Business software company Pegasystems (NASDAQ:PEGA) announced its first quarter 2004 earnings results yesterday after market close, and they were not pretty.
Total revenues declined 3.5%; a 40% drop-off in licensing revenues was not quite balanced by services revenues climbing 60%. Meanwhile, earnings simply collapsed: 75% lower than the year-ago period.
However, these results do not come as a complete surprise. In the words of guest analyst Jeff Fischer, who first highlighted Pegasystems in the July 2003 issue of Motley Fool Hidden Gems, the company's sales from each of its revenue streams tend to be "choppy, rather than smooth." Jeff further warned Hidden Gems investors to expect "lackluster" quarters following "great" ones. Point taken, Jeff.
As with the past few quarters' results, the primary source of the revenue decline was the company's renegotiated licensing agreement with First Data Resources, a division of First Data (NYSE:FDC). Under the terms of the new agreement, Pegasystems sacrificed one valuable revenue stream in the hopes of gaining several smaller (but hopefully larger, in the aggregate) revenue streams from new clients.
New contracts are indeed coming through, as Pegasystems signed up eight new clients over the past quarter, including such name-brand clients as Aetna (NYSE:AET) and ING's (NYSE:ING) Canadian branch. Pegasystems also expanded its relationships with Wells Fargo (NYSE:WFC) and American International Group (NYSE:AIG). But clearly, the new clients have not yet made up for the loss of revenues from First Data.
Perhaps more important than the decline in revenues, though, is the decline in free cash flow. It was Pegasystems' strong free cash flow, relative to its low enterprise value, after all, that attracted the interest of Hidden Gems subscribers in the first place. In the first quarter of 2004, the company posted $2.9 million in free cash flow vs. $3.8 million generated in the year-ago quarter. That 24% drop was not nearly as bad as the 75% drop in GAAP earnings. Still, that a 3.5% drop in revenues should have such a devastating effect on the company's ability to generate cash underscores the need for it to sign up new clients.
Fortunately, the firm already has a large cash war chest with which to finance its rebuilding phase. With $92.4 million in cash and equivalents, Pegasystems can afford to spend all it needs to on R&D and marketing to help restart its stalled growth.
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Fool contributor Rich Smith has no interest in any of the companies mentioned in this article.
