Pegasystems (NASDAQ:PEGA) is expected to file Q3 2006 earnings sometime within the next week, following a delay during which the provider of rules-based business software reviewed its revenue recognition policies.

What analysts say:

  • Buy, sell, or waffle? According to Capital IQ and Reuters Estimates, only one analyst covers this one-time Motley Fool Hidden Gems recommendation, and he's ruled the stock a hold.
  • Revenues. For the third quarter, he expects revenues to be pegged at $29.6 million, a modest 10% rise over the prior year.
  • Earnings. Profits for the quarter, however, are expected to fall 75% from the year ago period, coming in at only $0.01 per share.

What management says:
When management announced its decision to delay filing its quarterly report, it also took the liberty to point out that preliminary revenue for quarter looked as if it would be at record highs. It's a way to sugarcoat the bad news that the company would be late with its filings, and it calls to mind the way management had performed when it was a Hidden Gems selection -- which was also one of the factors that caused it to be jettisoned from the portfolio. The restatement that may end up occurring from its review will defer as much as $2 million in revenue into the third quarter, but management could not estimate what impact it will have on net income or revenues in any particular quarter.

Although management has been bringing new customers on board and expanding its licensing program -- those revenues increased 18% in the first half of the year -- it's been taking its toll on gross margins, which have declined year over year as new personnel has had to be hired. But that's also an investment in the future. Pegasystems' dilemma is that its revenues can be lumpy because it had used a "perpetual license agreement" -- a customer pays a single fee at the start -- but has begun to more frequently adopt "term license agreements," wherein the customer has to pay a monthly fee to use the product. That makes for lumpier quarterly results and explains why first-half revenues had declined by $5 million -- leading to a loss this year -- over the same profitable period in 2005.

What management does:
At the time Pegasystems got the heave-ho from Hidden Gems, the stock's price had collapsed by some 45% from its recommendation level, and insiders were dumping shares wholesale. CEO Alan Treffler had sold some $1.2 million worth of stock, even as the share price was crumbling. Insiders can sell for a variety of reasons, and selloffs are typically not a reason for concern, but it can all be worrisome. In the two years since the stock was sold, the stock price has recovered by nearly 50%, but insider sales have continued apace, with the vice chairman and the CFO selling more than $1.8 million worth of stock over the past year.

The company also has a habit of stockpiling its cash. While it has instituted a dividend policy and just recently declared a $0.03-per-share dividend for the most recent quarter, cash has grown from $3 million from the end of the second quarter, and it now has more than $129 million in cash and investments. One of the attractions of Pegasystems as an investment has always been its prodigious ability to make cash. It's also used that money to pay down its debt level, which stands now at only $9 million and could actually be gone when the numbers are finally released.

One Fool says:
Even with the recovery of the stock price over the past few years, this company would have essentially been dead money for an investor who held on. Management has been slow to adopt policies that increase shareholder value -- such as its dividend and share buybacks -- and it hasn't shown a belief in itself, as there hasn't been a single purchase of shares by insiders in a while. Option grants, on the other hand, which cost the company $1 million in the second quarter, have not been so hard to find. I believe that the disparity remains wide between shareholder-friendly policies and policies that benefit management.


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Fool contributor Rich Duprey does not own any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.