One day later then expected, but nevertheless :Pegasystems Flies !!!
Pegasystems (Nasdaq:PEGA - news) jumped $4 5/32 to $24 5/8 this morning after reporting Q1 EPS of $0.07 on revenues of $17.97 million. Compared with restated Q1 1997 results, EPS rose 133% and revenues increased 112%. Pegasystems specializes in providing software that streamlines a company's interactions with customers, a hot area in software over the last couple years. Despite the excellent growth in the sector, a number of blowups have occurred, due in part to a rush of money coming into the industry faster than the industry could absorb the investment. Rationalization and consolidation has set in, though. One notable example is Scopus (Nasdaq:SCOP - news) , which is expected to close its merger with sales automation software company Siebel Systems (Nasdaq:SEBL - news) later this month.
Pegasystems has traditionally gone with the rifle approach to customer interaction software. Rather than loading up the sales shotgun with small birdshot and hoping to hit as many industries as possible, the company has become a force by focusing on providing this software to the financial services industry. Heavy-hitting customers include mutual fund companies Franklin Resources (NYSE:BEN - news) and Fidelity Investments, BankAmerica (NYSE:BAC - news) , the Federal Reserve (the world's most profitable bank, actually), and British bank Barclays plc (NYSE:BCS - news) . The company claims, according to December 1997 Forbes article, that its software "...can replace from 30% to 50% of a bank's back-office staff." Pretty heady stuff for a sales rep to go out and pitch when a bank normally has to do an expensive merger with an in-market competitor to get that sort of overhead reduction.
No wonder, then, that the company's revenues are surging. For those who haven't heard the story, though, the bookkeeping is a little convoluted. The company signs a multi-year agreement with customers to provide services and software. If it were to operate on a standard system of percentage-of-completion accounting for its revenues, a three-year software license worth $1 million would yield software license revenues of $333,000 per year over three years. However, Pegasystems recognizes most of the contract's revenues upon closing a deal, discounting the out-years in the contract at a rate of 7%. The result is that cash doesn't flow in at the same rate as revenues, resulting in capitalized revenue assets under the heading of "Long-term license installments."
Working through the balance sheet and the income statements in the press release, it appears as though $5.56 million of the company's $11.4 million in revenues for the quarter were non-cash revenues. While the company's cash flows make it easier to understand where the cash is coming in and going out, investors have to wait 45 days for the 10-Q to be filed to assess these numbers. It would be much easier to value the company on a basis that was not so, shall we say, accrual-rich. The actual cash flow from operations looks like the company consumed around $4-$5 million for the quarter. Looking at the amount of orders taken during the quarter, though, the company's performance was excellent. On an accrual basis, the company is quite richly valued, at about 10 times annualized revenues. On more of a cash-based system of looking at revenues, it appears closer to being valued at 15 times revenues. Investors without a clear-cut investment thesis on the company should probably not get involved, but for those who have interests in the industry or in companies that compete with Pegasystems in the financial services arena and other markets where it intends to compete, the company deserves some attention.
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