Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 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 Main Street, Cambridge, MA02142
(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 81,675,315 shares of the Registrant’s common stock, $0.01 par value per share, outstanding on October 19, 2021.
Common stock, 200,000 shares authorized; 81,670 and 80,890 shares issued and outstanding at
September 30, 2021 and December 31, 2020, respectively
817
809
Additional paid-in capital
148,098
204,432
Retained earnings
316,150
339,879
Accumulated other comprehensive (loss)
(5,433)
(2,948)
Total stockholders’ equity
459,632
542,172
Total liabilities and stockholders’ equity
$
1,555,397
$
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 September 30,
Nine Months Ended September 30,
2021
2020
2021
2020
Revenue
Pega Cloud
$
78,369
$
54,776
$
219,520
$
147,080
Maintenance
83,188
74,670
237,531
220,587
Software license
38,295
39,784
272,148
187,023
Consulting
56,416
56,721
166,270
164,227
Total revenue
256,268
225,951
895,469
718,917
Cost of revenue
Pega Cloud
25,524
19,717
72,132
56,238
Maintenance
5,293
5,478
16,074
16,645
Software license
656
691
1,962
2,354
Consulting
52,749
51,913
161,032
158,781
Total cost of revenue
84,222
77,799
251,200
234,018
Gross profit
172,046
148,152
644,269
484,899
Operating expenses
Selling and marketing
152,479
132,053
457,641
395,684
Research and development
64,728
60,024
191,565
177,620
General and administrative
20,176
17,907
57,607
49,192
Total operating expenses
237,383
209,984
706,813
622,496
(Loss) from operations
(65,337)
(61,832)
(62,544)
(137,597)
Foreign currency transaction gain (loss)
518
4,236
(4,983)
2,545
Interest income
166
243
555
1,092
Interest expense
(1,908)
(5,956)
(5,747)
(13,791)
(Loss) income on capped call transactions
(14,735)
18,989
(7,543)
19,816
Other income, net
2
—
108
1,374
(Loss) before (benefit from) income taxes
(81,294)
(44,320)
(80,154)
(126,561)
(Benefit from) income taxes
(24,826)
(25,053)
(54,360)
(61,182)
Net (loss)
$
(56,468)
$
(19,267)
$
(25,794)
$
(65,379)
(Loss) per share
Basic
$
(0.69)
$
(0.24)
$
(0.32)
$
(0.82)
Diluted
$
(0.69)
$
(0.24)
$
(0.32)
$
(0.82)
Weighted-average number of common shares outstanding
Basic
81,526
80,537
81,284
80,191
Diluted
81,526
80,537
81,284
80,191
See notes to unaudited condensed consolidated financial statements.
4
PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS)
(in thousands)
Three Months Ended September 30,
Nine Months Ended September 30,
2021
2020
2021
2020
Net (loss)
$
(56,468)
$
(19,267)
$
(25,794)
$
(65,379)
Other comprehensive (loss) income, net of tax
Unrealized gain (loss) on available-for-sale securities
53
(166)
1,184
(66)
Foreign currency translation adjustments
(4,400)
113
(3,669)
1,627
Total other comprehensive (loss) income, net of tax
$
(4,347)
$
(53)
$
(2,485)
$
1,561
Comprehensive (loss)
$
(60,815)
$
(19,320)
$
(28,279)
$
(63,818)
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
Repurchase of common stock
(94)
(1)
(10,628)
—
—
(10,629)
Issuance of common stock for stock compensation plans
371
4
(22,524)
—
—
(22,520)
Stock-based compensation
—
—
27,931
—
—
27,931
Cash dividends declared ($0.03 per share)
—
—
—
(2,422)
—
(2,422)
Other comprehensive (loss)
—
—
—
—
(53)
(53)
Net (loss)
—
—
—
(19,267)
—
(19,267)
September 30, 2020
80,697
$
807
$
201,882
$
338,300
$
(11,667)
$
529,322
6
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, 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
Repurchase of common stock
(96)
(1)
(12,795)
—
—
(12,796)
Issuance of common stock for stock compensation plans
286
3
(18,117)
—
—
(18,114)
Issuance of common stock under the employee stock purchase plan
24
—
2,639
—
—
2,639
Stock-based compensation
—
—
28,701
—
—
28,701
Cash dividends declared ($0.03 per share)
—
—
—
(2,451)
—
(2,451)
Other comprehensive (loss)
—
—
—
—
(4,347)
(4,347)
Net (loss)
—
—
—
(56,468)
—
(56,468)
September 30, 2021
81,670
$
817
$
148,098
$
316,150
$
(5,433)
$
459,632
See notes to unaudited condensed consolidated financial statements.
7
PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Nine Months Ended September 30,
2021
2020
Operating activities
Net (loss)
$
(25,794)
$
(65,379)
Adjustments to reconcile net (loss) to cash (used in) operating activities
Stock-based compensation
89,483
76,755
Loss (gain) on capped call transactions
7,543
(19,816)
Deferred income taxes
(53,638)
(43,476)
Amortization of deferred commissions
31,388
24,922
Amortization of debt discount and issuance costs
2,025
10,405
Amortization of intangible assets and depreciation
24,030
15,677
Amortization of investments
2,916
252
Foreign currency transaction loss (gain)
4,983
(2,545)
Other non-cash
(8,421)
10,623
Change in operating assets and liabilities, net
(79,836)
(33,675)
Cash (used in) operating activities
(5,321)
(26,257)
Investing activities
Purchases of investments
(67,170)
(190,319)
Proceeds from maturities and called investments
96,859
—
Sales of investments
25,123
1,424
Payments for acquisitions, net of cash acquired
(4,993)
—
Investment in property and equipment
(7,089)
(21,806)
Cash provided by (used in) investing activities
42,730
(210,701)
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
7,786
1,403
Dividend payments to stockholders
(7,310)
(7,206)
Common stock repurchases
(91,907)
(78,140)
Cash (used in) provided by financing activities
(91,431)
449,630
Effect of exchange rate changes on cash and cash equivalents
(1,466)
183
Net (decrease) increase in cash and cash equivalents
(55,488)
212,855
Cash and cash equivalents, beginning of period
171,899
68,363
Cash and cash equivalents, end of period
$
116,411
$
281,218
See notes to unaudited condensed consolidated financial statements.
8
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
September 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
233,556
25
(144)
233,437
253,345
88
(152)
253,281
$
235,556
$
25
$
(144)
$
235,437
$
293,341
$
88
$
(160)
$
293,269
As of September 30, 2021, marketable securities’ maturities ranged from October 2021 to September 2024, with a weighted-average remaining maturity of 1.2 years.
9
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 4. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE
Receivables
(in thousands)
September 30, 2021
December 31, 2020
Accounts receivable
$
143,445
$
215,827
Unbilled receivables
239,774
207,155
Long-term unbilled receivables
132,147
113,278
$
515,366
$
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)
September 30, 2021
1 year or less
$
239,774
64
%
1-2 years
80,980
22
%
2-5 years
51,167
14
%
$
371,921
100
%
Unbilled receivables by contract effective date:
(Dollars in thousands)
September 30, 2021
2021
$
168,237
45
%
2020
109,904
29
%
2019
47,058
13
%
2018
22,169
6
%
2017 and prior
24,553
7
%
$
371,921
100
%
Major clients
Clients accounting for 10% or more of the Company’s total receivables:
September 30, 2021
December 31, 2020
Client A
12
%
*
* 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)
September 30, 2021
December 31, 2020
Contract assets (1)
$
11,495
$
15,296
Long-term contract assets (2)
8,485
7,777
$
19,980
$
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)
September 30, 2021
December 31, 2020
Deferred revenue
$
229,103
$
232,865
Long-term deferred revenue (1)
5,682
8,991
$
234,785
$
241,856
(1) Included in other long-term liabilities.
The change in deferred revenue in the nine months ended September 30, 2021 was primarily due to new billings in advance of revenue recognition, offset by $212.0 million of revenue recognized that was included in deferred revenue as of December 31, 2020.
10
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 5. DEFERRED COMMISSIONS
(in thousands)
September 30, 2021
December 31, 2020
Deferred commissions (1)
$
114,503
$
108,624
(1) Included in other long-term assets.
Three Months Ended September 30,
Nine Months Ended September 30,
(in thousands)
2021
2020
2021
2020
Amortization of deferred commissions (1)
$
10,186
$
8,861
$
31,388
$
24,922
(1) Included in selling and marketing expense.
NOTE 6. GOODWILL AND OTHER INTANGIBLES
Goodwill
Change in goodwill:
Nine Months Ended September 30,
(in thousands)
2021
January 1,
$
79,231
Acquisition
2,701
Currency translation adjustments
22
September 30,
$
81,954
Intangibles
Intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives.
September 30, 2021
(in thousands)
Useful Lives
Cost
Accumulated Amortization
Net Book Value (1)
Client-related
4-10 years
$
63,163
$
(56,988)
$
6,175
Technology
2-10 years
67,142
(58,273)
8,869
Other
1-5 years
5,361
(5,361)
—
$
135,666
$
(120,622)
$
15,044
(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.
11
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Amortization of intangible assets:
Three Months Ended September 30,
Nine Months Ended September 30,
(in thousands)
2021
2020
2021
2020
Cost of revenue
$
629
$
647
$
1,887
$
1,940
Selling and marketing
373
371
1,119
1,111
$
1,002
$
1,018
$
3,006
$
3,051
Future estimated intangibles assets amortization:
(in thousands)
September 30, 2021
2021
$
981
2022
3,886
2023
3,618
2024
2,849
2025
2,509
2026 and thereafter
1,201
$
15,044
NOTE 7. LEASES
Corporate headquarters
In February 2021, the Company agreed to accelerate its exit from its corporate headquarters to October 1, 2021, in exchange for a one-time payment from our landlord of $18 million, which was amortized over the remaining lease term. The accelerated exit from this lease reduced our future lease liabilities by $21.1 million and accelerated corporate headquarters-related depreciation. On March 31, 2021 the Company leased office space at One Main Street, Cambridge, Massachusetts, to serve as its corporate headquarters. The 4.5 year lease includes a base rent of $2 million per year.
New Waltham Office
On July 6, 2021, the Company entered into an office space lease for 131 thousand square feet in Waltham, Massachusetts. The lease term of 11 years began on August 1, 2021. The annual rent equals the base rent plus a portion of building operating costs and real estate taxes. Rent first becomes payable on August 1, 2022. Base rent for the first year is approximately $6 million and will increase by 3 percent annually. In addition, the Company will receive an improvement allowance from the landlord of up to $11.8 million. This lease increased the Company’s lease liabilities and lease-related right of use assets by $42.1 million on August 1, 2021.
Expense
Three Months Ended September 30,
Nine Months Ended September 30,
(in thousands)
2021
2020
2021
2020
Fixed lease costs (1)
$
(3,108)
$
5,172
$
(6,780)
$
14,933
Short-term lease costs
542
422
1,516
1,248
Variable lease costs
1,099
1,259
3,826
3,506
$
(1,467)
$
6,853
$
(1,438)
$
19,687
(1) The decrease in fixed lease costs in three and nine months ended September 30, 2021 was due to the modification of the corporate headquarters lease.
Right of use assets and lease liabilities
(in thousands)
September 30, 2021
December 31, 2020
Right of use assets (1)
$
91,349
$
67,651
Operating lease liabilities (2)
$
10,668
$
18,541
Long-term operating lease liabilities
$
87,088
$
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.
12
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Weighted-average remaining lease term and discount rate for the Company’s leases were:
September 30, 2021
December 31, 2020
Weighted-average remaining lease term
7.8 years
4.7 years
Weighted-average discount rate (1)
4.4
%
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.
Maturities of lease liabilities:
(in thousands)
September 30, 2021
Remainder of 2021
$
961
2022
9,948
2023
19,607
2024
16,482
2025
13,607
2026
9,866
Thereafter
48,515
Total lease payments
118,986
Less: imputed interest (1)
(21,230)
$
97,756
(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
Nine Months Ended September 30,
(in thousands)
2021
2020
Cash paid for leases
$
14,403
$
15,503
Right of use assets recognized for new leases and amendments (non-cash)
$
54,716
$
24,276
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 due 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 beginning 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 September 30, 2021, the Notes were not eligible for conversion.
13
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
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.
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)
September 30, 2021
December 31, 2020
Principal
$
600,000
$
600,000
Unamortized debt discount
—
(71,222)
Unamortized issuance costs
(10,231)
(10,575)
Convertible senior notes, net
$
589,769
$
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 September 30,
Nine Months Ended September 30,
(in thousands)
2021
2020
2021
2020
Contractual interest expense (0.75% coupon)
$
1,125
$
1,125
$
3,375
$
2,700
Amortization of debt discount
—
3,807
—
9,060
Amortization of issuance costs
677
565
2,025
1,345
$
1,802
$
5,497
$
5,400
$
13,105
14
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
The effective interest rate for the Notes:
Nine Months Ended September 30,
2021
2020
Weighted-average effective interest rate
1.2
%
4.3
%
Future payments of principal and contractual interest:
September 30, 2021
(in thousands)
Principal
Interest
Total
Remainder of 2021
$
—
$
—
$
—
2022
—
4,500
4,500
2023
—
4,500
4,500
2024
—
4,500
4,500
2025
600,000
1,488
601,488
$
600,000
$
14,988
$
614,988
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 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 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 following 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:
Nine Months Ended September 30,
(in thousands)
2021
2020
January 1,
$
83,597
$
—
Issuance
—
51,900
Fair value adjustment
(7,543)
19,816
September 30,
$
76,054
$
71,716
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 September 30, 2021 and December 31, 2020, the Company had no outstanding borrowings under the Credit Facility.
15
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:
September 30, 2021
December 31, 2020
(in thousands)
Level 1
Level 2
Level 3
Total
Level 1
Level 2
Level 3
Total
Cash equivalents
$
11,087
$
—
$
—
$
11,087
$
42,339
$
14,000
$
—
$
56,339
Marketable securities
$
—
$
235,437
$
—
$
235,437
$
—
$
293,269
$
—
$
293,269
Capped Call Transactions (1)
$
—
$
76,054
$
—
$
76,054
$
—
$
83,597
$
—
$
83,597
Venture investments (1) (2)
$
—
$
—
$
9,713
$
9,713
$
—
$
—
$
8,345
$
8,345
(1) Included in other long-term assets. (2) Investments in privately-held companies.
Changes in venture investments:
Nine Months Ended September 30,
(in thousands)
2021
2020
January 1,
$
8,345
$
4,871
New investments
500
3,006
Sales of investments
(400)
(1,424)
Changes in foreign exchange rates
(52)
—
Changes in fair value:
included in other income
100
1,374
included in other comprehensive income
1,220
100
September 30,
$
9,713
$
7,927
The carrying value of certain other financial instruments, including receivables and accounts payable, approximates fair value due to these items’ short maturity.
Fair value of the Notes
The Notes’ fair value (inclusive of the conversion feature embedded in the Notes) was $676.2 million as of September 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.
16
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 10. REVENUE
Geographic revenue
Three Months Ended September 30,
Nine Months Ended September 30,
(Dollars in thousands)
2021
2020
2021
2020
U.S.
$
132,016
52
%
$
120,971
53
%
$
515,881
58
%
$
436,199
61
%
Other Americas
17,510
7
%
10,737
5
%
43,469
5
%
35,009
5
%
United Kingdom (“U.K.”)
25,982
10
%
25,150
11
%
86,747
10
%
68,246
9
%
Europe (excluding U.K.), Middle East, and Africa
46,306
18
%
39,656
18
%
143,763
15
%
106,472
15
%
Asia-Pacific
34,454
13
%
29,437
13
%
105,609
12
%
72,991
10
%
$
256,268
100
%
$
225,951
100
%
$
895,469
100
%
$
718,917
100
%
Revenue streams
Three Months Ended September 30,
Nine Months Ended September 30,
(in thousands)
2021
2020
2021
2020
Pega Cloud
$
78,369
$
54,776
$
219,520
$
147,080
Maintenance
83,188
74,670
237,531
220,587
Consulting
56,416
56,721
166,270
164,227
Revenue recognized over time
217,973
186,167
623,321
531,894
Perpetual license
2,874
3,852
20,922
16,568
Term license
35,421
35,932
251,226
170,455
Revenue recognized at a point in time
38,295
39,784
272,148
187,023
$
256,268
$
225,951
$
895,469
$
718,917
(in thousands)
Three Months Ended September 30,
Nine Months Ended September 30,
2021
2020
2021
2020
Pega Cloud
$
78,369
$
54,776
$
219,520
$
147,080
Client Cloud
118,609
110,602
488,757
391,042
Maintenance
83,188
74,670
237,531
220,587
Term license
35,421
35,932
251,226
170,455
Cloud subscription (1)
196,978
165,378
708,277
538,122
Perpetual license
2,874
3,852
20,922
16,568
Consulting
56,416
56,721
166,270
164,227
$
256,268
$
225,951
$
895,469
$
718,917
(1) Reflects client arrangements subject to renewal (Pega Cloud, maintenance, and term license).
Remaining performance obligations ("Backlog")
Expected future revenue from existing non-cancellable contracts:
As of September 30, 2021:
Pega Cloud
Client Cloud
Consulting
Total
(Dollars in thousands)
Maintenance
Term license
Perpetual license
1 year or less
$
284,359
$
196,667
$
49,265
$
15,686
$
31,673
$
577,650
56
%
1-2 years
177,214
59,360
16,872
1,064
6,561
261,071
25
%
2-3 years
79,775
37,734
420
4,094
5,165
127,188
12
%
Greater than 3 years
30,113
33,935
245
2,127
1,697
68,117
7
%
$
571,461
$
327,696
$
66,802
$
22,971
$
45,096
$
1,034,026
100
%
17
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
As of September 30, 2020:
Pega Cloud
Client Cloud
Consulting
Total
(Dollars in thousands)
Maintenance
Term license
Perpetual license
1 year or less
$
211,661
$
170,643
$
50,788
$
8,708
$
14,977
$
456,777
54
%
1-2 years
157,500
40,631
5,341
1,700
2,042
207,214
25
%
2-3 years
93,283
18,277
7,052
—
770
119,382
14
%
Greater than 3 years
44,363
9,597
4
—
653
54,617
7
%
$
506,807
$
239,148
$
63,185
$
10,408
$
18,442
$
837,990
100
%
NOTE 11. STOCK-BASED COMPENSATION
Expense
Three Months Ended September 30,
Nine Months Ended September 30,
(in thousands)
2021
2020
2021
2020
Cost of revenue
$
5,114
$
5,100
$
16,889
$
15,636
Selling and marketing
13,376
12,658
41,844
33,968
Research and development
6,231
5,765
19,343
17,066
General and administrative
3,974
4,402
11,407
10,085
$
28,695
$
27,925
$
89,483
$
76,755
Income tax benefit
$
(5,845)
$
(5,604)
$
(18,028)
$
(15,293)
As of September 30, 2021, the Company had $131.7 million of unrecognized stock-based compensation expense, net of estimated forfeitures, which is expected to be recognized over a weighted-average period of 2.1 years.
Grants
Nine Months Ended September 30, 2021
(in thousands)
Shares
Total Fair Value
Restricted stock units
819
$
106,286
Non-qualified stock options
1,472
$
55,643
Common stock
5
$
601
NOTE 12. INCOME TAXES
Effective income tax rate
Three Months Ended September 30,
Nine Months Ended September 30,
(Dollars in thousands)
2021
2020
2021
2020
(Benefit from) income taxes
$
(24,826)
$
(25,053)
$
(54,360)
$
(61,182)
Effective income tax benefit rate
68
%
48
%
The change in the effective income tax benefit rate was primarily due to the impact of discrete tax items on a proportionately larger (loss) before income taxes in the nine months ended September 30, 2020. 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.
As of September 30, 2021 and December 31, 2020, the Company’s deferred tax assets were $157.9 million and $88.1 million, respectively.
NOTE 13. (LOSS) PER SHARE
Basic (loss) per share is calculated using the weighted-average number of common shares outstanding during the period. Diluted (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.
18
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Calculation of (loss) per share:
Three Months Ended September 30,
Nine Months Ended September 30,
(in thousands, except per share amounts)
2021
2020
2021
2020
Net (loss)
$
(56,468)
$
(19,267)
$
(25,794)
$
(65,379)
Weighted-average common shares outstanding
81,526
80,537
81,284
80,191
(Loss) per share, basic
$
(0.69)
$
(0.24)
$
(0.32)
$
(0.82)
Net (loss)
$
(56,468)
$
(19,267)
$
(25,794)
$
(65,379)
Weighted-average common shares outstanding, assuming dilution (1) (2) (3)
81,526
80,537
81,284
80,191
(Loss) per share, diluted
$
(0.69)
$
(0.24)
$
(0.32)
$
(0.82)
Outstanding anti-dilutive stock options and RSUs (4)
5,815
6,622
6,136
6,166
(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 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 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 (loss) per share. These awards may be dilutive in the future.
19
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 October 27, 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 enable 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.
20
Cloud Transition
We are transitioning our business to sell software primarily through subscription arrangements, particularly Pega Cloud. Until we substantially complete our Cloud Transition, which we expect 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 each 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 September 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 use 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 September 30, 2020
•ACV 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.
Note: Foreign currency exchange rate changes contributed 1-2% to total ACV growth in 2021.
21
Remaining performance obligations (“Backlog”) | Increased 23% since September 30, 2020
•Backlog represents expected future revenue from existing non-cancellable 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 about 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.
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.
22
RESULTS OF OPERATIONS
Revenue
Cloud Transition
We are 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 while revenue from license sales is recognized when the license rights become effective, typically upfront.
(Dollars in thousands)
Three Months Ended September 30,
Change
Nine Months Ended September 30,
Change
2021
2020
2021
2020
Pega Cloud
$
78,369
31
%
$
54,776
24
%
$
23,593
43
%
$
219,520
25
%
$
147,080
20
%
$
72,440
49
%
Client Cloud
$
118,609
46
%
$
110,602
49
%
$
8,007
7
%
$
488,757
54
%
$
391,042
55
%
$
97,715
25
%
Maintenance
83,188
32%
74,670
33%
8,518
11%
237,531
26%
220,587
31%
16,944
8%
Term license
35,421
14%
35,932
16%
(511)
(1)%
251,226
28%
170,455
24%
80,771
47%
Cloud subscription (1)
$
196,978
77
%
$
165,378
73
%
$
31,600
19
%
$
708,277
79
%
$
538,122
75
%
$
170,155
32
%
Perpetual license
2,874
1
%
3,852
2
%
(978)
(25)
%
20,922
2
%
16,568
2
%
4,354
26
%
Consulting
56,416
22
%
56,721
25
%
(305)
(1)
%
166,270
19
%
164,227
23
%
2,043
1
%
$
256,268
100
%
$
225,951
100
%
$
30,317
13
%
$
895,469
100
%
$
718,917
100
%
$
176,552
25
%
(1) Reflects client arrangements subject to renewal (Pega Cloud, maintenance, and term license).
The revenue changes in the three and nine months ended September 30, 2021 generally reflect our Cloud Transition. Other factors impacting our revenue include:
•The increases in perpetual and term license revenue were primarily due to several large software license contracts recognized in revenue in the nine months ended September 30, 2021.
•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 upon the effectiveness of the license rights as term license revenue. In the three months ended September 30, 2021, multi-year committed maintenance contributed $4.8 million to maintenance revenue growth and reduced term revenue growth by $1.0 million. In the nine months ended September 30, 2021, multi-year committed maintenance contributed $12.6 million to maintenance revenue growth and reduced term revenue growth by $22.0 million.
•Maintenance renewal rates of higher than 90%.
•The changes in consulting revenue in the three and nine months ended September 30, 2021 were primarily due to changes 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 September 30,
Change
Nine Months Ended September 30,
Change
(Dollars in thousands)
2021
2020
2021
2020
Pega Cloud
$
52,845
67
%
$
35,059
64
%
$
17,786
51
%
$
147,388
67
%
$
90,842
62
%
$
56,546
62
%
Maintenance
77,895
94
%
69,192
93
%
8,703
13
%
221,457
93
%
203,942
92
%
17,515
9
%
Software license
37,639
98
%
39,093
98
%
(1,454)
(4)
%
270,186
99
%
184,669
99
%
85,517
46
%
Consulting
3,667
6
%
4,808
8
%
(1,141)
(24)
%
5,238
3
%
5,446
3
%
(208)
(4)
%
$
172,046
67
%
$
148,152
66
%
$
23,894
16
%
$
644,269
72
%
$
484,899
67
%
$
159,370
33
%
•The changes in gross profit and gross profit percent in the three and nine months ended September 30, 2021 were primarily due to our Cloud Transition, revenue growth, and cost-efficiency gains as Pega Cloud grows and scales.
•The decrease in consulting gross profit percent in the three months ended September 30, 2021 was due to a decrease in consultant utilization in North America.
23
Operating expenses
(Dollars in thousands)
Three Months Ended September 30,
Change
Nine Months Ended September 30,
Change
2021
2020
2021
2020
% of Revenue
% of Revenue
% of Revenue
% of Revenue
Selling and marketing
$
152,479
59
%
$
132,053
58
%
$
20,426
15
%
$
457,641
51
%
$
395,684
55
%
$
61,957
16
%
Research and development
$
64,728
25
%
$
60,024
27
%
$
4,704
8
%
$
191,565
21
%
$
177,620
25
%
$
13,945
8
%
General and administrative
$
20,176
8
%
$
17,907
8
%
$
2,269
13
%
$
57,607
6
%
$
49,192
7
%
$
8,415
17
%
•The increases in selling and marketing in the three and nine months ended September 30, 2021 were primarily due to increases in compensation and benefits of $15.8 million and $63.8 million, attributable to increases in headcount, sales commissions, 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 nine months ended September 30, 2021 were primarily due to increases in compensation and benefits of $5.1 million and $16.9 million, attributable to increases in headcount.
•The increases in general and administrative in the three and nine months ended September 30, 2021 were primarily due to increases in compensation and benefits of $0.4 million and $3.8 million, attributable to increases in headcount and equity compensation, and increases in legal and other professional services fees of $2.7 million and $6.1 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 $5.5 million in selling and marketing, $2.0 million and $5.6 million in research and development, and $1.0 million and $2.8 million in general and administrative, in the three and nine months ended September 30, 2021.
Other income (expense), net
(Dollars in thousands)
Three Months Ended September 30,
Change
Nine Months Ended September 30,
Change
2021
2020
2021
2020
Foreign currency transaction gain (loss)
$
518
$
4,236
$
(3,718)
(88)
%
$
(4,983)
$
2,545
$
(7,528)
*
Interest income
166
243
(77)
(32)
%
555
1,092
(537)
(49)
%
Interest expense
(1,908)
(5,956)
4,048
68
%
(5,747)
(13,791)
8,044
58
%
(Loss) income on capped call transactions
(14,735)
18,989
(33,724)
*
(7,543)
19,816
(27,359)
*
Other income, net
2
—
2
*
108
1,374
(1,266)
(92)
%
$
(15,957)
$
17,512
$
(33,469)
*
$
(17,610)
$
11,036
$
(28,646)
*
* not meaningful
•The changes in foreign currency transaction gain (loss) in the three and nine months ended September 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 nine months ended September 30, 2021 were primarily due to declines in market interest rates.
•The decreases in interest expense in the three and nine months ended September 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 September 30,
Change
Nine Months Ended September 30,
Change
(in thousands)
2021
2020
2021
2020
Contractual interest expense (0.75% coupon)
$
1,125
$
1,125
$
—
$
3,375
$
2,700
$
675
Amortization of debt discount
—
3,807
(3,807)
—
9,060
(9,060)
Amortization of issuance costs
677
565
112
2,025
1,345
680
$
1,802
$
5,497
$
(3,695)
$
5,400
$
13,105
$
(7,705)
•The decreases in the (loss) income on capped call transactions in the three and nine months ended September 30, 2021, were due to fair value adjustments driven by changes in our stock price.
•The decrease in other income, net in the nine months ended September 30, 2021, was due to larger fair value adjustments on equity securities held in our venture investments portfolio in the nine months ended September 30, 2020.
24
(Benefit from) income taxes
Three Months Ended September 30,
Nine Months Ended September 30,
(Dollars in thousands)
2021
2020
2021
2020
(Benefit from) income taxes
$
(24,826)
$
(25,053)
$
(54,360)
$
(61,182)
Effective income tax benefit rate
68
%
48
%
During the nine months ended September 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 (loss) before income taxes in the nine months ended September 30, 2020. 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 on our effective tax rate in each period depends on our profitability and the tax deductions from our stock compensation activity, which depend upon our stock price and the award holders' exercise behavior.
LIQUIDITY AND CAPITAL RESOURCES
Nine Months Ended September 30,
(in thousands)
2021
2020
Cash provided by (used in):
Operating activities
$
(5,321)
$
(26,257)
Investing activities
42,730
(210,701)
Financing activities
(91,431)
449,630
Effect of exchange rates on cash and cash equivalents
(1,466)
183
Net (decrease) increase in cash and cash equivalents
$
(55,488)
$
212,855
(in thousands)
September 30, 2021
December 31, 2020
Held by U.S. entities
$
267,378
$
399,138
Held by foreign entities
84,470
66,030
Total cash, cash equivalents, and marketable securities
$
351,848
$
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 needed to support our operations. If we require additional capital resources to grow our business, we may utilize available funds or additional external financing.
If it becomes necessary to repatriate foreign funds, we may have 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 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 (used in) operating activities in the nine months ended September 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 previous corporate headquarters to October 1, 2021, in exchange for a one-time payment from our landlord of $18 million, which was paid in October 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 corporate headquarters. The 4.5 year lease includes a base rent of $2 million per year.
New Waltham Office
On July 6, 2021, we entered into an office space lease for 131 thousand square feet in Waltham, Massachusetts. The lease term of 11 years began on August 1, 2021. The annual rent equals the base rent plus a portion of building operating costs and real estate taxes. Rent first becomes payable on August 1, 2022. Base rent for the first year is approximately $6 million and will increase by 3% annually. In addition, we will receive an improvement allowance from the landlord of up to $11.8 million as part of the lease. This lease increased our lease liabilities and lease-related right of use assets by $42.1 million on August 1, 2021.
25
Investing activities
The change in cash provided by (used in) investing activities in the nine months ended September 30, 2021 was primarily driven by investments in financial instruments, an acquisition, and a decrease in office space related capital expenditures.
Financing activities
Debt financing
In February 2020, we issued $600 million in aggregate principal amount of convertible senior notes which mature on 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 September 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)
Nine Months Ended September 30, 2021
December 31, 2020
$
37,726
Authorizations (1)
38,467
Repurchases (2)
(32,188)
September 30, 2021
$
44,005
(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) All purchases under this program have been made on the open market.
Common stock repurchases
Nine Months Ended September 30,
2021
2020
(in thousands)
Shares
Amount
Shares
Amount
Tax withholdings for net settlement of equity awards
462
$
59,819
599
$
59,613
Stock repurchase program
248
32,188
204
18,828
710
$
92,007
803
$
78,441
During the nine months ended September 30, 2021 and 2020, instead of receiving cash from the equity holders, we withheld shares with a value of $47.1 million and $49.5 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.
Nine Months Ended September 30,
(in thousands)
2021
2020
Dividend payments to stockholders
$
7,310
$
7,206
Contractual obligations
As of September 30, 2021, our contractual obligations were:
Payments due by period
(in thousands)
Remainder of 2021
2022
2023
2024
2025
2026 and thereafter
Other
Total
Convertible senior notes (1)
$
—
$
4,500
$
4,500
$
4,500
$
601,488
$
—
$
—
$
614,988
Purchase obligations (2)
7,386
64,810
18,361
5,271
429
—
—
96,257
Operating lease obligations
961
9,948
19,607
16,482
13,607
58,381
—
118,986
Liability for uncertain tax positions (3)
—
—
—
—
—
—
1,677
1,677
$
8,347
$
79,258
$
42,468
$
26,253
$
615,524
$
58,381
$
1,677
$
831,908
(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) We are unable to reasonably estimate the timing of this cash outflow due to uncertainties in the timing of the effective settlement of tax positions.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in financial market prices and rates.
Foreign currency exposure
Translation risk
Our international 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:
Nine Months Ended September 30,
2021
2020
(Decrease) increase in revenue
(4)
%
(4)
%
(Decrease) increase in net (loss)
(9)
%
(13)
%
Remeasurement risk
We experience 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, cash equivalents, receivables, and intercompany balances 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:
Nine Months Ended September 30,
(in thousands)
2021
2020
Foreign currency gain (loss)
$
(4,480)
$
(6,326)
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 September 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 September 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 September 30, 2021 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
27
PART II - OTHER INFORMATION
ITEM 1A. RISK FACTORS
We encourage you to carefully consider 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 September 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)
July 1, 2021 - July 31, 2021
46
$
135.62
31
$
52,603
August 1, 2021 - August 31, 2021
167
130.67
34
$
48,204
September 1, 2021 - September 30, 2021
160
138.24
31
$
44,005
373
$
134.52
96
(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 allowed under SEC rules and regulations.
28
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:
October 27, 2021
By:
/s/ KENNETH STILLWELL
Kenneth Stillwell
Chief Operating Officer and Chief Financial Officer