Pegasystems (PEGA)

Enterprise workflow software provider Pegasystems (NASDAQ:PEGA) announced better-than-expected revenue in Q1 CY2025, with sales up 44.1% year on year to $475.6 million. Its non-GAAP profit of $1.53 per share was significantly above analysts’ consensus estimates.

Company Overview

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.

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.

A company’s long-term performance is an indicator of its overall quality. Even a bad business can shine for one or two quarters, but a top-tier one grows for years. Over the last three years, Pegasystems grew its sales at a sluggish 8.8% compounded annual growth rate. This was below our standard for the software sector and is a poor baseline for our analysis.

This quarter, Pegasystems reported magnificent year-on-year revenue growth of 44.1%, and its $475.6 million of revenue beat Wall Street’s estimates by 33.1%.

Looking ahead, sell-side analysts expect revenue to decline by 1.6% over the next 12 months, a deceleration versus the last three years. This projection doesn't excite us and indicates its products and services will face some demand challenges.

Billings is a non-GAAP metric that is often called “cash revenue” because it shows how much money the company has collected from customers in a certain period. This is different from revenue, which must be recognized in pieces over the length of a contract.

Pegasystems’s billings punched in at $519 million in Q1, and over the last four quarters, its growth was solid as it averaged 17.5% year-on-year increases. This alternate topline metric grew faster than total sales, meaning the company collects cash upfront and then recognizes the revenue over the length of its contracts - a boost for its liquidity and future revenue prospects.

The customer acquisition cost (CAC) payback period measures the months a company needs to recoup the money spent on acquiring a new customer. This metric helps assess how quickly a business can break even on its sales and marketing investments.

Pegasystems’s recent customer acquisition efforts haven’t yielded returns as its CAC payback period was negative this quarter, meaning its incremental sales and marketing investments outpaced its revenue. The company’s inefficiency indicates it operates in a highly competitive environment where there is little differentiation between Pegasystems’s products and its peers.

For software companies like Pegasystems, gross profit tells us how much money remains after paying for the base cost of products and services (typically servers, licenses, and certain personnel). These costs are usually low as a percentage of revenue, explaining why software is more lucrative than other sectors.

Pegasystems’s gross margin is good for a software business and points to its solid unit economics, competitive products and services, and lack of meaningful pricing pressure. As you can see below, it averaged an impressive 75.7% gross margin over the last year. Said differently, Pegasystems paid its providers $24.26 for every $100 in revenue.

Pegasystems’s gross profit margin came in at 78.5% this quarter, up 7.1 percentage points year on year. Pegasystems’s full-year margin has also been trending up over the past 12 months, increasing by 1.8 percentage points. If this move continues, it could suggest better unit economics due to more leverage from its growing sales on the fixed portion of its cost of goods sold (such as servers).

Many software businesses adjust their profits for stock-based compensation (SBC), but we prioritize GAAP operating margin because SBC is a real expense used to attract and retain engineering and sales talent. This is one of the best measures of profitability because it shows how much money a company takes home after developing, marketing, and selling its products.

Pegasystems has been a well-oiled machine over the last year. It demonstrated elite profitability for a software business, boasting an average operating margin of 16.5%. This result isn’t too surprising as its gross margin gives it a favorable starting point.

Looking at the trend in its profitability, Pegasystems’s operating margin rose by 10.8 percentage points over the last year, as its sales growth gave it operating leverage.

In Q1, Pegasystems generated an operating profit margin of 26.7%, up 32.9 percentage points year on year. The increase was solid, and because its operating margin rose more than its gross margin, we can infer it was more efficient with expenses such as marketing, R&D, and administrative overhead.

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

Pegasystems has shown robust cash profitability, driven by its attractive business model that enables it to reinvest or return capital to investors while maintaining a cash cushion. The company’s free cash flow margin averaged 22% over the last year, quite impressive for a software business.

Pegasystems’s free cash flow clocked in at $202.3 million in Q1, equivalent to a 42.5% margin. The company’s cash profitability regressed as it was 11.8 percentage points lower than in the same quarter last year, but it’s still above its one-year average. We wouldn’t put too much weight on this quarter’s decline because investment needs can be seasonal, causing short-term swings. Long-term trends trump temporary fluctuations.

Over the next year, analysts predict Pegasystems’s cash conversion will improve. Their consensus estimates imply its free cash flow margin of 22% for the last 12 months will increase to 27.5%, giving it more flexibility for investments, share buybacks, and dividends.

Pegasystems reported $371.7 million of cash and $534.4 million of debt on its balance sheet in the most recent quarter. As investors in high-quality companies, we primarily focus on two things: 1) that a company’s debt level isn’t too high and 2) that its interest payments are not excessively burdening the business.

With $441.5 million of EBITDA over the last 12 months, we view Pegasystems’s 0.4× net-debt-to-EBITDA ratio as safe. We also see its $19.72 million of annual interest expenses as appropriate. The company’s profits give it plenty of breathing room, allowing it to continue investing in growth initiatives.

We were impressed by how significantly Pegasystems blew past analysts’ revenue and EPS expectations this quarter. Zooming out, we think this was a solid quarter. The stock traded up 22.8% to $84.50 immediately after reporting.

Updated: May 22, 2025 at 10:36 PM EDT

Are you wondering whether to buy Pegasystems or pass? We urge investors to not only consider the latest earnings results but also longer-term business quality and valuation as well.

Pegasystems isn’t a terrible business, but it doesn’t pass our quality test. First off, its revenue growth was weak over the last three years, and analysts expect its demand to deteriorate over the next 12 months. And while Pegasystems’s impressive operating margins show it has a highly efficient business model, its customer acquisition is less efficient than many comparable companies.

Pegasystems’s price-to-sales ratio based on the next 12 months is 5.8x. Investors with a higher risk tolerance might like the company, but we think the potential downside is too great. We're fairly confident there are better stocks to buy right now.

Wall Street analysts have a consensus one-year price target of $101.12 on the company (compared to the current share price of $99.41).

Want to invest in a High Quality big tech company? We’d point you in the direction of Microsoft and Google, which have durable competitive moats and strong fundamentals, factors that are large determinants of long-term market outperformance.

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