Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2021
OR
☐
Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number: 1-11859
____________________________
PEGASYSTEMS INC.
(Exact name of Registrant as specified in its charter)
____________________________
Massachusetts
04-2787865
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)
One Rogers Street, Cambridge, MA02142-1209
(Address of principal executive offices, including zip code)
(617) 374-9600
(Registrant’s telephone number, including area code)
____________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading symbol(s)
Name of each exchange on which registered
Common Stock, $.01 par value per share
PEGA
NASDAQ Global Select Market
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx No ¨
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files). Yesx No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
☐
Emerging growth company
☐
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐No ☒
There were 81,455,672 shares of the Registrant’s common stock, $0.01 par value per share, outstanding on July 19, 2021.
Common stock, 200,000 shares authorized; 81,456 and 80,890 shares issued and outstanding at
June 30, 2021 and December 31, 2020, respectively
815
809
Additional paid-in capital
147,670
204,432
Retained earnings
375,069
339,879
Accumulated other comprehensive (loss)
(1,086)
(2,948)
Total stockholders’ equity
522,468
542,172
Total liabilities and stockholders’ equity
$
1,602,570
$
1,604,262
See notes to unaudited condensed consolidated financial statements.
3
PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Three Months Ended June 30,
Six Months Ended June 30,
2021
2020
2021
2020
Revenue
Software license
$
116,892
$
53,323
$
233,853
$
147,239
Maintenance
78,782
72,222
154,343
145,917
Pega Cloud
73,293
48,838
141,151
92,304
Consulting
56,735
52,992
109,854
107,506
Total revenue
325,702
227,375
639,201
492,966
Cost of revenue
Software license
656
979
1,306
1,663
Maintenance
4,995
5,591
10,781
11,167
Pega Cloud
24,051
18,988
46,608
36,521
Consulting
54,829
51,133
108,283
106,868
Total cost of revenue
84,531
76,691
166,978
156,219
Gross profit
241,171
150,684
472,223
336,747
Operating expenses
Selling and marketing
156,423
127,607
305,162
263,631
Research and development
64,395
58,869
126,837
117,596
General and administrative
19,161
15,655
37,431
31,285
Total operating expenses
239,979
202,131
469,430
412,512
Income (loss) from operations
1,192
(51,447)
2,793
(75,765)
Foreign currency transaction (loss) gain
(403)
4,256
(5,501)
(1,691)
Interest income
236
242
389
849
Interest expense
(1,959)
(5,529)
(3,839)
(7,835)
Gain on capped call transactions
26,309
19,419
7,192
827
Other income, net
—
—
106
1,374
Income (loss) before (benefit from) income taxes
25,375
(33,059)
1,140
(82,241)
(Benefit from) income taxes
(11,916)
(12,319)
(29,534)
(36,129)
Net income (loss)
$
37,291
$
(20,740)
$
30,674
$
(46,112)
Earnings (loss) per share
Basic
$
0.46
$
(0.26)
$
0.38
$
(0.58)
Diluted
$
0.43
$
(0.26)
$
0.36
$
(0.58)
Weighted-average number of common shares outstanding
Basic
81,316
80,224
81,161
80,016
Diluted
90,320
80,224
86,006
80,016
See notes to unaudited condensed consolidated financial statements.
4
PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
Three Months Ended June 30,
Six Months Ended June 30,
2021
2020
2021
2020
Net income (loss)
$
37,291
$
(20,740)
$
30,674
$
(46,112)
Other comprehensive income, net of tax
Unrealized gain on available-for-sale securities
121
—
1,131
100
Foreign currency translation adjustments
1,461
2,028
731
1,514
Total other comprehensive income, net of tax
$
1,582
$
2,028
$
1,862
$
1,614
Comprehensive income (loss)
$
38,873
$
(18,712)
$
32,536
$
(44,498)
See notes to unaudited condensed consolidated financial statements.
5
PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (in thousands, except per share amounts)
Common Stock
Additional Paid-In Capital
Retained Earnings
Accumulated Other Comprehensive (Loss)
Total Stockholders’ Equity
Number of Shares
Amount
December 31, 2019
79,599
$
796
$
140,523
$
410,919
$
(13,228)
$
539,010
Equity component of convertible senior notes, net
—
—
61,604
—
—
61,604
Repurchase of common stock
(87)
(1)
(5,999)
—
—
(6,000)
Issuance of common stock for stock compensation plans
564
6
(23,017)
—
—
(23,011)
Stock-based compensation
—
—
23,199
—
—
23,199
Cash dividends declared ($0.03 per share)
—
—
—
(2,405)
—
(2,405)
Other comprehensive (loss)
—
—
—
—
(414)
(414)
Net (loss)
—
—
—
(25,372)
—
(25,372)
March 31, 2020
80,076
$
801
$
196,310
$
383,142
$
(13,642)
$
566,611
Repurchase of common stock
(23)
—
(2,199)
—
—
(2,199)
Issuance of common stock for stock compensation plans
349
3
(14,085)
—
—
(14,082)
Issuance of common stock under the employee stock purchase plan
18
—
1,403
—
—
1,403
Stock-based compensation
—
—
25,674
—
—
25,674
Cash dividends declared ($0.03 per share)
—
—
—
(2,413)
—
(2,413)
Other comprehensive income
—
—
—
—
2,028
2,028
Net (loss)
—
—
—
(20,740)
—
(20,740)
June 30, 2020
80,420
$
804
$
207,103
$
359,989
$
(11,614)
$
556,282
December 31, 2020
80,890
$
809
$
204,432
$
339,879
$
(2,948)
$
542,172
Cumulative-effect adjustment from adoption of ASU 2020-06, net
—
—
(61,604)
9,399
—
(52,205)
Repurchase of common stock
(70)
(1)
(9,145)
—
—
(9,146)
Issuance of common stock for stock compensation plans
402
4
(25,513)
—
—
(25,509)
Issuance of common stock under the employee stock purchase plan
24
—
2,288
—
—
2,288
Stock-based compensation
—
—
30,100
—
—
30,100
Cash dividends declared ($0.03 per share)
—
—
—
(2,438)
—
(2,438)
Other comprehensive income
—
—
—
—
280
280
Net (loss)
—
—
—
(6,617)
—
(6,617)
March 31, 2021
81,246
$
812
$
140,558
$
340,223
$
(2,668)
$
478,925
Repurchase of common stock
(81)
(1)
(10,245)
—
—
(10,246)
Issuance of common stock for stock compensation plans
267
3
(16,199)
—
—
(16,196)
Issuance of common stock under the employee stock purchase plan
24
1
2,858
—
—
2,859
Stock-based compensation
—
—
30,698
—
—
30,698
Cash dividends declared ($0.03 per share)
—
—
—
(2,445)
—
(2,445)
Other comprehensive income
—
—
—
—
1,582
1,582
Net income
—
—
—
37,291
—
37,291
June 30, 2021
81,456
$
815
$
147,670
$
375,069
$
(1,086)
$
522,468
See notes to unaudited condensed consolidated financial statements.
6
PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Six Months Ended June 30,
2021
2020
Operating activities
Net income (loss)
$
30,674
$
(46,112)
Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities
Stock-based compensation
60,788
48,831
(Gain) on capped call transactions
(7,192)
(827)
Deferred income taxes
(28,232)
(18,399)
Amortization of deferred commissions
21,202
16,061
Amortization of debt discount and issuance costs
1,348
6,033
Amortization of intangible assets and depreciation
15,504
10,134
Amortization of investments
1,988
—
Foreign currency transaction loss
5,501
1,691
Other non-cash
(4,869)
6,445
Change in operating assets and liabilities, net
(77,302)
(45,056)
Cash provided by (used in) operating activities
19,410
(21,199)
Investing activities
Purchases of investments
(51,601)
(1,769)
Proceeds from maturities and called investments
68,798
—
Sales of investments
2,450
1,424
Payments for acquisitions, net of cash acquired
(4,993)
—
Investment in property and equipment
(4,161)
(19,059)
Cash provided by (used in) investing activities
10,493
(19,404)
Financing activities
Proceeds from issuance of convertible senior notes
—
600,000
Purchase of capped calls related to convertible senior notes
—
(51,900)
Payment of debt issuance costs
—
(14,527)
Proceeds from employee stock purchase plan
5,146
1,403
Dividend payments to stockholders
(4,865)
(4,793)
Common stock repurchases
(60,998)
(44,890)
Cash (used in) provided by financing activities
(60,717)
485,293
Effect of exchange rate changes on cash and cash equivalents
(1,207)
(942)
Net (decrease) increase in cash and cash equivalents
(32,021)
443,748
Cash and cash equivalents, beginning of period
171,899
68,363
Cash and cash equivalents, end of period
$
139,878
$
512,111
See notes to unaudited condensed consolidated financial statements.
7
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
Pegasystems Inc. (together with its subsidiaries, “the Company”) has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all the information required by accounting principles generally accepted in the United States of America (“U.S.”) for complete financial statements. These financial statements should be read in conjunction with the Company’s audited financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2020.
In the opinion of management, the Company has prepared the accompanying unaudited condensed consolidated financial statements on the same basis as its audited financial statements, and these financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented.
All intercompany transactions and balances were eliminated in consolidation. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year 2021.
NOTE 2. NEW ACCOUNTING PRONOUNCEMENTS
Convertible debt
In August 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2020-06, “Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity” (“ASU 2020-06”), which simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts in an entity’s own equity. The standard eliminates the liability and equity separation model for convertible instruments with a cash conversion feature. As a result, after adoption, entities will no longer separately present in stockholders’ equity an embedded conversion feature for such debt. Additionally, the debt discount resulting from separating the embedded conversion feature will no longer be amortized into income as interest expense over the instrument’s life. Instead, entities will account for a convertible debt instrument wholly as debt unless (1) a convertible instrument contains features that require bifurcation as a derivative under ASC Topic 815, “Derivatives and Hedging”, or (2) a convertible debt instrument was issued at a substantial premium. The standard also requires the convertible instruments’ impact on diluted earnings per share (“EPS”) be determined using the if-converted method.
The Company adopted ASU 2020-06 using the modified retrospective approach on January 1, 2021. Upon adoption, the book value of the Company’s Convertible Senior Notes (the “Notes”) increased by $69.5 million to $587.7 million, and retained earnings increased by $9.4 million. The retained earnings adjustment reflects the tax effected difference between the value of the Notes and the embedded conversion feature before adoption and the combined convertible instrument's amortized cost after adoption.
See "Note 8. Debt" for additional information.
NOTE 3. MARKETABLE SECURITIES
June 30, 2021
December 31, 2020
(in thousands)
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
Government debt
$
2,000
$
—
$
—
$
2,000
$
39,996
$
—
$
(8)
$
39,988
Corporate debt
269,649
20
(210)
269,459
253,345
88
(152)
253,281
$
271,649
$
20
$
(210)
$
271,459
$
293,341
$
88
$
(160)
$
293,269
As of June 30, 2021, marketable securities’ maturities ranged from July 2021 to May 2024, with a weighted-average remaining maturity of approximately 1.3 years.
8
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 4. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE
Receivables
(in thousands)
June 30, 2021
December 31, 2020
Accounts receivable
$
166,226
$
215,827
Unbilled receivables
236,451
207,155
Long-term unbilled receivables
144,065
113,278
$
546,742
$
536,260
Unbilled receivables
Unbilled receivables are client-committed amounts for which revenue recognition precedes billing, and billing is solely subject to the passage of time.
Unbilled receivables by expected billing date:
(Dollars in thousands)
June 30, 2021
1 year or less
$
236,451
62
%
1-2 years
88,350
23
%
2-5 years
55,715
15
%
$
380,516
100
%
Unbilled receivables by contract effective date:
(Dollars in thousands)
June 30, 2021
2021
$
140,395
37
%
2020
131,618
34
%
2019
55,282
15
%
2018
26,688
7
%
2017 and prior
26,533
7
%
$
380,516
100
%
Major clients
Clients accounting for 10% or more of the Company’s total receivables:
June 30, 2021
December 31, 2020
Client A
13
%
*
* Client accounted for less than 10% of total receivables.
Contract assets
Contract assets are client-committed amounts for which revenue recognized exceeds the amount billed to the client, and billing is subject to conditions other than the passage of time, such as completing a related performance obligation.
(in thousands)
June 30, 2021
December 31, 2020
Contract assets (1)
$
14,031
$
15,296
Long-term contract assets (2)
10,097
7,777
$
24,128
$
23,073
(1) Included in other current assets. (2) Included in other long-term assets.
Deferred revenue
Deferred revenue consists of billings and payments received in advance of revenue recognition.
(in thousands)
June 30, 2021
December 31, 2020
Deferred revenue
$
242,194
$
232,865
Long-term deferred revenue (1)
6,041
8,991
$
248,235
$
241,856
(1) Included in other long-term liabilities.
The change in deferred revenue in the six months ended June 30, 2021 was primarily due to new billings in advance of revenue recognition, offset by $172.1 million of revenue recognized that was included in deferred revenue as of December 31, 2020.
9
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 5. DEFERRED COMMISSIONS
(in thousands)
June 30, 2021
December 31, 2020
Deferred commissions (1)
$
109,803
$
108,624
(1) Included in other long-term assets.
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2021
2020
2021
2020
Amortization of deferred commissions (1)
$
9,706
$
7,564
$
21,202
$
16,061
(1) Included in selling and marketing expense.
NOTE 6. GOODWILL AND OTHER INTANGIBLES
Goodwill
Change in goodwill:
Six Months Ended June 30,
(in thousands)
2021
2020
January 1,
$
79,231
$
79,039
Acquisition
2,701
—
Currency translation adjustments
241
(364)
June 30,
$
82,173
$
78,675
Intangibles
Intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives.
June 30, 2021
(in thousands)
Useful Lives
Cost
Accumulated Amortization
Net Book Value (1)
Client-related
4-10 years
$
63,186
$
(56,638)
$
6,548
Technology
2-10 years
67,142
(57,644)
9,498
Other
1-5 years
5,361
(5,361)
—
$
135,689
$
(119,643)
$
16,046
(1) Included in other long-term assets.
December 31, 2020
(in thousands)
Useful Lives
Cost
Accumulated Amortization
Net Book Value (1)
Client-related
4-10 years
$
63,168
$
(55,877)
$
7,291
Technology
2-10 years
64,843
(56,386)
8,457
Other
1-5 years
5,361
(5,361)
—
$
133,372
$
(117,624)
$
15,748
(1) Included in other long-term assets.
10
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Amortization of intangible assets:
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2021
2020
2021
2020
Cost of revenue
$
629
$
647
$
1,258
$
1,294
Selling and marketing
373
370
746
740
$
1,002
$
1,017
$
2,004
$
2,034
Future estimated intangibles assets amortization:
(in thousands)
June 30, 2021
2021
$
1,983
2022
3,886
2023
3,618
2024
2,849
2025
2,509
2026 and thereafter
1,201
$
16,046
NOTE 7. LEASES
Headquarters lease
In February 2021, the Company agreed to accelerate its exit from its Cambridge, Massachusetts headquarters to October 1, 2021, in exchange for a one-time payment from the Company’s landlord of $18 million, which is being amortized over the remaining lease term. Upon modification, the Company reduced its lease liabilities by $21.1 million and accelerated depreciation related to its corporate headquarters.
Expense
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2021
2020
2021
2020
Fixed lease costs (1)
$
(3,972)
$
4,943
$
(3,672)
$
9,761
Short-term lease costs
515
371
974
826
Variable lease costs
1,340
969
2,727
2,247
$
(2,117)
$
6,283
$
29
$
12,834
(1) The decrease in fixed lease costs in three and six months ended June 30, 2021 was due to the modification of the Headquarters Lease.
Right of use assets and lease liabilities
(in thousands)
June 30, 2021
December 31, 2020
Right of use assets (1)
$
51,058
$
67,651
Lease liabilities (2)
$
13,682
$
18,541
Long-term lease liabilities
$
42,063
$
59,053
(1) Represents the Company’s right to use the leased asset during the lease term. Included in other long-term assets.
(2) Included in other current liabilities.
Weighted-average remaining lease term and discount rate for the Company’s leases were:
June 30, 2021
December 31, 2020
Weighted-average remaining lease term
4.9 years
4.7 years
Weighted-average discount rate (1)
4.6
%
5.4
%
(1) The rates implicit in most of the Company’s leases are not readily determinable. Therefore, the Company uses its incremental borrowing rate as the discount rate when measuring operating lease liabilities. The incremental borrowing rate represents an estimate of the interest rate the Company would incur to borrow an amount equal to the lease payments on a collateralized basis over the lease term in a similar economic environment.
11
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Maturities of lease liabilities:
(in thousands)
June 30, 2021
Remainder of 2021
$
8,783
2022
13,888
2023
13,300
2024
10,021
2025
6,913
2026
2,653
Thereafter
7,170
Total lease payments
62,728
Less: imputed interest (1)
(6,983)
$
55,745
(1) Lease liabilities are measured at the present value of the remaining lease payments using a discount rate determined at lease commencement, unless the discount rate is updated due to a lease reassessment event.
Cash flow information
Six Months Ended June 30,
(in thousands)
2021
2020
Cash paid for leases
$
11,605
$
10,945
Right of use assets recognized for new leases and amendments (non-cash)
$
10,160
$
10,077
NOTE 8. DEBT
Convertible senior notes and capped calls
Convertible senior notes
In February 2020, the Company issued Convertible Senior Notes (the "Notes") with an aggregate principal of $600 million, due March 1, 2025, in a private placement. No principal payments are required before maturity. The Notes accrue interest at an annual rate of 0.75%, payable semi-annually in arrears on March 1 and September 1, beginning on September 1, 2020.
Conversion rights
The conversion rate is 7.4045 shares of common stock per $1,000 principal amount of the Notes, representing an initial conversion price of $135.05 per share of common stock. The Company will settle conversions by paying or delivering cash, shares of its common stock, or a combination of cash and shares of its common stock, at the Company’s election, based on the applicable conversion rate. The conversion rate will be adjusted upon certain events, including spin-offs, tender offers, exchange offers, and certain stockholder distributions.
Beginning on September 1, 2024, noteholders may convert their Notes at any time at their election.
Before September 1, 2024, noteholders may convert their Notes in the following circumstances:
•During any calendar quarter commencing after June 30, 2020 (and only during such calendar quarter), if the last reported sale price per share of the Company’s common stock exceeds 130% of the conversion price for each of at least 20 trading days (whether or not consecutive) during the 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter.
•During the five consecutive business days immediately after any five consecutive trading day period (the “Measurement Period”), if the trading price per $1,000 principal amount of Notes for each trading day of the Measurement Period was less than 98% of the product of the last reported sale price per share of common stock on such trading day and the conversion rate on such trading day.
•Upon certain corporate events or distributions or if the Company calls any Notes for redemption, noteholders may convert before the close of business on the business day immediately before the related redemption date (or, if the Company fails to pay the redemption price in full on the redemption date, until the Company pays the redemption price).
As of June 30, 2021, the Notes were not eligible for conversion at the noteholders’ election.
Repurchase rights
On or after March 1, 2023 and on or before the 40th scheduled trading day immediately before the maturity date, the Company may redeem for cash all or part of the Notes at a repurchase price equal to 100% of the principal amount, plus accrued and unpaid interest, if the last reported sale price of the Company’s common stock exceeded 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period ending on, and including, the trading day immediately preceding the date on which the Company provides a redemption notice.
12
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
If certain corporate events that constitute a “Fundamental Change” occur, each noteholder will have the right to require the Company to repurchase for cash all of such noteholder’s Notes, or any portion of the principal thereof that is equal to $1,000 or a multiple of $1,000, at a repurchase price equal to 100% of the principal amount thereof, plus accrued and unpaid interest. A Fundamental Change relates to mergers, changes in control of the Company, liquidation/dissolution of the Company, or the delisting of the Company’s common stock.
Impact of the Notes
The Company adopted ASU 2020-06 using the modified retrospective approach on January 1, 2021. The standard eliminates the liability and equity separation model for convertible instruments with a cash conversion feature. See "Note 2. New Accounting Pronouncements" for additional information.
Until January 1, 2021, the Notes were separated into liability and equity components.
•The initial carrying amount of the liability component was calculated by measuring a similar debt instrument’s fair value that does not have an associated conversion feature. The excess of the Notes’ principal amount over the initial carrying amount of the liability component, the debt discount, was amortized as interest expense over the Notes’ contractual term.
•The equity component was recorded as an increase to additional paid-in capital and not remeasured.
Upon adoption of ASU 2020-06, the book value of the Notes increased by $69.5 million to $587.7 million, and retained earnings increased by $9.4 million. The retained earnings adjustment reflects the tax effected difference between the value of the Notes and the embedded conversion feature before adoption and the combined convertible instrument's amortized cost after adoption.
Carrying value of the Notes:
(in thousands)
June 30, 2021
December 31, 2020
Principal
$
600,000
$
600,000
Unamortized debt discount
—
(71,222)
Unamortized issuance costs
(10,908)
(10,575)
Convertible senior notes, net
$
589,092
$
518,203
Conversion options
$
—
$
84,120
Issuance costs
—
(2,037)
Deferred taxes
—
(20,479)
Additional paid-in capital
$
—
$
61,604
Interest expense related to the Notes:
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2021
2020
2021
2020
Contractual interest expense (0.75% coupon)
$
1,125
$
1,125
$
2,250
$
1,575
Amortization of debt discount
—
3,757
—
5,253
Amortization of issuance costs
675
558
1,348
780
$
1,800
$
5,440
$
3,598
$
7,608
13
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
The effective interest rate for the Notes:
Six Months Ended June 30,
2021
2020
Weighted-average effective interest rate
1.2
%
4.3
%
Future payments of principal and contractual interest:
June 30, 2021
(in thousands)
Principal
Interest
Total
2021
$
—
$
2,250
$
2,250
2022
—
4,500
4,500
2023
—
4,500
4,500
2024
—
4,500
4,500
2025
600,000
1,488
601,488
$
600,000
$
17,238
$
617,238
Capped call transactions
In February 2020, the Company entered into privately negotiated capped call transactions (the “Capped Call Transactions”) with certain financial institutions. The Capped Call Transactions cover approximately 4.4 million shares (representing the number of shares for which the Notes are initially convertible) of the Company’s common stock. The Capped Call Transactions are generally expected to reduce common stock dilution and/or offset any potential cash payments the Company must make, other than for principal and interest, upon conversion of the Notes, with such reduction and/or offset subject to a cap of $196.44. The cap price of the Capped Call Transactions is subject to adjustment upon the occurrence of specified extraordinary events affecting the Company, including mergers and tender offers.
The Capped Call Transactions are accounted for as derivative instruments and do not qualify for the Company’s own equity scope exception in ASC 815 since, in some cases of early settlement, the settlement value of the Capped Call Transactions, calculated in accordance with the governing documents, may not represent a fair value measurement. The Capped Call Transactions are classified as other long-term assets and remeasured to fair value at the end of each reporting period, resulting in a non-operating gain or loss.
Change in capped call transactions:
Six Months Ended June 30,
(in thousands)
2021
2020
January 1,
$
83,597
$
—
Issuance
—
51,900
Fair value adjustment
7,192
827
June 30,
$
90,789
$
52,727
Credit facility
In November 2019, and as amended as of February 2020, July 2020, and September 2020, the Company entered into a five-year $100 million senior secured revolving credit agreement (the “Credit Facility”) with PNC Bank, National Association. The Company may use borrowings to finance working capital needs and for general corporate purposes. Subject to specific conditions, the Credit Facility allows the Company to increase the aggregate commitment to $200 million. The commitments expire on November 4, 2024, and any outstanding loans will be payable on such date. The Credit Facility, as amended, contains customary covenants, including, but not limited to, those relating to additional indebtedness, liens, asset divestitures, and affiliate transactions.
The Company is also required to comply with financial covenants, including:
•Beginning with the fiscal quarter ended September 30, 2020 and ending with the fiscal quarter ended December 31, 2021, at least $200 million in cash and investments held by Pegasystems Inc.
•Beginning with the quarter ended March 31, 2022, a maximum net consolidated leverage ratio of 3.5 to 1.0 (with a step-up in the event of certain acquisitions) and a minimum consolidated interest coverage ratio of 3.5 to 1.0.
As of June 30, 2021 and December 31, 2020, the Company had no outstanding borrowings under the Credit Facility.
14
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 9. FAIR VALUE MEASUREMENTS
Assets and liabilities measured at fair value on a recurring basis
The Company records its cash equivalents, marketable securities, Capped Call Transactions, and venture investments at fair value on a recurring basis. Fair value is an exit price, representing the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants based on assumptions that market participants would use in pricing an asset or liability.
As a basis for classifying the fair value measurements, a three-tier fair value hierarchy, which classifies the fair value measurements based on the inputs used in measuring fair value, was established as follows:
•Level 1 - observable inputs such as quoted prices in active markets for identical assets or liabilities;
•Level 2 - significant other inputs that are observable either directly or indirectly; and
•Level 3 - significant unobservable inputs on which there is little or no market data, which require the Company to develop its own assumptions. This hierarchy requires the Company to use observable market data, when available, and minimize unobservable inputs when determining fair value.
The fair value of the Capped Call Transactions at the end of each reporting period is determined using a Black-Scholes option-pricing model. The valuation models use various market-based inputs, including stock price, remaining contractual term, expected volatility, risk-free interest rate, and expected dividend yield. The Company applies judgment when determining expected volatility. The Company considers both historical and implied volatility levels of the underlying equity security. The Company’s venture investments are recorded at fair value based on valuation methods, including observable public companies and transaction prices and unobservable inputs, including the volatility, rights, and obligations of the securities the Company holds.
Assets and liabilities measured at fair value on a recurring basis:
June 30, 2021
December 31, 2020
(in thousands)
Level 1
Level 2
Level 3
Total
Level 1
Level 2
Level 3
Total
Cash equivalents
$
4,650
$
—
$
—
$
4,650
$
42,339
$
14,000
$
—
$
56,339
Marketable securities
$
—
$
271,459
$
—
$
271,459
$
—
$
293,269
$
—
$
293,269
Capped Call Transactions (1)
$
—
$
90,789
$
—
$
90,789
$
—
$
83,597
$
—
$
83,597
Venture investments (1) (2)
$
—
$
—
$
9,779
$
9,779
$
—
$
—
$
8,345
$
8,345
(1) Included in other long-term assets. (2) Investments in privately-held companies.
Changes in venture investments:
Six Months Ended June 30,
(in thousands)
2021
2020
January 1,
$
8,345
$
4,871
New investments
500
1,769
Sales of investments
(400)
(1,424)
Changes in foreign exchange rates
14
(50)
Changes in fair value:
included in other income
100
1,374
included in other comprehensive income
1,220
100
June 30,
$
9,779
$
6,640
The carrying value of certain other financial instruments, including receivables and accounts payable, approximates fair value due to these items’ relatively short maturity.
Fair value of the Notes
The Notes’ fair value (inclusive of the conversion feature embedded in the Notes) was $726.2 million as of June 30, 2021 and $706.5 million as of December 31, 2020. The fair value was determined based on the Notes’ quoted price in an over-the-counter market on the last trading day of the reporting period and classified within Level 2 in the fair value hierarchy. See "Note 8. Debt" for additional information.
15
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 10. REVENUE
Geographic revenue
Three Months Ended June 30,
Six Months Ended June 30,
(Dollars in thousands)
2021
2020
2021
2020
U.S.
$
189,297
58
%
$
142,811
63
%
$
383,865
60
%
$
315,228
63
%
Other Americas
14,058
4
%
8,930
4
%
25,959
4
%
24,272
5
%
United Kingdom (“U.K.”)
32,553
10
%
21,259
9
%
60,765
10
%
43,096
9
%
Europe (excluding U.K.), Middle East, and Africa
45,798
14
%
34,878
15
%
97,457
15
%
66,816
14
%
Asia-Pacific
43,996
14
%
19,497
9
%
71,155
11
%
43,554
9
%
$
325,702
100
%
$
227,375
100
%
$
639,201
100
%
$
492,966
100
%
Revenue streams
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2021
2020
2021
2020
Perpetual license
$
12,596
$
9,057
$
18,048
$
12,716
Term license
104,296
44,266
215,805
134,523
Revenue recognized at a point in time
116,892
53,323
233,853
147,239
Maintenance
78,782
72,222
154,343
145,917
Pega Cloud
73,293
48,838
141,151
92,304
Consulting
56,735
52,992
109,854
107,506
Revenue recognized over time
208,810
174,052
405,348
345,727
$
325,702
$
227,375
$
639,201
$
492,966
(in thousands)
Three Months Ended June 30,
Six Months Ended June 30,
2021
2020
2021
2020
Pega Cloud
$
73,293
$
48,838
$
141,151
$
92,304
Client Cloud
$
183,078
$
116,488
$
370,148
$
280,440
Maintenance
78,782
72,222
154,343
145,917
Term license
104,296
44,266
215,805
134,523
Subscription (1)
256,371
165,326
511,299
372,744
Perpetual license
12,596
9,057
18,048
12,716
Consulting
56,735
52,992
109,854
107,506
$
325,702
$
227,375
$
639,201
$
492,966
(1) Reflects client arrangements subject to renewal (Pega Cloud, maintenance, and term license).
Remaining performance obligations ("Backlog")
Expected future revenue on existing non-cancellable contracts:
June 30, 2021
(Dollars in thousands)
Perpetual license
Term license
Maintenance
Pega Cloud
Consulting
Total
1 year or less
$
6,707
$
46,146
$
214,645
$
281,793
$
17,863
$
567,154
56
%
1-2 years
234
15,708
59,164
194,841
2,675
272,622
26
%
2-3 years
—
909
36,076
88,855
762
126,602
12
%
Greater than 3 years
—
255
26,564
37,246
693
64,758
6
%
$
6,941
$
63,018
$
336,449
$
602,735
$
21,993
$
1,031,136
100
%
June 30, 2020
(Dollars in thousands)
Perpetual license
Term license
Maintenance
Pega Cloud
Consulting
Total
1 year or less
$
8,120
$
53,550
$
186,618
$
191,187
$
21,923
$
461,398
57
%
1-2 years
1,700
6,187
40,153
140,860
1,986
190,886
23
%
2-3 years
—
6,460
20,671
88,273
631
116,035
14
%
Greater than 3 years
—
646
10,517
37,071
626
48,860
6
%
$
9,820
$
66,843
$
257,959
$
457,391
$
25,166
$
817,179
100
%
16
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Major clients
Clients accounting for 10% or more of the Company’s total revenue:
Three Months Ended June 30,
Six Months Ended June 30,
(Dollars in thousands)
2021
2020
2021
2020
Total revenue
$
325,702
$
227,375
$
639,201
$
492,966
Client A
13
%
*
*
*
*Client accounted for less than 10% of total revenue.
NOTE 11. STOCK-BASED COMPENSATION
Expense
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2021
2020
2021
2020
Cost of revenue
$
5,849
$
5,384
$
11,774
$
10,536
Selling and marketing
14,748
11,592
28,468
21,310
Research and development
6,343
5,805
13,113
11,302
General and administrative
3,748
2,874
7,433
5,683
$
30,688
$
25,655
$
60,788
$
48,831
Income tax benefit
$
(6,192)
$
(5,107)
$
(12,183)
$
(9,689)
As of June 30, 2021, the Company had $157.3 million of unrecognized stock-based compensation expense, net of estimated forfeitures, which is expected to be recognized over a weighted-average period of 2.2 years.
Grants
Six Months Ended June 30, 2021
(in thousands)
Shares
Total Fair Value
RSUs
753
$
97,483
Non-qualified stock options
1,368
$
51,594
NOTE 12. INCOME TAXES
Effective income tax rate
Three Months Ended June 30,
Six Months Ended June 30,
(Dollars in thousands)
2021
2020
2021
2020
(Benefit from) income taxes
$
(11,916)
$
(12,319)
$
(29,534)
$
(36,129)
Effective income tax benefit rate
(2,591)
%
44
%
The change in the effective income tax benefit rate was primarily due to the impact of discrete tax items on a proportionately larger income (loss) before income taxes in the prior period. The most significant discrete items were excess tax benefits from stock-based compensation and the impact of changes in statutory tax rates applicable to our U.K.-based deferred tax assets.
NOTE 13. EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is calculated using the weighted-average number of common shares outstanding during the period. Diluted earnings (loss) per share is calculated using the weighted-average number of common shares outstanding during the period, plus the dilutive effect of outstanding stock options, RSUs, and convertible senior notes.
17
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Calculation of earnings (loss) per share:
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands, except per share amounts)
2021
2020
2021
2020
Net income (loss)
$
37,291
$
(20,740)
$
30,674
$
(46,112)
Weighted-average common shares outstanding
81,316
80,224
81,161
80,016
Earnings (loss) per share, basic
$
0.46
$
(0.26)
$
0.38
$
(0.58)
Net income (loss)
$
37,291
$
(20,740)
$
30,674
$
(46,112)
Interest expense associated with convertible debt instruments, net of tax
1,351
—
—
—
Numerator for diluted EPS
$
38,642
$
(20,740)
$
30,674
$
(46,112)
Weighted-average effect of dilutive securities:
Convertible debt (1)
4,443
—
—
—
Stock options
3,266
—
3,416
—
RSUs
1,295
—
1,429
—
Effect of dilutive securities (2)
9,004
—
4,845
—
Weighted-average common shares outstanding, assuming dilution (1) (2) (3)
90,320
80,224
86,006
80,016
Earnings (loss) per share, diluted
$
0.43
$
(0.26)
$
0.36
$
(0.58)
Outstanding anti-dilutive stock options and RSUs (4)
19
5,929
22
5,939
(1) The shares underlying the conversion options in the Company’s Notes are included using the if-converted method, if dilutive in the period. If the outstanding conversion options were fully exercised, the Company would issue an additional 4.4 million shares.
(2) In periods of loss, all dilutive securities are excluded as their inclusion would be anti-dilutive.
(3) The Company’s Capped Call Transactions convert to approximately 4.4 million shares of the Company’s common stock (representing the number of shares for which the Notes are initially convertible). The Capped Call Transactions are generally expected to reduce common stock dilution and/or offset any potential cash payments the Company must make, other than for principal and interest, upon conversion of the Notes, with such reduction and/or offset subject to a cap of $196.44. The Capped Call Transactions are excluded from weighted-average common shares outstanding, assuming dilution, in all periods as their effect would be anti-dilutive.
(4) Outstanding stock options and RSUs that were anti-dilutive under the treasury stock method in the period were excluded from the computation of diluted earnings (loss) per share. These awards may be dilutive in the future.
NOTE 14. SUBSEQUENT EVENTS
On July 6, 2021, the Company entered into an office space lease (the “Lease”) for 131 thousand square feet in Waltham, Massachusetts. The lease term of approximately 11 years is expected to commence on August 1, 2021 (the “Lease Commencement Date”), subject to certain adjustments for the initial occupancy date. The annual rent equals the base rent plus the Company’s portion of building operating costs and real estate taxes for the year. Rent first becomes payable on August 1, 2022, subject to adjustment based on the Lease Commencement Date. Base rent for the first year is $6 million and will increase by 3% annually. In addition, the Company will receive an improvement allowance from the landlord of $11.8 million.
18
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q (“Quarterly Report”) contains or incorporates forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.
Words such as expects, anticipates, intends, plans, believes, will, could, should, estimates, may, targets, strategies, projects, forecasts, guidance, likely, and usually, or variations of such words and other similar expressions identify forward-looking statements, which are based on current expectations and assumptions.
Forward-looking statements deal with future events and are subject to risks and uncertainties that are difficult to predict, including, but not limited to:
•our future financial performance and business plans;
•the adequacy of our liquidity and capital resources;
•the continued payment of our quarterly dividends;
•the timing of revenue recognition;
•management of our transition to a more subscription-based business model;
•variation in demand for our products and services, including among clients in the public sector;
•the impact of actual or threatened public health emergencies, such as the Coronavirus (“COVID-19”);
•reliance on third-party service providers;
•compliance with our debt obligations and covenants;
•the potential impact of our convertible senior notes and Capped Call Transactions;
•reliance on key personnel;
•the relocation of our corporate headquarters;
•the continued uncertainties in the global economy;
•foreign currency exchange rates;
•the potential legal and financial liabilities and reputation damage due to cyber-attacks;
•security breaches and security flaws;
•our ability to protect our intellectual property rights and costs associated with defending such rights;
•our client retention rate; and
•management of our growth.
These risks and others that may cause actual results to differ materially from those expressed in such forward-looking statements are described further in Part I of our Annual Report on Form 10-K for the year ended December 31, 2020, and other filings we make with the U.S. Securities and Exchange Commission (“SEC”). Except as required by applicable law, we do not undertake and expressly disclaim any obligation to update or revise these forward-looking statements publicly, whether from new information, future events, or otherwise.
The forward-looking statements contained in this Quarterly Report represent our views as of July 28, 2021.
BUSINESS OVERVIEW
We develop, market, license, host, and support enterprise software applications that help organizations simplify business complexity. Our intelligent technology and scalable architecture enables the world’s leading brands and government agencies to solve problems quickly and transform for tomorrow. Our clients are able to make better decisions and get work done using real-time artificial intelligence (“AI”) and intelligent automation on applications built on the low-code, cloud-native Pega Platform™, enabling our clients to streamline service, increase customer lifetime value, and boost efficiency. Our consulting and client success teams, along with our world-class partners, leverage our Pega Express™ methodology and low code to allow clients to design and deploy critical applications quickly and collaboratively.
Our target clients are Global 3000 organizations and government agencies that require applications to differentiate themselves in the markets they serve. Our applications achieve and facilitate differentiation by increasing business agility, driving growth, improving productivity, attracting and retaining customers, and reducing risk. We deliver applications tailored to our clients’ specific industry needs.
19
Cloud Transition
We are in the process of transitioning our business to sell software primarily through subscription arrangements, particularly Pega Cloud. Until we substantially complete our Cloud Transition, which we anticipate will occur in 2023, we may experience lower revenue growth and lower operating cash flow growth or negative cash flow. Operating performance and the actual mix of revenue and new arrangements in a given period can fluctuate based on client preferences for our perpetual and subscription offerings. See the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2020 for additional information.
Coronavirus (“COVID-19”)
As of June 30, 2021, COVID-19 has not had a material impact on our results of operations or financial condition. See “Coronavirus (“COVID-19”)” in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2020 for additional information.
Performance metrics
We utilize performance metrics to analyze and assess our overall performance, make operating decisions, and forecast and plan for future periods, including:
Annual contract value (“ACV”) | Increased 22% since June 30, 2020
•ACV, as reported, represents the annualized value of our active contracts as of the measurement date. The contract's total value is divided by its duration in years to calculate ACV for term license and Pega Cloud contracts. Maintenance revenue for the quarter then ended is multiplied by four to calculate ACV for maintenance. Client Cloud ACV is composed of maintenance ACV and term license ACV. ACV is a performance measure that we believe provides useful information to our management and investors, particularly during our Cloud Transition.
* Foreign currency exchange rate changes contributed 3-4% to total ACV growth in 2021.
20
Remaining performance obligations (“Backlog”) | Increased 26% since June 30, 2020
•Backlog represents expected future revenue on existing non-cancellable contracts.
Year to date Pega Cloud revenue | Increased 53% since the six months ended June 30, 2020
•Pega Cloud revenue is revenue under U.S. GAAP for cloud contracts.
CRITICAL ACCOUNTING POLICIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our unaudited condensed consolidated financial statements, which have been prepared following accounting principles generally accepted in the United States and the rules and regulations of the SEC for interim financial reporting. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, knowledge of current conditions, and expectations of what could occur in the future given the available information.
For more information regarding our critical accounting policies, we encourage you to read the discussion in the following locations in our Annual Report on Form 10-K for the year ended December 31, 2020:
•“Critical Accounting Estimates and Significant Judgments” in Item 7; and
•“Note 2. Significant Accounting Policies” in Item 8.
21
There have been no significant changes other than those disclosed in “Note 2. New Accounting Pronouncements” in Item 1 of this Quarterly Report on Form 10-Q to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2020.
RESULTS OF OPERATIONS
Revenue
Cloud Transition
We are in the process of transitioning our business to sell software primarily through subscription arrangements, particularly Pega Cloud. Revenue growth has been slower because of this transition. Revenue from Pega Cloud and maintenance arrangements is typically recognized over the contract term. In contrast, revenue from license sales is recognized when the license rights become effective, typically upfront.
(Dollars in thousands)
Three Months Ended June 30,
Change
Six Months Ended June 30,
Change
2021
2020
2021
2020
Pega Cloud
$
73,293
23
%
$
48,838
21
%
$
24,455
50
%
$
141,151
22
%
$
92,304
19
%
$
48,847
53
%
Client Cloud
$
183,078
56
%
$
116,488
52
%
$
66,590
57
%
$
370,148
58
%
$
280,440
57
%
$
89,708
32
%
Maintenance
78,782
24
%
72,222
33
%
6,560
9
%
154,343
24
%
145,917
30
%
8,426
6
%
Term license
104,296
32
%
44,266
19
%
60,030
136
%
215,805
34
%
134,523
27
%
81,282
60
%
Subscription (1)
$
256,371
79
%
$
165,326
73
%
91,045
55
%
511,299
80
%
372,744
76
%
138,555
37
%
Perpetual license
12,596
4
%
9,057
4
%
3,539
39
%
18,048
3
%
12,716
3
%
5,332
42
%
Consulting
56,735
17
%
52,992
23
%
3,743
7
%
109,854
17
%
107,506
21
%
2,348
2
%
$
325,702
100
%
$
227,375
100
%
$
98,327
43
%
$
639,201
100
%
$
492,966
100
%
$
146,235
30
%
(1) Reflects client arrangements subject to renewal (Pega Cloud, maintenance, and term license).
The total revenue changes in the three and six months ended June 30, 2021 generally reflect our Cloud Transition. Other factors impacting our revenue include:
•An increasing portion of our term license contracts include multi-year committed maintenance periods instead of annually renewable maintenance. Under multi-year committed maintenance arrangements, a larger portion of the total contract value is recognized as maintenance revenue over the contract term rather than as term license revenue upon the effectiveness of the license rights. In the three months ended June 30, 2021, multi-year committed maintenance contributed $4.3 million to maintenance revenue growth and reduced term revenue growth by $15.4 million. In the six months ended June 30, 2021, multi-year committed maintenance contributed $7.8 million to maintenance revenue growth and reduced term revenue growth by $20.9 million.
•Maintenance renewal rates of higher than 90%.
•The increases in term license revenue in the three and six months ended June 30, 2021 were driven by a large, existing customer that expanded their use of our software, renewed an existing multi-year contract, and extended the term of the agreement earlier in the year than anticipated.
•The increases in perpetual license revenue were primarily due to several large perpetual license contracts recognized in revenue in the three and six months ended June 30, 2021.
•The increases in consulting revenue in the three and six months ended June 30, 2021 were primarily due to increases in billable hours. As part of our long-term strategy, we intend to continue growing and leveraging our ecosystem of partners on implementation projects, potentially reducing our future consulting revenue growth.
Gross profit
Three Months Ended June 30,
Change
Six Months Ended June 30,
Change
(Dollars in thousands)
2021
2020
2021
2020
Software license
$
116,236
99
%
$
52,344
98
%
$
63,892
122
%
$
232,547
99
%
$
145,576
99
%
$
86,971
60
%
Maintenance
73,787
94
%
66,631
92
%
7,156
11
%
143,562
93
%
134,750
92
%
8,812
7
%
Pega Cloud
49,242
67
%
29,850
61
%
19,392
65
%
94,543
67
%
55,783
60
%
38,760
69
%
Consulting
1,906
3
%
1,859
4
%
47
3
%
1,571
1
%
638
1
%
933
146
%
$
241,171
74
%
$
150,684
66
%
$
90,487
60
%
$
472,223
74
%
$
336,747
68
%
$
135,476
40
%
•The changes in gross profit in the three and six months ended June 30, 2021 were primarily due to our Cloud Transition, revenue growth, and cost-efficiency gains as Pega Cloud grows and scales.
22
Operating expenses
(Dollars in thousands)
Three Months Ended June 30,
Change
Six Months Ended June 30,
Change
2021
2020
2021
2020
% of Revenue
% of Revenue
% of Revenue
% of Revenue
Selling and marketing
$
156,423
48
%
$
127,607
56
%
$
28,816
23
%
$
305,162
48
%
$
263,631
53
%
$
41,531
16
%
Research and development
$
64,395
20
%
$
58,869
26
%
$
5,526
9
%
$
126,837
20
%
$
117,596
24
%
$
9,241
8
%
General and administrative
$
19,161
6
%
$
15,655
7
%
$
3,506
22
%
$
37,431
6
%
$
31,285
6
%
$
6,146
20
%
•The increases in selling and marketing in the three and six months ended June 30, 2021 were primarily due to increases in compensation and benefits of $22.6 million and $48.0 million, attributable to increases in headcount and equity compensation. The increase in headcount reflects our efforts to increase our sales capacity to deepen relationships with existing clients and target new accounts.
•The increases in research and development in the three and six months ended June 30, 2021 were primarily due to increases in compensation and benefits of $7.2 million and $11.8 million, attributable to increases in headcount and equity compensation.
•The increases in general and administrative in the three and six months ended June 30, 2021 were primarily due to increases in compensation and benefits of $2.2 million and $3.5 million, attributable to increases in headcount and equity compensation, and increases in professional services fees of $1.8 million and $3.4 million.
•In February 2021, we agreed to accelerate our exit from our Cambridge, Massachusetts headquarters to October 1, 2021, in exchange for a one-time payment from our landlord of $18 million. This agreement was the primary contributor to decreases in facilities expenses of $2.1 million and $3.3 million in selling and marketing, $2.4 million and $3.6 million in research and development, and $1.1 million and $1.6 million in general and administrative, in the three and six months ended June 30, 2021.
Other income (expense), net
(Dollars in thousands)
Three Months Ended June 30,
Change
Six Months Ended June 30,
Change
2021
2020
2021
2020
Foreign currency transaction (loss) gain
$
(403)
$
4,256
$
(4,659)
*
$
(5,501)
$
(1,691)
$
(3,810)
(225)
%
Interest income
236
242
(6)
(2)
%
389
849
(460)
(54)
%
Interest expense
(1,959)
(5,529)
3,570
65
%
(3,839)
(7,835)
3,996
51
%
Gain on capped call transactions
26,309
19,419
6,890
35
%
7,192
827
6,365
770
%
Other income, net
—
—
—
*
106
1,374
(1,268)
(92)
%
$
24,183
$
18,388
$
5,795
32
%
$
(1,653)
$
(6,476)
$
4,823
74
%
* not meaningful
•The changes in foreign currency transaction (loss) gain in the three and six months ended June 30, 2021 were primarily due to the impact of fluctuations in foreign currency exchange rates associated with our foreign currency-denominated cash, receivables, and intercompany balances held by our subsidiary in the United Kingdom.
•The decreases in interest income in the three and six months ended June 30, 2021 were primarily due to declines in market interest rates.
•The decreases in interest expense in the three and six months ended June 30, 2021 were primarily due to our adoption of ASU 2020-06 on January 1, 2021. See "Note 2. New Accounting Pronouncements" in Item 1 of this Quarterly Report for additional information.
Interest expense related to the Notes:
Three Months Ended June 30,
Change
Six Months Ended June 30,
Change
(in thousands)
2021
2020
2021
2020
Contractual interest expense (0.75% coupon)
$
1,125
$
1,125
$
—
$
2,250
$
1,575
$
675
Amortization of debt discount
—
3,757
(3,757)
—
5,253
(5,253)
Amortization of issuance costs
675
558
117
1,348
780
568
$
1,800
$
5,440
$
(3,640)
$
3,598
$
7,608
$
(4,010)
•The increases in the gain on capped call transactions in the three and six months ended June 30, 2021, were due to fair value adjustments driven by increases in our stock price.
•The decrease in other income, net in the six months ended June 30, 2021, was due to larger fair value adjustments on equity securities held in our venture investments portfolio in the six months ended June 30, 2020.
23
(Benefit from) income taxes
Three Months Ended June 30,
Six Months Ended June 30,
(Dollars in thousands)
2021
2020
2021
2020
(Benefit from) income taxes
$
(11,916)
$
(12,319)
$
(29,534)
$
(36,129)
Effective income tax benefit rate
(2,591)
%
44
%
During the six months ended June 30, 2021, the change in our effective income tax benefit rate was primarily due to the impact of discrete tax items on a proportionately larger income (loss) before income taxes in the prior period. The most significant discrete items were excess tax benefits from stock-based compensation and the impact of changes in statutory tax rates applicable to our U.K.-based deferred tax assets.
Stock-based compensation increases the variability of our effective tax rates. The impact of stock-based compensation on a given period depends on our profitability, the attributes of our stock compensation awards we grant, and award holders' exercise behavior.
LIQUIDITY AND CAPITAL RESOURCES
Six Months Ended June 30,
(in thousands)
2021
2020
Cash provided by (used in):
Operating activities
$
19,410
$
(21,199)
Investing activities
10,493
(19,404)
Financing activities
(60,717)
485,293
Effect of exchange rates on cash and cash equivalents
(1,207)
(942)
Net (decrease) increase in cash and cash equivalents
$
(32,021)
$
443,748
(in thousands)
June 30, 2021
December 31, 2020
Held by U.S. entities
$
306,754
$
399,138
Held by foreign entities
104,583
66,030
Total cash, cash equivalents, and marketable securities
$
411,337
$
465,168
We believe that our current cash, cash flow from operations, and borrowing capacity will be sufficient to fund our operations, stock repurchases, and quarterly cash dividends for at least the next 12 months. Whether these resources are adequate to meet our liquidity needs beyond that period will depend on our future growth, operating results, and the investments required to support our operations. If we require additional capital resources to grow our business, we may seek to finance our operations from available funds or additional external financing.
If it becomes necessary to repatriate foreign funds, we may be required to pay U.S. and foreign taxes upon repatriation. Due to the complexity of income tax laws and regulations, it is impracticable to estimate the amount of taxes we would have to pay.
Operating activities
We are in the process of transitioning our business to sell software primarily through subscription arrangements, particularly Pega Cloud. This transition has impacted and is expected to continue to impact the timing of our billings and cash collections. Pega Cloud, term license, and maintenance arrangements are generally billed and collected over the contract term, while perpetual license arrangements are generally billed and collected upfront when the license rights become effective. As client preferences shift in favor of Pega Cloud arrangements, we could experience slower operating cash flow growth, or negative cash flow, in the near term.
The change in cash provided by (used in) operating activities in the six months ended June 30, 2021 was primarily due to a significant increase in client collections.
Corporate headquarters
In February 2021, we agreed to accelerate our exit from our existing Cambridge, Massachusetts corporate headquarters to October 1, 2021, in exchange for a one-time payment from our landlord of $18 million, which is expected to be paid in the last quarter of 2021. The accelerated exit from this lease reduced our future lease liabilities by $21.1 million. On March 31, 2021 we leased office space at One Main Street, Cambridge, Massachusetts, to serve as our future corporate headquarters. The approximately 4.5 year lease includes base rent of approximately $2 million per year.
New Waltham Office
On July 6, 2021, we entered into an office space lease (the “Lease”) for 131 thousand square feet in Waltham, Massachusetts. The lease term of approximately 11 years is expected to commence on August 1, 2021 (the “Lease Commencement Date”), subject to certain adjustments for the initial occupancy date. The annual rent equals the base rent plus our portion of building operating costs and real estate taxes. Rent first becomes payable on August 1, 2022, subject to adjustment based on the Lease Commencement Date. Base rent for the first year is $6 million and will increase by 3% annually. In addition, we will receive an improvement allowance from the landlord of $11.8 million.
24
Investing activities
The change in cash provided by (used in) investing activities in the six months ended June 30, 2021 was primarily driven by investments in financial instruments, an acquisition, and a decrease in office space related capital expenditures.
Financing activities
In February 2020, we issued $600 million in aggregate principal amount of convertible senior notes due March 1, 2025.
In November 2019, and as amended as of February 2020, July 2020, and September 2020, we entered into a five-year $100 million senior secured revolving credit agreement with PNC Bank, National Association. As of June 30, 2021, we had no outstanding borrowings under the Credit Facility. See "Note 8. Debt" in Item 1 of this Quarterly Report for additional information.
Stock repurchase program
Changes in the remaining stock repurchase authority:
(in thousands)
Six Months Ended June 30, 2021
December 31, 2020
$
37,726
Authorizations (1)
38,467
Repurchases (2)
(19,392)
June 30, 2021
$
56,801
(1) On June 8, 2021, we announced that our Board of Directors extended the current stock repurchase program’s expiration date to June 30, 2022 and increased the remaining common stock repurchase authority to $60 million.
(2) Purchases under this program have been made on the open market.
Common stock repurchases
Six Months Ended June 30,
2021
2020
(in thousands)
Shares
Amount
Shares
Amount
Tax withholdings for net settlement of equity awards
328
$
41,706
411
$
37,093
Stock repurchase program
151
19,392
110
8,199
479
$
61,098
521
$
45,292
During the six months ended June 30, 2021 and 2020, instead of receiving cash from the equity holders, we withheld shares with a value of $27.8 million and $31.2 million, respectively, for the exercise price of options. These amounts are not included in the table above.
Dividends
We intend to pay a quarterly cash dividend of $0.03 per share. However, the Board of Directors may terminate or modify the dividend program at any time without prior notice.
Six Months Ended June 30,
(in thousands)
2021
2020
Dividend payments to stockholders
$
4,865
$
4,793
Contractual obligations
As of June 30, 2021, our contractual obligations were:
Payments due by period
(in thousands)
2021
2022
2023
2024
2025
2026 and thereafter
Other
Total
Convertible senior notes (1)
$
2,250
$
4,500
$
4,500
$
4,500
$
601,488
$
—
$
—
$
617,238
Purchase obligations (2)
28,215
60,242
12,539
1,938
429
—
—
103,363
Operating lease obligations (3)
8,783
13,888
13,300
10,021
6,913
9,823
—
62,728
Liability for uncertain tax positions (4)
—
—
—
—
—
—
1,665
1,665
$
39,248
$
78,630
$
30,339
$
16,459
$
608,830
$
9,823
$
1,665
$
784,994
(1) Includes principal and interest.
(2) Represents the fixed or minimum amounts due under purchase obligations for hosting services and sales and marketing programs
(3) Excludes the Waltham lease, which we entered into on July 6, 2021. See "Note 14. Subsequent Events" in Item 1 of this Quarterly Report for additional information.
(4) We are unable to reasonably estimate the timing of the cash outflow due to uncertainties in the timing of the effective settlement of tax positions.
25
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss from adverse changes in financial market prices and rates.
Foreign currency exposure
Translation risk
Our foreign operations’ operating expenses are primarily denominated in foreign currencies. However, our international sales are also primarily denominated in foreign currencies, which partially offsets our foreign currency exposure.
A hypothetical 10% strengthening in the U.S. dollar against other currencies would have resulted in:
Six Months Ended June 30,
2021
2020
(Decrease) increase in revenue
(4)
%
(3)
%
(Decrease) increase in net income
(1)
%
(15)
%
Remeasurement risk
We experience fluctuations in transaction gains and losses from the remeasurement of monetary assets and liabilities denominated in currencies other than the functional currency of the entities in which they are recorded.
We are primarily exposed to changes in foreign currency exchange rates associated with the Australian dollar, Euro, and U.S. dollar-denominated cash and cash equivalents, receivables, and intercompany receivables and payables held by our U.K. subsidiary, a British pound functional entity.
A hypothetical 10% strengthening in the British pound exchange rate in comparison to the Australian dollar, Euro, and U.S. dollar would have resulted in the following impact:
Six Months Ended June 30,
(in thousands)
2021
2020
Foreign currency gain (loss)
$
(5,676)
$
8,932
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures
Our management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)) as of June 30, 2021. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of June 30, 2021.
(b) Changes in internal control over financial reporting
There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended June 30, 2021 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
26
PART II - OTHER INFORMATION
ITEM 1A. RISK FACTORS
We encourage you to consider carefully the risk factors identified in Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the U.S. Securities and Exchange Commission. These risk factors could materially affect our business, financial condition, and future results, and may cause our actual business and financial results to differ materially from those contained in forward-looking statements made in this Quarterly Report on Form 10-Q or elsewhere by management.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer purchases of equity securities
Common stock repurchased in the three months ended June 30, 2021:
(in thousands, except per share amounts)
Total Number of Shares Purchased (1) (2)
Average
Price Paid
per Share (1) (2)
Total Number of Shares Purchased as Part of Publicly Announced Share Repurchase Program (2)
Approximate Dollar Value of Shares That May Yet Be Purchased at Period End Under Publicly Announced Share Repurchase Programs (2)
April 1, 2021 - April 30, 2021
53
$
125.24
25
$
25,430
May 1, 2021 - May 31, 2021
96
121.41
25
$
22,431
June 1, 2021 - June 30, 2021
204
126.99
31
$
56,801
353
$
125.20
81
(1) Shares withheld to cover the option exercise price and tax withholding obligations under the net settlement provisions of our stock compensation awards have been included in these amounts.
(2) On June 8, 2021, we announced that our Board of Directors extended the current stock repurchase program’s expiration date to June 30, 2022 and increased the remaining stock repurchase authority to $60 million. See "Liquidity and Capital Resources" in Item 2 of this Quarterly Report for additional information.
Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
X
++ Indicates that the exhibit is being furnished with this report and is not filed as a part of it.
** Certain portions of this exhibit are considered confidential and have been omitted as permitted under SEC rules and regulations.
27
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Pegasystems Inc.
Dated:
July 28, 2021
By:
/s/ KENNETH STILLWELL
Kenneth Stillwell
Chief Operating Officer and Chief Financial Officer