Pegasystems (NASDAQ:PEGA) posted third-quarter earnings results Tuesday evening. And judging by the early stock market reaction, Wall Street wasn't impressed with the software company's performance over the past three months.
Here are a few highlights from the announcement:
- Total revenue rose 13% to $138 million.
- Net income fell 35% to $0.11 per share.
- Licensing revenue was up 8%.
- Backlog rose 18% to $334 million.
- Free cash flow improved by 17% to $93 million.
Sales growth is down
Pegasystems missed analysts' estimates on both the top and bottom lines. But the sales growth figure is the bigger story here. The Street was expecting an 18% revenue improvement to $143 million, which would have been just a slight slowdown from Q2's 23% gain. Instead, the rate of growth over the prior-year period tumbled to 13%. That dip alone could explain the pressure on the stock, given that Pega is valued as a high-growth company at nearly 50 times trailing-12-month earnings.
Licensing revenue gains were soft, coming in at 9% in Q3 as compared twith the 35% gain in Q2 and the 23% gain in Q1. Still, executives were pleased that Pegasystems is winning a hefty portion of new business from its current customer base. In a press release accompanying the results, Chief Financial Officer Rafe Brown said, "It has been encouraging that our year-to-date performance has been driven by a high level of expansion within our existing clients, further evidence of the value they have found with Pega."
Regarding the slowdown in Q3, management stressed a bigger-picture approach by highlighting the company's strong growth so far in 2014. "Our year-to-date results are very solid and reflect the increasing benefits Pega clients are achieving through the use of our technology," CEO Alan Trefler said.
Expenses are up
Meanwhile, Pegasystems' $0.11-per-share profit was 35% below last year's result and also failed to meet Wall Street's estimate of $0.14 per share. The culprit here appears to be rising costs. Operating expenses grew by 23% year over year, outpacing sales gains. And profitability fell as a result: Operating margin dropped by 7 percentage points to 4% of sales. Pegasystems has been spending particularly heavily on research and development: That expense grew by 40% in Q3.
Looking ahead, Wall Street expects Pegasystems to book $610 million of sales for the full year. But to do that, the company's revenue growth will need to bounce back in Q4 to 19%. That's not out of the question, particularly in light of Pega's 18% improvement in its license and cloud backlog. But this quarter's growth slowdown may keep the stock volatile in the meantime.
Demitrios Kalogeropoulos owns shares of Apple. The Motley Fool recommends Apple and Pegasystems and recommends Apple. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.