
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