Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2023
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 82,961,204 shares of the Registrant’s common stock, $0.01 par value per share, outstanding on April 19, 2023.
Common stock, 200,000 shares authorized; 82,940 and 82,436 shares issued and outstanding at
March 31, 2023 and December 31, 2022, respectively
829
824
Additional paid-in capital
272,481
229,602
Accumulated deficit
(97,287)
(76,513)
Accumulated other comprehensive (loss)
(21,527)
(23,070)
Total stockholders’ equity
154,496
130,843
Total liabilities and stockholders’ equity
$
1,281,841
$
1,357,672
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 March 31,
2023
2022
Revenue
Subscription services
$
187,509
$
170,033
Subscription license
84,527
137,533
Consulting
53,033
61,301
Perpetual license
403
7,440
Total revenue
325,472
376,307
Cost of revenue
Subscription services
36,864
32,030
Subscription license
719
622
Consulting
60,348
55,511
Perpetual license
3
34
Total cost of revenue
97,934
88,197
Gross profit
227,538
288,110
Operating expenses
Selling and marketing
149,797
162,236
Research and development
75,376
71,490
General and administrative
23,110
35,764
Restructuring
1,461
—
Total operating expenses
249,744
269,490
(Loss) income from operations
(22,206)
18,620
Foreign currency transaction (loss) gain
(2,675)
2,876
Interest income
1,485
207
Interest expense
(1,918)
(1,946)
Gain (loss) on capped call transactions
3,206
(30,560)
Other income, net
6,583
2,741
(Loss) before provision for (benefit from) income taxes
(15,525)
(8,062)
Provision for (benefit from) income taxes
5,249
(7,683)
Net (loss)
$
(20,774)
$
(379)
(Loss) per share
Basic
$
(0.25)
$
—
Diluted
$
(0.25)
$
—
Weighted-average number of common shares outstanding
Basic
82,604
81,680
Diluted
82,604
81,680
See notes to unaudited condensed consolidated financial statements.
4
PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS)
(in thousands)
Three Months Ended March 31,
2023
2022
Net (loss)
$
(20,774)
$
(379)
Other comprehensive income (loss), net of tax
Unrealized (loss) gain on available-for-sale securities
(46)
222
Foreign currency translation adjustments
1,589
(2,770)
Total other comprehensive income (loss), net of tax
1,543
(2,548)
Comprehensive (loss)
$
(19,231)
$
(2,927)
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 Deficit)
Accumulated Other Comprehensive (Loss)
Total Stockholders’ Equity
Number of Shares
Amount
December 31, 2021
81,712
$
817
$
145,810
$
276,449
$
(6,988)
$
416,088
Repurchase of common stock
(242)
(2)
(22,581)
—
—
(22,583)
Issuance of common stock for stock compensation plans
297
3
(12,131)
—
—
(12,128)
Issuance of common stock under the employee stock purchase plan
35
—
2,446
—
—
2,446
Stock-based compensation
—
—
28,227
—
—
28,227
Cash dividends declared ($0.03 per share)
—
—
—
(2,455)
—
(2,455)
Other comprehensive (loss)
—
—
—
—
(2,548)
(2,548)
Net (loss)
—
—
—
(379)
—
(379)
March 31, 2022
81,802
$
818
$
141,771
$
273,615
$
(9,536)
$
406,668
December 31, 2022
82,436
$
824
$
229,602
$
(76,513)
$
(23,070)
$
130,843
Issuance of common stock for stock compensation plans
452
4
668
—
—
672
Issuance of common stock under the employee stock purchase plan
52
1
2,142
—
—
2,143
Stock-based compensation
—
—
42,557
—
—
42,557
Cash dividends declared ($0.03 per share)
—
—
(2,488)
—
—
(2,488)
Other comprehensive income
—
—
—
—
1,543
1,543
Net (loss)
—
—
—
(20,774)
—
(20,774)
March 31, 2023
82,940
$
829
$
272,481
$
(97,287)
$
(21,527)
$
154,496
See notes to unaudited condensed consolidated financial statements.
6
PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Three Months Ended March 31,
2023
2022
Operating activities
Net (loss)
$
(20,774)
$
(379)
Adjustments to reconcile net (loss) to cash provided by operating activities
Stock-based compensation
42,557
28,227
Deferred income taxes
(126)
(9,295)
(Gain) loss on capped call transactions
(3,206)
30,560
Amortization of deferred commissions
14,277
17,221
Lease expense
4,594
3,919
Amortization of intangible assets and depreciation
4,724
4,171
Foreign currency transaction loss (gain)
2,675
(2,876)
Other non-cash
(5,729)
(1,100)
Change in operating assets and liabilities, net
29,115
(55,332)
Cash provided by operating activities
68,107
15,116
Investing activities
Purchases of investments
(39,401)
(33,690)
Proceeds from maturities and called investments
36,475
20,915
Sales of investments
—
13,350
Investment in property and equipment
(11,487)
(6,657)
Cash (used in) investing activities
(14,413)
(6,082)
Financing activities
Repurchases of convertible senior notes
(29,901)
—
Proceeds from settlement of capped calls transactions
188
—
Dividend payments to stockholders
(2,474)
(2,454)
Proceeds from employee stock purchase plan
2,143
2,446
Proceeds from stock option exercises
1,779
—
Common stock repurchases
(1,107)
(35,910)
Cash (used in) financing activities
(29,372)
(35,918)
Effect of exchange rate changes on cash, cash equivalents, and restricted cash
782
(310)
Net increase (decrease) in cash, cash equivalents, and restricted cash
25,104
(27,194)
Cash, cash equivalents, and restricted cash, beginning of period
145,054
159,965
Cash, cash equivalents, and restricted cash, end of period
$
170,158
$
132,771
Cash and cash equivalents
$
168,318
$
132,771
Restricted cash included in other long-term assets
1,840
—
Total cash, cash equivalents and restricted cash
$
170,158
$
132,771
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 and 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, 2022.
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 do not necessarily indicate the expected results for the full year 2023.
NOTE 2. MARKETABLE SECURITIES
March 31, 2023
December 31, 2022
(in thousands)
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
Government debt
$
2,970
$
—
$
(33)
$
2,937
$
2,960
$
—
$
(52)
$
2,908
Corporate debt
154,299
8
(1,680)
152,627
151,906
—
(2,647)
149,259
$
157,269
$
8
$
(1,713)
$
155,564
$
154,866
$
—
$
(2,699)
$
152,167
As of March 31, 2023, marketable securities’ maturities ranged from April 2023 to January 2026, with a weighted-average remaining maturity of 0.5 years.
NOTE 3. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE
Receivables
(in thousands)
March 31, 2023
December 31, 2022
Accounts receivable
$
201,585
$
255,150
Unbilled receivables
196,279
213,719
Long-term unbilled receivables
79,704
95,806
$
477,568
$
564,675
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)
March 31, 2023
1 year or less
$
196,279
71
%
1-2 years
64,812
24
%
2-5 years
14,892
5
%
$
275,983
100
%
Unbilled receivables by contract effective date:
(Dollars in thousands)
March 31, 2023
2023
$
51,895
19
%
2022
96,349
34
%
2021
87,278
32
%
2020
27,755
10
%
2019 and prior
12,706
5
%
$
275,983
100
%
8
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
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 the completion of a related performance obligation.
(in thousands)
March 31, 2023
December 31, 2022
Contract assets (1)
$
14,463
$
17,546
Long-term contract assets (2)
11,323
16,470
$
25,786
$
34,016
(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)
March 31, 2023
December 31, 2022
Deferred revenue
$
342,591
$
325,212
Long-term deferred revenue (1)
3,323
3,552
$
345,914
$
328,764
(1) Included in other long-term liabilities.
The increase in deferred revenue in the three months ended March 31, 2023 was primarily due to new billings in advance of revenue recognition exceeding the $139.7 million of revenue recognized during the period that was included in deferred revenue as of December 31, 2022.
NOTE 4. DEFERRED COMMISSIONS
(in thousands)
March 31, 2023
December 31, 2022
Deferred commissions (1)
$
124,069
$
130,195
(1) Included in other long-term assets.
Three Months Ended March 31,
(in thousands)
2023
2022
Amortization of deferred commissions (1)
$
14,277
$
17,221
(1) Included in selling and marketing expense.
NOTE 5. GOODWILL AND OTHER INTANGIBLES
Goodwill
Three Months Ended March 31,
(in thousands)
2023
2022
January 1,
$
81,399
$
81,923
Currency translation adjustments
35
108
March 31,
$
81,434
$
82,031
Intangibles
Intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives.
March 31, 2023
(in thousands)
Useful Lives
Cost
Accumulated Amortization
Net Book Value (1)
Client-related
4-10 years
$
63,094
$
(58,983)
$
4,111
Technology
2-10 years
68,085
(62,335)
5,750
Other
1-5 years
5,361
(5,361)
—
$
136,540
$
(126,679)
$
9,861
(1) Included in other long-term assets.
9
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2022
(in thousands)
Useful Lives
Cost
Accumulated Amortization
Net Book Value (1)
Client-related
4-10 years
$
63,076
$
(58,623)
$
4,453
Technology
2-10 years
68,056
(61,621)
6,435
Other
1-5 years
5,361
(5,361)
—
$
136,493
$
(125,605)
$
10,888
(1) Included in other long-term assets.
Future estimated intangibles assets amortization:
(in thousands)
March 31, 2023
Remainder of 2023
$
2,884
2024
3,163
2025
2,613
2026
874
2027
327
$
9,861
Amortization of intangible assets:
Three Months Ended March 31,
(in thousands)
2023
2022
Cost of revenue
$
706
$
629
Selling and marketing
343
343
$
1,049
$
972
NOTE 6. OTHER ASSETS AND LIABILITIES
Other current assets
(in thousands)
March 31, 2023
December 31, 2022
Income tax receivables
$
22,344
$
25,354
Contract assets
14,463
17,546
Other
37,175
37,488
$
73,982
$
80,388
Other long-term assets
(in thousands)
March 31, 2023
December 31, 2022
Deferred commissions
$
124,069
$
130,195
Right of use assets
72,549
76,114
Property and equipment
55,775
55,056
Venture investments
16,265
13,069
Contract assets
11,323
16,470
Intangible assets
9,861
10,888
Capped call transactions
5,600
2,582
Deferred income taxes
4,827
4,795
Restricted cash
1,840
—
Other
22,866
24,820
$
324,975
$
333,989
Other current liabilities
(in thousands)
March 31, 2023
December 31, 2022
Operating lease liabilities
$
15,314
$
14,976
Dividends payable
2,488
2,474
$
17,802
$
17,450
10
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Other long-term liabilities
(in thousands)
March 31, 2023
December 31, 2022
Deferred revenue
$
3,323
$
3,552
Income taxes payable
3,578
3,207
Other
7,743
8,369
$
14,644
$
15,128
NOTE 7. LEASES
Expense
Three Months Ended March 31,
(in thousands)
2023
2022
Fixed lease costs
$
5,766
$
5,093
Short-term lease costs
781
806
Variable lease costs
1,975
764
$
8,522
$
6,663
Right of use assets and lease liabilities
(in thousands)
March 31, 2023
December 31, 2022
Right of use assets (1)
$
72,549
$
76,114
Operating lease liabilities (2)
$
15,314
$
14,976
Long-term operating lease liabilities
$
76,082
$
79,152
(1) 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:
March 31, 2023
December 31, 2022
Weighted-average remaining lease term
7.3 years
7.5 years
Weighted-average discount rate (1)
4.1
%
4.1
%
(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)
March 31, 2023
Remainder of 2023
$
14,003
2024
17,642
2025
14,562
2026
10,917
2027
9,863
2028
9,290
Thereafter
30,090
Total lease payments
106,367
Less: imputed interest (1)
(14,971)
$
91,396
(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
Three Months Ended March 31,
(in thousands)
2023
2022
Cash paid for operating leases, net of tenant improvement allowances
$
5,038
$
3,650
Right of use assets recognized for new leases and amendments (non-cash)
$
721
$
3,854
11
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
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.
In the three months ended March 31, 2023, the Company recorded a gain of $2.8 million in other income, net from the repurchase of Notes representing $33 million in aggregate principal amount.
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 March 31, 2023, the Notes were not eligible for conversion.
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.
Carrying value of the Notes:
(in thousands)
March 31, 2023
December 31, 2022
Principal
$
567,000
$
600,000
Unamortized issuance costs
(5,345)
(6,391)
Convertible senior notes, net
$
561,655
$
593,609
Interest expense related to the Notes:
Three Months Ended March 31,
(in thousands)
2023
2022
Contractual interest expense (0.75% coupon)
$
1,125
$
1,125
Amortization of issuance costs
728
719
$
1,853
$
1,844
12
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
The average interest rate on the Notes in the three months ended March 31, 2023 and 2022 was 1.2%.
Future payments of principal and contractual interest:
March 31, 2023
(in thousands)
Principal
Interest
Total
Remainder of 2023
$
—
$
1,772
$
1,772
2024
—
4,253
4,253
2025
567,000
2,126
569,126
$
567,000
$
8,151
$
575,151
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 covered approximately 4.4 million shares (representing the number of shares for which the Notes were initially convertible) of the Company’s common stock. In the three months ended March 31, 2023, Capped Call Transactions covering approximately 0.2 million shares were settled for proceeds of $0.2 million.
As of March 31, 2023, Capped Call Transactions representing approximately 4.2 million shares were outstanding.
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 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 each reporting period, resulting in a non-operating gain or loss.
Change in capped call transactions:
Three Months Ended March 31,
(in thousands)
2023
2022
January 1,
$
2,582
$
59,964
Settlements
(188)
—
Fair value adjustment
3,206
(30,560)
March 31,
$
5,600
$
29,404
Credit facility
In November 2019, and as since amended, 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 for general corporate purposes and to finance working capital needs. Subject to specific conditions and the agreement of the financial institutions lending the additional amount, the aggregate commitment may be increased 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 required to comply with financial covenants, including:
•Beginning with the fiscal quarter ended March 31, 2022 and ending with the fiscal quarter ended December 31, 2023, Pegasystems Inc. must maintain at least $200 million in cash, investments, and availability under the Revolving Credit Loan.
•Beginning with the fiscal quarter ended March 31, 2023 and ending with the fiscal year ended December 31, 2023, maintain
Year to Date
(in thousands)
March 31, 2023
June 30, 2023
September 30, 2023
December 31, 2023
Minimum Consolidated EBITDA (as defined in the Credit Facility)
$
38,862
$
59,894
$
95,597
$
214,590
•Beginning with the fiscal quarter ended March 31, 2024, a maximum net consolidated leverage ratio of 3.5 to 1.0 (with a step-up for certain acquisitions) and a minimum consolidated interest coverage ratio of 3.5 to 1.0.
As of March 31, 2023 and December 31, 2022, the Company had no outstanding cash borrowings under the Credit Facility.
As of March 31, 2023, the Company had $27.3 million in outstanding letters of credit, which reduce the Company’s available borrowing capacity under the Credit Facility.
13
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 9. RESTRUCTURING
Go-to-market plan and Salem office
During the fourth quarter of 2022, management committed to a restructuring plan aligned with the Company’s target organization go-to-market strategy. The plan resulted in a restructuring expense of $21.7 million, primarily associated with severance and benefits for impacted employees and expenses incurred as a result of the closure of the Company’s Salem, New Hampshire office.
Accrued employee severance and related benefits:
(in thousands)
2023
January 1,
$
18,573
Costs incurred
220
Cash disbursements
(14,458)
Currency translation adjustments
181
March 31,
$
4,516
2023 office space closure
In the three months ended March 31, 2023, the Company recognized an impairment of $1.2 million on its operating lease right of use assets primarily due to the closure of leased office space in Poland.
NOTE 10. 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 model uses 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 the underlying equity security’s historical and implied volatility levels. The Company’s venture investments are recorded at fair value based on multiple 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:
March 31, 2023
December 31, 2022
(in thousands)
Level 1
Level 2
Level 3
Total
Level 1
Level 2
Level 3
Total
Cash equivalents
$
41,088
$
—
$
—
$
41,088
$
2,526
$
—
$
—
$
2,526
Marketable securities
$
—
$
155,564
$
—
$
155,564
$
—
$
152,167
$
—
$
152,167
Capped Call Transactions (1)
$
—
$
5,600
$
—
$
5,600
$
—
$
2,582
$
—
$
2,582
Venture investments (1) (2)
$
—
$
—
$
16,265
$
16,265
$
—
$
—
$
13,069
$
13,069
(1) Included in other long-term assets. (2) Investments in privately-held companies.
14
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Changes in venture investments:
Three Months Ended March 31,
(in thousands)
2023
2022
January 1,
$
13,069
$
7,648
New investments
400
—
Changes in foreign exchange rates
58
(61)
Changes in fair value:
included in other income, net
3,802
2,741
included in other comprehensive (loss)
(1,064)
2,502
March 31,
$
16,265
$
12,830
The carrying value of certain other financial instruments, including receivables and accounts payable, approximates fair value due to these items’ short maturities.
Fair value of the Notes
The fair value of the Notes outstanding (including the embedded conversion feature) was $507.8 million as of March 31, 2023 and $521.1 million as of December 31, 2022. In the three months ended March 31, 2023 the Company repurchased Notes representing $33 million in aggregate principal amount.
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.
NOTE 11. REVENUE
Geographic revenue
Three Months Ended March 31,
(Dollars in thousands)
2023
2022
U.S.
$
184,519
56
%
$
217,272
58
%
Other Americas
15,011
5
%
45,751
12
%
United Kingdom (“U.K.”)
42,237
13
%
30,932
8
%
Europe (excluding U.K.), Middle East, and Africa
51,318
16
%
49,136
13
%
Asia-Pacific
32,387
10
%
33,216
9
%
$
325,472
100
%
$
376,307
100
%
Revenue streams
Three Months Ended March 31,
(in thousands)
2023
2022
Perpetual license
$
403
$
7,440
Subscription license
84,527
137,533
Revenue recognized at a point in time
84,930
144,973
Maintenance
79,630
79,716
Pega Cloud
107,879
90,317
Consulting
53,033
61,301
Revenue recognized over time
240,542
231,334
Total revenue
$
325,472
$
376,307
15
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Three Months Ended March 31,
(in thousands)
2023
2022
Pega Cloud
$
107,879
$
90,317
Maintenance
79,630
79,716
Subscription services
187,509
170,033
Subscription license
84,527
137,533
Subscription
272,036
307,566
Perpetual license
403
7,440
Consulting
53,033
61,301
$
325,472
$
376,307
Remaining performance obligations ("Backlog")
Expected future revenue from existing non-cancellable contracts:
As of March 31, 2023:
(Dollars in thousands)
Subscription services
Subscription license
Perpetual license
Consulting
Total
Maintenance
Pega Cloud
1 year or less
$
235,315
$
389,632
$
35,346
$
5,262
$
41,203
$
706,758
54
%
1-2 years
66,272
239,228
3,215
2,252
6,653
317,620
24
%
2-3 years
29,295
131,085
6,777
—
2,292
169,449
13
%
Greater than 3 years
7,479
106,778
—
—
—
114,257
9
%
$
338,361
$
866,723
$
45,338
$
7,514
$
50,148
$
1,308,084
100
%
As of March 31, 2022:
(Dollars in thousands)
Subscription services
Subscription license
Perpetual license
Consulting
Total
Maintenance
Pega Cloud
1 year or less
$
228,984
$
329,857
$
47,428
$
7,281
$
40,661
$
654,211
55
%
1-2 years
63,870
208,875
16,111
4,505
10,955
304,316
26
%
2-3 years
33,617
106,156
2,422
2,252
3,876
148,323
13
%
Greater than 3 years
22,611
44,596
1,758
—
522
69,487
6
%
$
349,082
$
689,484
$
67,719
$
14,038
$
56,014
$
1,176,337
100
%
NOTE 12. STOCK-BASED COMPENSATION
Expense
Three Months Ended March 31,
(in thousands)
2023
2022
Cost of revenue
$
8,912
$
6,378
Selling and marketing
17,661
10,958
Research and development
9,060
7,346
General and administrative
6,924
3,545
$
42,557
$
28,227
Income tax benefit
$
(672)
$
(5,311)
As of March 31, 2023, the Company had $178.6 million of unrecognized stock-based compensation expense, net of estimated forfeitures, which is expected to be recognized over a weighted-average period of 2 years.
Grants
Three Months Ended March 31, 2023
(in thousands)
Shares
Total Fair Value
Restricted stock units
1,460
$
68,352
Non-qualified stock options
43
$
615
16
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 13. INCOME TAXES
Effective income tax rate
Three Months Ended March 31,
(Dollars in thousands)
2023
2022
Provision for (benefit from) income taxes
$
5,249
$
(7,683)
Effective income tax rate
(34)
%
95
%
The effective income tax rate in the three months ended March 31, 2023 was impacted by the valuation allowance on the Company’s U.S. and U.K. deferred tax assets and current taxes payable in the U.S. as a result of projecting taxable income that cannot be fully offset by net operating losses and available tax credits.
The Company recognizes deferred tax assets to the extent that it believes that these assets are more likely than not to be realized. Future realization of deferred tax assets ultimately depends on sufficient taxable income within the available carryback or carryforward periods. The Company’s deferred tax valuation allowance requires significant judgment and uncertainties, including assumptions about future taxable income based on historical and projected information. On a quarterly basis, the Company reassesses the need for a valuation allowance on its existing net deferred tax assets by tax-paying jurisdiction, weighing positive and negative evidence to assess its recoverability. In making such a determination, the Company considers all available and objectively verifiable negative and positive evidence, including future reversals of existing taxable temporary differences, committed contractual backlog (“Backlog”), projected future taxable income inclusive of the impact of enacted legislation, tax-planning strategies, and results of recent operations. The weight given to the potential effect of negative and positive evidence is commensurate with the extent to which it can be objectively verified.
The Company intends to continue maintaining a full valuation allowance on the Company’s U.S and U.K. deferred tax assets until there is sufficient evidence to support the realization of these deferred tax assets.
NOTE 14. (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.
Calculation of (loss) per share:
Three Months Ended March 31,
(in thousands, except per share amounts)
2023
2022
Net (loss)
$
(20,774)
$
(379)
Weighted-average common shares outstanding
82,604
81,680
(Loss) per share, basic
$
(0.25)
$
—
Net (loss)
$
(20,774)
$
(379)
Weighted-average common shares outstanding, assuming dilution (1) (2) (3)
82,604
81,680
(Loss) per share, diluted
$
(0.25)
$
—
Outstanding anti-dilutive stock options and RSUs (4)
1,348
4,178
(1) In periods of loss, all dilutive securities are excluded as their inclusion would be anti-dilutive.
(2) 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 approximately 4.2 million shares as of March 31, 2023.
(3) The Company’s Capped Call Transactions represent the equivalent of approximately 4.2 million shares of the Company’s common stock (representing the number of shares for which the Notes are initially convertible) as of March 31, 2023. 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.
NOTE 15. COMMITMENTS AND CONTINGENCIES
Commitments
See "Note 7. Leases" for additional information.
17
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Legal proceedings
In addition to the matters below, the Company is or may become involved in a variety of claims, demands, suits, investigations, and proceedings that arise from time to time relating to matters incidental to the ordinary course of the Company’s business, including actions concerning contracts, intellectual property, employment, benefits, and securities matters. Regardless of the outcome, legal disputes can have a material effect on the Company because of defense and settlement costs, diversion of management resources, and other factors.
In addition, as the Company is a party to ongoing litigation, it is at least reasonably possible that the Company’s estimates will change in the near term, and the effect may be material.
The Company had no accrued losses for litigation as of March 31, 2023 and December 31, 2022.
Appian Corp. v. Pegasystems Inc. & Youyong Zou
As previously reported, the Company is a defendant in litigation brought by Appian in the Circuit Court of Fairfax County, Virginia (the “Court”) titled Appian Corp. v. Pegasystems Inc. & Youyong Zou, No. 2020-07216 (Fairfax Cty. Ct.). On May 9, 2022, the jury rendered its verdict finding that the Company had misappropriated one or more of Appian’s trade secrets, that the Company had violated the Virginia Computer Crimes Act, and that the trade secret misappropriation was willful and malicious. The jury awarded damages of $2,036,860,045 for trade secret misappropriation and $1.00 for violating the Virginia Computer Crimes Act. On September 15, 2022, the circuit court of Fairfax County entered judgment of $2,060,479,287, consisting of the damages previously awarded by the jury plus attorneys’ fees and costs, and stating that the judgment is subject to post-judgment interest at a rate of 6.0% per annum, from the date of the jury verdict (May 9, 2022) as to the amount of the jury verdict and from September 15, 2022 as to the amount of the award of attorneys’ fees and costs. On September 15, 2022, the Company filed a notice of appeal from the judgment. On September 29, 2022, the circuit court of Fairfax County approved a $25,000,000 letter of credit obtained by the Company to secure the judgment and entered an order suspending the judgment during the pendency of the Company’s appeal. Appellate briefing is currently in process. Although it is not possible to predict timing, this appeals process could potentially take years to complete. The Company continues to believe that it did not misappropriate any alleged trade secrets and that its sales of the Company’s products at issue were not caused by, or the result of, any alleged misappropriation of trade secrets. The Company is unable to reasonably estimate possible damages because of, among other things, uncertainty as to the outcome of appellate proceedings and/or any potential new trial resulting from the appellate proceedings.
City of Fort Lauderdale Police and Firefighters’ Retirement System, Individually and on Behalf of All Others Similarly Situated v. Pegasystems Inc., Alan Trefler, and Kenneth Stillwell
On May 19, 2022, a lawsuit was filed against the Company, the Company’s chief executive officer and the Company’s chief operating and financial officer in the United States District Court for the Eastern District of Virginia Alexandria Division, captioned City of Fort Lauderdale Police and Firefighters’ Retirement System, Individually and on Behalf of All Others Similarly Situated v. Pegasystems Inc., Alan Trefler, and Kenneth Stillwell (Case 1:22-cv-00578-LMB-IDD). The complaint generally alleges, among other things, that the defendants violated Section 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Rule 10b-5 promulgated thereunder and that the individual defendants violated Section 20(a) of the Exchange Act, in each case by allegedly making materially false and/or misleading statements, as well as allegedly failing to disclose material adverse facts about the Company’s business, operations, and prospects, which caused the Company’s securities to trade at artificially inflated prices. The complaint seeks unspecified damages on behalf of a class of purchasers of the Company’s securities between May 29, 2020 and May 9, 2022. The litigation has since been transferred to the United States District Court for the District of Massachusetts (Case 1:22-cv-11220-WGY), and lead plaintiff class representatives—Central Pennsylvania Teamsters Pension Fund - Defined Benefit Plan, Central Pennsylvania Teamsters Pension Fund - Retirement Income Plan 1987, and Construction Industry Laborers Pension Fund—have been appointed. On October 18, 2022, a consolidated amended complaint was filed that does not add any new parties or legal claims, is based upon the same general factual allegations as the original complaint, and now seeks unspecified damages on behalf of a class of purchasers of the Company’s securities between June 16, 2020 and May 9, 2022. The Company moved to dismiss the consolidated amended complaint on December 19, 2022. The hearing on the motion to dismiss is scheduled for May 17, 2023. The Company believes the claims brought against the defendants are without merit and intends to defend against these claims vigorously. The Company is unable to reasonably estimate possible damages or a range of possible damages in this matter given the stage of the lawsuit, the Company’s belief that the claims are without merit, and there being no specified quantum of damages sought in the complaint.
18
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Mary Larkin, derivatively on behalf of nominal defendant Pegasystems Inc. v. Peter Gyenes, Richard Jones, Christopher Lafond, Dianne Ledingham, Sharon Rowlands, Alan Trefler, Larry Weber, and Kenneth Stillwell, defendants, and Pegasystems Inc., nominal defendant
On November 21, 2022, a lawsuit was filed against the members of the Company’s board of directors, the Company’s chief operating and financial officer and the Company in the United States District Court for the District of Massachusetts, captioned Mary Larkin, derivatively on behalf of nominal defendant Pegasystems Inc. v. Peter Gyenes, Richard Jones, Christopher Lafond, Dianne Ledingham, Sharon Rowlands, Alan Trefler, Larry Weber, and Kenneth Stillwell, defendants, and Pegasystems Inc., nominal defendant (Case 1:22-cv-11985). The complaint generally alleges the defendants sold shares of the Company while in possession of material nonpublic information relating to (i) the litigation brought by Appian in the Circuit Court of Fairfax County, Virginia, described above, and (ii) alleged misconduct by Company employees alleged in that litigation. On January 10, 2023, the Court entered an order staying the matter until after a final judgment dismissing the City of Fort Lauderdale matter referenced above, the denial of a motion to dismiss in the City of Fort Lauderdale action, or if any related derivative complaint is filed and not stayed for the same or longer duration. The Company believes the claims brought against the defendants are without merit and intends to defend against these claims vigorously. The Company is unable to reasonably estimate possible damages or a range of possible damages in this matter given the stage of the lawsuit, the Company’s belief that the claims are without merit, and there being no specified quantum of damages sought in the complaint.
SEC Inquiry
Beginning in March 2023, the U.S. Securities and Exchange Commission (“SEC”) has requested certain information relating to, among other things, the accounting treatment of the Company’s above-described litigation with Appian Corporation. The Company is fully cooperating with the SEC’s requests.
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;
•reliance on key personnel;
•global economic and political conditions and uncertainty, including impacts from public health emergencies and the war in Ukraine;
•reliance on third-party service providers, including hosting providers;
•compliance with our debt obligations and covenants;
•the potential impact of our convertible senior notes and Capped Call Transactions;
•foreign currency exchange rates;
•the potential legal and financial liabilities and damage to our reputation due to cyber-attacks;
•security breaches and security flaws;
•our ability to protect our intellectual property rights, costs associated with defending such rights, intellectual property rights claims, and other related claims by third parties against us, including related costs, damages, and other relief that may be granted against us;
•our ongoing litigation with Appian Corp.;
•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, 2022, Part II of this Quarterly Report on Form 10-Q, 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 due to new information, future events, or otherwise.
The forward-looking statements in this Quarterly Report represent our views as of April 26, 2023.
BUSINESS OVERVIEW
We develop, market, license, host, and support enterprise software that helps organizations build agility into their business so they can adapt to change. Our powerful low-code platform for workflow automation and artificial intelligence-powered decisioning enables the world’s leading brands and government agencies to hyper-personalize customer experiences, streamline customer service, and automate mission-critical business processes and workflows. With Pega, our clients can leverage our intelligent technology and scalable architecture to accelerate their digital transformation. In addition, our client success teams, world-class partners, and clients leverage our Pega Express™ methodology to design and deploy mission-critical applications quickly and collaboratively.
Our target clients are Global 2000 organizations and government agencies that require solutions to distinguish themselves in the markets they serve. Our solutions achieve and facilitate differentiation by increasing business agility, driving growth, improving productivity, attracting and retaining customers, and reducing risk. Along with our partners, we deliver solutions tailored to the specific industry needs of our clients.
Subscription transition
We are transitioning our business to sell software primarily through subscription arrangements. Until we fully complete our subscription transition, which we expect will occur in 2023, our operating results may be impacted. Operating performance, revenue mix, 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, 2022 for additional information.
20
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”)
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. ACV is a performance measure that we believe provides useful information to our management and investors.
In 2023, we changed our ACV calculation methodology for maintenance and all contracts less than 12 months to align with other contract types. Previously disclosed ACV amounts have been updated to allow for comparability.
Constant currency ACV is calculated by applying the Q1 2022 foreign exchange rates to all periods shown.
21
Remaining performance obligations (“Backlog”)
Reconciliation of GAAP Backlog and Constant Currency Backlog
(in millions, except percentages)
Q1 2023
1 Year Growth Rate
Backlog
$
1,308
11
%
Impact of changes in foreign exchange rates
28
3
%
Backlog - Constant Currency
$
1,336
14
%
Constant currency Backlog is calculated by applying the Q1 2022 foreign exchange rates to all periods shown.
We believe that non-GAAP financial measures help investors understand our core operating results and prospects, consistent with how management measures and forecasts our performance without the effect of often one-time charges and other items outside our normal operations. The supplementary non-GAAP financial measures are not meant to be superior to or a substitute for financial measures prepared under U.S. GAAP.
22
Free cash flow (1)
(in thousands, except percentages)
Three Months Ended March 31,
2023
2022
Change
Cash provided by operating activities
$
68,107
$
15,116
351
%
Investment in property and equipment
(11,487)
(6,657)
Legal fees
1,515
6,887
Restructuring
14,458
—
Interest on convertible senior notes
2,250
2,250
Free cash flow
$
74,843
$
17,596
325
%
Total revenue
$
325,472
$
376,307
Free cash flow margin
23
%
5
%
(1) We believe that non-GAAP financial measures help investors understand our core operating results and prospects, consistent with how management measures and forecasts our performance without the effect of often one-time charges and other items outside our normal operations. The supplementary non-GAAP financial measures are not meant to be superior to or a substitute for financial measures prepared under U.S. GAAP. Our non-GAAP free cash flow measures reflect the following adjustments:
•Investment in property and equipment: Investment in property and equipment fluctuates in amount and frequency and is significantly affected by the timing and size of investments in our facilities. We believe excluding these amounts provides a useful comparison of our operational performance in different periods.
•Legal fees: Includes legal and related fees arising from proceedings outside of the ordinary course of business. We believe excluding these amounts from our non-GAAP financial measures is useful to investors as the disputes giving rise to them are not representative of our core business operations and ongoing operational performance.
•Restructuring: We have excluded restructuring from our non-GAAP financial measures. Restructuring fluctuates in amount and frequency and is significantly affected by the timing and size of our restructuring activities. We believe excluding the impact from our non-GAAP financial measures is useful to investors as these amounts are not representative of our core business operations and ongoing operational performance.
•Interest on convertible senior notes: In February 2020, we issued convertible senior notes, due March 1, 2025, in a private placement. We believe excluding the interest payments provides a useful comparison of our operational performance in different periods.
23
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 of America (“U.S.”) and the rules and regulations of the SEC for interim financial reporting. Preparing 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, 2022:
•“Critical Accounting Estimates and Significant Judgments” in Item 7; and
•“Note 2. Significant Accounting Policies” in Item 8.
There have been no other significant changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022.
RESULTS OF OPERATIONS
Revenue
Subscription transition
We are transitioning our business to sell software primarily through subscription arrangements.
This transition has impacted revenue growth as revenue from subscription service arrangements, which includes Pega Cloud and maintenance, 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 March 31,
Change
2023
2022
Pega Cloud
$
107,879
33
%
$
90,317
24
%
$
17,562
19
%
Maintenance
79,630
25
%
79,716
21
%
(86)
—
%
Subscription services
187,509
58
%
170,033
45
%
17,476
10
%
Subscription license
84,527
26
%
137,533
37
%
(53,006)
(39)
%
Subscription
272,036
84
%
307,566
82
%
(35,530)
(12)
%
Perpetual license
403
—
%
7,440
2
%
(7,037)
(95)
%
Consulting
53,033
16
%
61,301
16
%
(8,268)
(13)
%
$
325,472
100
%
$
376,307
100
%
$
(50,835)
(14)
%
The revenue changes in the three months ended March 31, 2023 generally reflect the impact of our subscription transition. Other factors impacting our revenue include:
•The decrease in subscription license revenue in the three months ended March 31, 2023 was primarily due to several large software license contracts recognized in revenue in the three months ended March 31, 2022.
•The decrease in consulting revenue in the three months ended March 31, 2023 was primarily due to a decrease in billable hours and realization rates.
Gross profit
(Dollars in thousands)
Three Months Ended March 31,
Change
2023
2022
Pega Cloud
$
77,629
72
%
$
63,418
70
%
$
14,211
22
%
Maintenance
73,016
92
%
74,585
94
%
(1,569)
(2)
%
Subscription services
150,645
80
%
138,003
81
%
12,642
9
%
Subscription license
83,808
99
%
136,911
100
%
(53,103)
(39)
%
Subscription
234,453
86
%
274,914
89
%
(40,461)
(15)
%
Perpetual license
400
99
%
7,406
100
%
(7,006)
(95)
%
Consulting
(7,315)
(14)
%
5,790
9
%
(13,105)
*
$
227,538
70
%
$
288,110
77
%
$
(60,572)
(21)
%
* not meaningful
The gross profit percent changes in the three months ended March 31, 2023 were primarily due to a shift in the revenue mix.
24
•The increase in Pega Cloud gross profit percent in the three months ended March 31, 2023 was primarily due to cost-efficiency gains as Pega Cloud continues to grow and scale.
•The decrease in maintenance gross profit percent in the three months ended March 31, 2023 was primarily due to an increase in compensation and benefits due to increased headcount.
•The decrease in consulting gross profit percent in the three months ended March 31, 2023 was due to a decrease in realization rates and consultant utilization.
Operating expenses
(Dollars in thousands)
Three Months Ended March 31,
Change
2023
2022
% of Revenue
% of Revenue
Selling and marketing
$
149,797
46
%
$
162,236
43
%
$
(12,439)
(8)
%
Research and development
$
75,376
23
%
$
71,490
19
%
$
3,886
5
%
General and administrative
$
23,110
7
%
$
35,764
10
%
$
(12,654)
(35)
%
Restructuring
$
1,461
—
$
—
—
$
1,461
100
%
•The decrease in selling and marketing in the three months ended March 31, 2023 was primarily due to a decrease in compensation and benefits of $12.2 million.
•The increase in research and development in the three months ended March 31, 2023 was primarily due to an increase in compensation and benefits of $2.5 million, attributable to increases in headcount and incentive compensation. The increase in headcount reflects additional investments in developing our solutions.
•The decrease in general and administrative in the three months ended March 31, 2023 was primarily due to a decrease in legal fees and related expenses arising from litigation proceedings outside the ordinary course of business of $15.9 million. We expect to continue to incur additional costs for these proceedings. See "Note 15. Commitments and Contingencies" in Part I, Item 1 of this Quarterly Report and “Risk Factors” in Part I, Item 1A of our Annual Report for the year ended December 31, 2022.
•The increase in restructuring in the three months ended March 31, 2023 was primarily due to an impairment of $1.2 million on our operating lease right of use assets primarily due to the closure of leased office space in Poland.
Other income and expenses
(Dollars in thousands)
Three Months Ended March 31,
Change
2023
2022
Foreign currency transaction (loss) gain
$
(2,675)
$
2,876
$
(5,551)
*
Interest income
1,485
207
1,278
617
%
Interest expense
(1,918)
(1,946)
28
1
%
Gain (loss) on capped call transactions
3,206
(30,560)
33,766
*
Other income, net
6,583
2,741
3,842
140
%
$
6,681
$
(26,682)
$
33,363
*
* not meaningful
•The decrease in foreign currency transaction (loss) gain in the three months ended March 31, 2023 was primarily due to the impact of fluctuations in foreign currency exchange rates associated with foreign currency-denominated cash and receivables held by our subsidiary in the United Kingdom.
•The increase in interest income in the three months ended March 31, 2023 was primarily due to an increase in market interest rates.
•The change in gain (loss) on capped call transactions in the three months ended March 31, 2023 was due to fair value adjustments for our capped call transactions.
•The increase in other income, net in the three months ended March 31, 2023 was due to a gain from the repurchase of convertible senior notes and from our venture investments portfolio.
25
Provision for (benefit from) income taxes
Three Months Ended March 31,
(Dollars in thousands)
2023
2022
Provision for (benefit from) income taxes
$
5,249
$
(7,683)
Effective income tax rate
(34)
%
95
%
The effective income tax rate in the three months ended March 31, 2023 was impacted by the valuation allowance on our U.S. and U.K. deferred tax assets and current taxes payable in the U.S. as a result of projecting taxable income that cannot be fully offset by net operating losses and available tax credits.
LIQUIDITY AND CAPITAL RESOURCES
Three Months Ended March 31,
(in thousands)
2023
2022
Cash provided by (used in):
Operating activities
$
68,107
$
15,116
Investing activities
(14,413)
(6,082)
Financing activities
(29,372)
(35,918)
Effect of exchange rate changes on cash, cash equivalents, and restricted cash
782
(310)
Net increase (decrease) in cash, cash equivalents, and restricted cash
$
25,104
$
(27,194)
(in thousands)
March 31, 2023
December 31, 2022
Held by U.S. entities
$
229,214
$
248,389
Held by foreign entities
94,668
48,832
Total cash, cash equivalents, and marketable securities
$
323,882
$
297,221
We believe that our current cash, cash flow from operations, borrowing capacity, and ability to engage in capital market transactions will be sufficient to fund our operations, stock repurchases, and quarterly cash dividends for at least the next 12 months and to meet our known long-term cash requirements. 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. We may utilize available funds or seek external financing if we require additional capital resources.
If it becomes necessary or desirable to repatriate foreign funds, we may be required to pay federal, state, and local income and foreign withholding taxes upon repatriation. However, 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. This transition has impacted and is expected to continue impacting our billings and cash collections. Subscription licenses and services are typically billed and collected over the contract term, while perpetual license arrangements are generally billed and collected upfront when the license rights become effective.
The change in cash provided by operating activities in the three months ended March 31, 2023 was primarily due to our subscription transition and improved client collections. In addition, in the three months ended March 31, 2023 and 2022, we paid $1.5 million and $6.9 million in legal fees and related expenses arising from proceedings that originated outside of the ordinary course of business. We expect to continue to incur additional costs for these proceedings. See "Note 15. Commitments and Contingencies" in Part I, Item 1 of this Quarterly Report for additional information.
Investing activities
The change in cash (used in) investing activities in the three months ended March 31, 2023 was primarily driven by an increase in office space-related capital expenditures.
26
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 the three months ended March 31, 2023, we paid $29.9 million to repurchase $33 million in aggregate principal amount of convertible senior notes. As of March 31, 2023, we had $567 million in aggregate principal amount of convertible senior notes outstanding.
See "Note 8. Debt" in Part I, Item 1 of this Quarterly Report for additional information.
In November 2019, and as since amended, we entered into a five-year $100 million senior secured revolving credit agreement (the “Credit Facility”) with PNC Bank, National Association. As of March 31, 2023, we had no outstanding cash borrowings under the Credit Facility but had $27.3 million in outstanding letters of credit which reduces our available borrowing capacity. See "Note 8. Debt" in Part I, Item 1 of this Quarterly Report for additional information.
Stock repurchase program
Changes in the remaining stock repurchase authority:
(in thousands)
Three Months Ended March 31, 2023
December 31, 2022
$
58,075
Authorizations (1)
—
March 31, 2023
$
58,075
(1) On April 25, 2023, our Board of Directors extended the expiration date of our current share repurchase program to June 30, 2024, and the amount of stock we are authorized to repurchase has been increased to $60 million.
Common stock repurchases
Three Months Ended March 31,
2023
2022
(in thousands)
Shares
Amount
Shares
Amount
Repurchases paid
—
$
—
242
$
22,583
Stock repurchase program
—
—
242
22,583
Tax withholdings for net settlement of equity awards
27
1,107
141
12,128
27
$
1,107
383
$
34,711
In the three months ended March 31, 2023 and 2022, instead of receiving cash from the equity holders, we withheld shares with a value of $0.6 million and $6.1 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 without prior notice.
Three Months Ended March 31,
(in thousands)
2023
2022
Dividend payments to stockholders
$
2,474
$
2,454
Contractual obligations
As of March 31, 2023, our contractual obligations were:
Payments due by period
(in thousands)
Remainder of 2023
2024
2025
2026
2027
2028 and after
Other
Total
Convertible senior notes (1)
$
1,772
$
4,253
$
569,126
$
—
$
—
$
—
$
—
$
575,151
Purchase obligations (2)
98,303
117,729
127,367
131,146
133,500
14
—
608,059
Operating lease obligations
14,003
17,642
14,562
10,917
9,863
39,380
—
106,367
Investment commitments
1,000
—
—
—
—
—
—
1,000
Liability for uncertain tax positions (3)
—
—
—
—
—
—
3,578
3,578
$
115,078
$
139,624
$
711,055
$
142,063
$
143,363
$
39,394
$
3,578
$
1,294,155
(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 cannot reasonably estimate the timing of this cash outflow due to uncertainties in the timing of the effective settlement of tax positions.
27
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:
Three Months Ended March 31,
2023
2022
(Decrease) increase in revenue
(4)
%
(3)
%
Increase (decrease) in net income
1
%
186
%
Remeasurement risk
We incur 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:
Three Months Ended March 31,
(in thousands)
2023
2022
Foreign currency gain (loss)
$
(9,251)
$
(7,937)
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 March 31, 2023. 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 March 31, 2023.
(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 March 31, 2023 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
28
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information set forth in “Note 15. Commitments and Contingencies”, in Part I, Item 1 of this Quarterly Report is incorporated herein by reference.
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, 2022, 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 (1)
Common stock repurchased in the three months ended March 31, 2023:
(in thousands, except per share amounts)
Total Number
of Shares
Purchased (2)
Average Price
Paid per
Share (2)
Total Number
of Shares Purchased as Part of
Publicly Announced Share
Repurchase Program
Approximate Dollar
Value of Shares That
May Yet Be Purchased at Period
End Under Publicly Announced
Share Repurchased Programs
January 1, 2023 - January 31, 2023
23
$
36.52
—
$
58,075
February 1, 2023 - February 28, 2023
11
39.60
—
$
58,075
March 1, 2023 - March 31, 2023
9
46.49
—
$
58,075
43
$
39.40
—
(1) See "Liquidity and Capital Resources" in Part I, Item 2 of this Quarterly Report for additional information.
(2) 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.
ITEM 5. OTHER INFORMATION
Credit Facility
On April 21, 2023 and effective on March 31, 2023, we entered into an amendment (the “Amendment”) to our $100 million senior secured revolving credit agreement (the “Credit Agreement”) with PNC Bank, National Association (“PNC”), among other changes. The Amendment modifies the financial covenants as reflected in “Note 8. Debt” of Part I, Item 1 of this Quarterly Report on Form 10-Q.
The description contained herein is qualified in its entirety by reference to the Amendment, a copy of which is filed as Exhibit 10.1 to this Quarterly Report on Form 10-Q.
Share Repurchase Program
On April 25, 2023, our Board of Directors extended the expiration date of our current share repurchase program from June 30, 2023 to June 30, 2024, and the amount of stock we are authorized to repurchase has been increased to $60 million. Any actual repurchases under the current repurchase program will be disclosed in the Company’s annual reports on Form 10-K and quarterly reports on Form 10-Q filed with the Securities and Exchange Commission for the annual and applicable quarterly periods ending between June 30, 2023 and December 31, 2024.
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.
++ Management contracts and compensatory plans or arrangements required to be filed pursuant to Item 15(b) of Form 10-K.
** Certain portions of this exhibit are considered confidential and have been omitted as allowed under SEC rules and regulations
30
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:
April 26, 2023
By:
/s/ KENNETH STILLWELL
Kenneth Stillwell
Chief Operating Officer and Chief Financial Officer
