Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 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 83,247,963 shares of the Registrant’s common stock, $0.01 par value per share, outstanding on July 19, 2023.
Common stock, 200,000 shares authorized; 83,212 and 82,436 shares issued and outstanding at
June 30, 2023 and December 31, 2022, respectively
832
824
Additional paid-in capital
310,016
229,602
Accumulated deficit
(144,091)
(76,513)
Accumulated other comprehensive (loss)
(21,361)
(23,070)
Total stockholders’ equity
145,396
130,843
Total liabilities and stockholders’ equity
$
1,192,438
$
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 June 30,
Six Months Ended June 30,
2023
2022
2023
2022
Revenue
Subscription services
$
197,105
$
171,832
$
384,614
$
341,865
Subscription license
41,197
41,600
125,724
179,133
Consulting
58,387
58,639
111,420
119,940
Perpetual license
1,579
2,266
1,982
9,706
Total revenue
298,268
274,337
623,740
650,644
Cost of revenue
Subscription services
36,783
36,533
73,647
68,563
Subscription license
623
673
1,342
1,295
Consulting
58,710
57,873
119,058
113,384
Perpetual license
24
36
27
70
Total cost of revenue
96,140
95,115
194,074
183,312
Gross profit
202,128
179,222
429,666
467,332
Operating expenses
Selling and marketing
143,858
157,198
293,655
319,434
Research and development
73,931
74,341
149,307
145,831
General and administrative
23,462
32,723
46,572
68,487
Restructuring
2,167
—
3,628
—
Total operating expenses
243,418
264,262
493,162
533,752
(Loss) from operations
(41,290)
(85,040)
(63,496)
(66,420)
Foreign currency transaction (loss) gain
(3,290)
1,713
(5,965)
4,589
Interest income
1,814
309
3,299
516
Interest expense
(1,778)
(1,944)
(3,696)
(3,890)
(Loss) income on capped call transactions
(1,361)
(18,945)
1,845
(49,505)
Other income, net
5,702
3,785
12,285
6,526
(Loss) before provision for income taxes
(40,203)
(100,122)
(55,728)
(108,184)
Provision for income taxes
6,601
186,174
11,850
178,491
Net (loss)
$
(46,804)
$
(286,296)
$
(67,578)
$
(286,675)
(Loss) per share
Basic
$
(0.56)
$
(3.50)
$
(0.82)
$
(3.51)
Diluted
$
(0.56)
$
(3.50)
$
(0.82)
$
(3.51)
Weighted-average number of common shares outstanding
Basic
83,039
81,847
82,823
81,764
Diluted
83,039
81,847
82,823
81,764
See notes to unaudited condensed consolidated financial statements.
4
PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS)
(in thousands)
Three Months Ended June 30,
Six Months Ended June 30,
2023
2022
2023
2022
Net (loss)
$
(46,804)
$
(286,296)
$
(67,578)
$
(286,675)
Other comprehensive income (loss), net of tax
Unrealized (loss) on available-for-sale securities
(195)
(1,149)
(241)
(927)
Foreign currency translation adjustments
361
(11,466)
1,950
(14,236)
Total other comprehensive income (loss), net of tax
$
166
$
(12,615)
1,709
(15,163)
Comprehensive (loss)
$
(46,638)
$
(298,911)
$
(65,869)
$
(301,838)
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
Repurchase of common stock
(38)
—
(1,925)
—
—
(1,925)
Issuance of common stock for stock compensation plans
117
1
(3,252)
—
—
(3,251)
Issuance of common stock under the employee stock purchase plan
59
—
2,357
—
—
2,357
Stock-based compensation
—
—
31,300
—
—
31,300
Cash dividends declared ($0.03 per share)
—
—
—
(2,459)
—
(2,459)
Other comprehensive (loss)
—
—
—
—
(12,615)
(12,615)
Net (loss)
—
—
—
(286,296)
—
(286,296)
June 30, 2022
81,940
$
819
$
170,251
$
(15,140)
$
(22,151)
$
133,779
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
Issuance of common stock for stock compensation plans
225
2
1,824
—
—
1,826
Issuance of common stock under the employee stock purchase plan
47
1
1,980
—
—
1,981
Stock-based compensation
—
—
36,227
—
—
36,227
Cash dividends declared ($0.03 per share)
—
—
(2,496)
—
—
(2,496)
Other comprehensive income
—
—
—
—
166
166
Net (loss)
—
—
—
(46,804)
—
(46,804)
June 30, 2023
83,212
$
832
$
310,016
$
(144,091)
$
(21,361)
$
145,396
See notes to unaudited condensed consolidated financial statements.
6
PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Six Months Ended June 30,
2023
2022
Operating activities
Net (loss)
$
(67,578)
$
(286,675)
Adjustments to reconcile net (loss) to cash provided by (used in) operating activities
Stock-based compensation
78,784
59,527
Deferred income taxes
(136)
169,105
(Gain) loss on capped call transactions
(1,845)
49,505
Amortization of deferred commissions
29,027
28,155
Lease expense
8,186
7,832
Amortization of intangible assets and depreciation
9,553
8,175
Foreign currency transaction loss (gain)
5,965
(4,589)
Other non-cash
(10,163)
(3,479)
Change in operating assets and liabilities, net
61,959
(32,625)
Cash provided by (used in) operating activities
113,752
(5,069)
Investing activities
Purchases of investments
(69,662)
(38,489)
Proceeds from maturities and called investments
88,849
34,912
Sales of investments
10,725
14,839
Payments for acquisitions, net of cash acquired
—
(922)
Investment in property and equipment
(13,933)
(11,863)
Cash provided by (used in) investing activities
15,979
(1,523)
Financing activities
Repurchases of convertible senior notes
(88,989)
—
Proceeds from settlement of capped calls transactions
341
—
Dividend payments to stockholders
(4,962)
(4,908)
Proceeds from employee stock purchase plan
4,124
4,803
Proceeds from stock option exercises
3,920
—
Common stock repurchases
(1,422)
(41,086)
Cash (used in) financing activities
(86,988)
(41,191)
Effect of exchange rate changes on cash, cash equivalents, and restricted cash
1,010
(2,907)
Net increase (decrease) in cash, cash equivalents, and restricted cash
43,753
(50,690)
Cash, cash equivalents, and restricted cash, beginning of period
145,054
159,965
Cash, cash equivalents, and restricted cash, end of period
$
188,807
$
109,275
Cash and cash equivalents
$
186,874
$
109,275
Restricted cash included in other long-term assets
1,933
—
Total cash, cash equivalents, and restricted cash
$
188,807
$
109,275
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 2023.
NOTE 2. MARKETABLE SECURITIES
June 30, 2023
December 31, 2022
(in thousands)
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
Government debt
$
16,372
$
—
$
(17)
$
16,355
$
2,960
$
—
$
(52)
$
2,908
Corporate debt
110,483
—
(899)
109,584
151,906
—
(2,647)
149,259
$
126,855
$
—
$
(916)
$
125,939
$
154,866
$
—
$
(2,699)
$
152,167
As of June 30, 2023, marketable securities’ maturities ranged from July 2023 to January 2026, with a weighted average remaining maturity of 0.4 years.
NOTE 3. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE
Receivables
(in thousands)
June 30, 2023
December 31, 2022
Accounts receivable
$
163,915
$
255,150
Unbilled receivables
182,257
213,719
Long-term unbilled receivables
70,486
95,806
$
416,658
$
564,675
Unbilled receivables
Unbilled receivables are client-committed amounts for which revenue recognition precedes billing. Billing is solely subject to the passage of time.
Unbilled receivables by expected billing date:
(Dollars in thousands)
June 30, 2023
1 year or less
$
182,257
72
%
1-2 years
58,025
23
%
2-5 years
12,461
5
%
$
252,743
100
%
Unbilled receivables by contract effective date:
(Dollars in thousands)
June 30, 2023
2023
$
62,243
25
%
2022
88,337
35
%
2021
67,852
27
%
2020
23,157
9
%
2019 and prior
11,154
4
%
$
252,743
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)
June 30, 2023
December 31, 2022
Contract assets (1)
$
13,850
$
17,546
Long-term contract assets (2)
11,126
16,470
$
24,976
$
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)
June 30, 2023
December 31, 2022
Deferred revenue
$
311,330
$
325,212
Long-term deferred revenue (1)
3,020
3,552
$
314,350
$
328,764
(1) Included in other long-term liabilities.
Deferred revenue decreased in the six months ended June 30, 2023 primarily due to $230.3 million of revenue recognized during the period included in deferred revenue as of December 31, 2022 exceeded new billings in advance of revenue recognition.
NOTE 4. DEFERRED COMMISSIONS
(in thousands)
June 30, 2023
December 31, 2022
Deferred commissions (1)
$
114,406
$
130,195
(1) Included in other long-term assets.
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2023
2022
2023
2022
Amortization of deferred commissions (1)
$
14,750
$
10,934
$
29,027
$
28,155
(1) Included in selling and marketing.
NOTE 5. GOODWILL AND OTHER INTANGIBLES
Goodwill
Six Months Ended June 30,
(in thousands)
2023
2022
January 1,
$
81,399
$
81,923
Currency translation adjustments
194
(206)
June 30,
$
81,593
$
81,717
Intangibles
Intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives.
June 30, 2023
(in thousands)
Useful Lives
Cost
Accumulated Amortization
Net Book Value (1)
Client-related
4-10 years
$
63,111
$
(59,344)
$
3,767
Technology
2-10 years
68,137
(62,972)
5,165
Other
1-5 years
5,361
(5,361)
—
$
136,609
$
(127,677)
$
8,932
(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)
June 30, 2023
Remainder of 2023
$
1,932
2024
3,180
2025
2,619
2026
874
2027
327
$
8,932
Amortization of intangible assets:
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2023
2022
2023
2022
Cost of revenue
$
621
$
683
$
1,327
$
1,312
Selling and marketing
342
342
685
685
$
963
$
1,025
$
2,012
$
1,997
NOTE 6. OTHER ASSETS AND LIABILITIES
Other current assets
(in thousands)
June 30, 2023
December 31, 2022
Income tax receivables
$
21,383
$
25,354
Contract assets
13,850
17,546
Other
43,293
37,488
$
78,526
$
80,388
Other long-term assets
(in thousands)
June 30, 2023
December 31, 2022
Deferred commissions
$
114,406
$
130,195
Right of use assets
69,839
76,114
Property and equipment
52,698
55,056
Venture investments
13,382
13,069
Contract assets
11,126
16,470
Intangible assets
8,932
10,888
Capped call transactions
4,086
2,582
Deferred income taxes
4,836
4,795
Restricted cash
1,933
—
Other
21,610
24,820
$
302,848
$
333,989
Other current liabilities
(in thousands)
June 30, 2023
December 31, 2022
Operating lease liabilities
$
14,773
$
14,976
Dividends payable
2,496
2,474
$
17,269
$
17,450
10
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Other long-term liabilities
(in thousands)
June 30, 2023
December 31, 2022
Deferred revenue
$
3,020
$
3,552
Income taxes payable
3,989
3,207
Other
7,895
8,369
$
14,904
$
15,128
NOTE 7. LEASES
Expense
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2023
2022
2023
2022
Fixed lease costs
$
4,495
$
4,965
$
10,261
$
10,059
Short-term lease costs
696
787
1,477
1,594
Variable lease costs
2,186
727
4,160
1,491
$
7,377
$
6,479
$
15,898
$
13,144
Right of use assets and lease liabilities
(in thousands)
June 30, 2023
December 31, 2022
Right of use assets (1)
$
69,839
$
76,114
Operating lease liabilities (2)
$
14,773
$
14,976
Long-term operating lease liabilities
$
72,886
$
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:
June 30, 2023
December 31, 2022
Weighted-average remaining lease term
7.1 years
7.5 years
Weighted-average discount rate (1)
4.0
%
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)
June 30, 2023
Remainder of 2023
$
8,596
2024
18,024
2025
14,869
2026
10,940
2027
9,882
2028
9,312
Thereafter
30,149
Total lease payments
101,772
Less: imputed interest (1)
(14,113)
$
87,659
(1) Lease liabilities are measured at the present value of the remaining lease payments using a discount rate determined at lease commencement unless the discount rate is updated due to a lease reassessment event.
Cash flow information
Six Months Ended June 30,
(in thousands)
2023
2022
Cash paid for operating leases, net of tenant improvement allowances
$
10,540
$
7,296
Right of use assets recognized for new leases and amendments (non-cash)
$
1,465
$
2,223
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 September 1, 2020.
In the three and six months ended June 30, 2023, the Company recognized gains of $5.1 million and $7.9 million, respectively, in other income, net from repurchases of Notes representing $64.7 million and $97.7 million, respectively, 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 June 30, 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)
June 30, 2023
December 31, 2022
Principal
$
502,270
$
600,000
Unamortized issuance costs
(4,130)
(6,391)
Convertible senior notes, net
$
498,140
$
593,609
Interest expense related to the Notes:
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2023
2022
2023
2022
Contractual interest expense (0.75% coupon)
$
997
$
1,125
$
2,122
$
2,250
Amortization of issuance costs
647
720
1,375
1,439
$
1,644
$
1,845
$
3,497
$
3,689
12
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
The average interest rate on the Notes in the six months ended June 30, 2023 and 2022 was 1.2%.
Future payments:
June 30, 2023
(in thousands)
Principal
Interest
Total
Remainder of 2023
$
—
$
1,998
$
1,998
2024
—
3,767
3,767
2025
502,270
1,884
504,154
$
502,270
$
7,649
$
509,919
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 and six months ended June 30, 2023, Capped Call Transactions covering approximately 0.5 million and 0.7 million shares, respectively, were settled for proceeds of $0.1 million and $0.3 million, respectively.
As of June 30, 2023, Capped Call Transactions representing approximately 3.7 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:
Six Months Ended June 30,
(in thousands)
2023
2022
January 1,
$
2,582
$
59,964
Settlements
(341)
—
Fair value adjustment
1,845
(49,505)
June 30,
$
4,086
$
10,459
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:
•Through December 31, 2023, the parent company must maintain at least $200 million in cash, investments, and availability under the Credit Facility and the Company must 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 June 30, 2023 and December 31, 2022, the Company had $27.3 million in outstanding letters of credit, which reduced the Company’s available borrowing capacity under the Credit Facility and no outstanding cash borrowings under the Credit Facility.
13
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 9. RESTRUCTURING
The Company has undertaken the following restructuring activities as it optimizes its go-to-market strategy and reassesses its office space needs:
Three months ended
Expense
Employee severance and related benefits and closure of a US office
December 31, 2022
$
21,743
Office space reduction
March 31, 2023
$
1,241
Employee severance and related benefits
June 30, 2023
$
1,581
Accrued employee severance and related benefits:
Change for all restructuring actions:
Six Months Ended June 30,
(in thousands)
2023
January 1,
$
18,573
Costs incurred
2,387
Cash disbursements
(17,521)
Currency translation adjustments
185
June 30,
$
3,624
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 with 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:
June 30, 2023
December 31, 2022
(in thousands)
Level 1
Level 2
Level 3
Total
Level 1
Level 2
Level 3
Total
Cash equivalents
$
16,733
$
—
$
—
$
16,733
$
2,526
$
—
$
—
$
2,526
Marketable securities
$
—
$
125,939
$
—
$
125,939
$
—
$
152,167
$
—
$
152,167
Capped Call Transactions (1)
$
—
$
4,086
$
—
$
4,086
$
—
$
2,582
$
—
$
2,582
Venture investments (1) (2)
$
—
$
—
$
13,382
$
13,382
$
—
$
—
$
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:
Six Months Ended June 30,
(in thousands)
2023
2022
January 1,
$
13,069
$
7,648
New investments
400
400
Sales of investments
(2,773)
(165)
Changes in foreign exchange rates
119
(290)
Changes in fair value:
included in other income, net
4,475
5,978
included in other comprehensive (loss)
(1,908)
2,502
June 30,
$
13,382
$
16,073
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 $460.8 million as of June 30, 2023 and $521.1 million as of December 31, 2022. In the six months ended June 30, 2023 the Company repurchased Notes representing $97.7 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 June 30,
Six Months Ended June 30,
(Dollars in thousands)
2023
2022
2023
2022
U.S.
$
150,385
50
%
$
147,725
54
%
$
334,904
54
%
$
364,997
55
%
Other Americas
19,505
7
%
16,261
6
%
34,516
6
%
62,012
10
%
United Kingdom (“U.K.”)
28,892
10
%
28,831
11
%
71,129
11
%
59,763
9
%
Europe (excluding U.K.), Middle East, and Africa
54,353
18
%
45,238
16
%
105,671
17
%
94,374
15
%
Asia-Pacific
45,133
15
%
36,282
13
%
77,520
12
%
69,498
11
%
$
298,268
100
%
$
274,337
100
%
$
623,740
100
%
$
650,644
100
%
Revenue streams
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2023
2022
2023
2022
Perpetual license
$
1,579
$
2,266
$
1,982
$
9,706
Subscription license
41,197
41,600
125,724
179,133
Revenue recognized at a point in time
42,776
43,866
127,706
188,839
Maintenance
82,042
78,326
161,672
158,042
Pega Cloud
115,063
93,506
222,942
183,823
Consulting
58,387
58,639
111,420
119,940
Revenue recognized over time
255,492
230,471
496,034
461,805
Total revenue
$
298,268
$
274,337
$
623,740
$
650,644
15
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2023
2022
2023
2022
Pega Cloud
$
115,063
$
93,506
$
222,942
$
183,823
Maintenance
82,042
78,326
161,672
158,042
Subscription services
197,105
171,832
384,614
341,865
Subscription license
41,197
41,600
125,724
179,133
Subscription
238,302
213,432
510,338
520,998
Consulting
58,387
58,639
111,420
119,940
Perpetual license
1,579
2,266
1,982
9,706
$
298,268
$
274,337
$
623,740
$
650,644
Remaining performance obligations ("Backlog")
Expected future revenue from existing non-cancellable contracts:
As of June 30, 2023:
(Dollars in thousands)
Subscription services
Subscription license
Perpetual license
Consulting
Total
Maintenance
Pega Cloud
1 year or less
$
214,579
$
397,183
$
35,616
$
4,979
$
37,355
$
689,712
55
%
1-2 years
58,551
238,691
3,026
2,252
6,772
309,292
24
%
2-3 years
25,103
124,616
6,764
—
1,523
158,006
12
%
Greater than 3 years
7,592
101,494
—
—
—
109,086
9
%
$
305,825
$
861,984
$
45,406
$
7,231
$
45,650
$
1,266,096
100
%
As of June 30, 2022:
(Dollars in thousands)
Subscription services
Subscription license
Perpetual license
Consulting
Total
Maintenance
Pega Cloud
1 year or less
$
204,974
$
320,102
$
46,810
$
6,681
$
32,159
$
610,726
54
%
1-2 years
57,862
200,135
10,711
4,505
7,919
281,132
25
%
2-3 years
28,403
96,861
2,126
2,252
2,574
132,216
12
%
Greater than 3 years
18,447
81,069
1,680
—
424
101,620
9
%
$
309,686
$
698,167
$
61,327
$
13,438
$
43,076
$
1,125,694
100
%
NOTE 12. STOCK-BASED COMPENSATION
Expense
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2023
2022
2023
2022
Cost of revenue
$
7,174
$
6,579
$
16,087
$
12,957
Selling and marketing
15,349
12,633
33,009
23,591
Research and development
7,851
7,355
16,911
14,701
General and administrative
5,853
4,733
12,777
8,278
$
36,227
$
31,300
$
78,784
$
59,527
Income tax benefit
$
(581)
$
(543)
$
(1,253)
$
(905)
As of June 30, 2023, the Company had $171.0 million of unrecognized stock-based compensation expense, net of estimated forfeitures, which is expected to be recognized over a weighted-average period of 1.9 years.
16
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Grants
Six Months Ended June 30, 2023
(in thousands)
Shares
Total Fair Value
Restricted stock units
1,489
$
69,704
Non-qualified stock options
870
$
18,289
Performance stock options (1)
906
$
18,265
(1) Performance stock options allow the holder to purchase a specified number of common stock shares at an exercise price equal to or greater than the shares' fair market value at the grant date. The options usually vest over two years and expire ten years from the grant date, subject to specific performance conditions.
NOTE 13. INCOME TAXES
Effective income tax rate
Three Months Ended June 30,
Six Months Ended June 30,
(Dollars in thousands)
2023
2022
2023
2022
Provision for income taxes
$
6,601
$
186,174
$
11,850
$
178,491
Effective income tax rate
(21)
%
(165)
%
The Company’s effective income tax rate in the six months ended June 30, 2023 was impacted by the valuation allowance on the Company’s deferred tax assets in the U.S. and U.K. Also, impacted by current taxes payable in the U.S. due to projected taxable income partially 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. A deferred tax valuation allowance requires significant judgment and uncertainties, including assumptions about future taxable income. Quarterly, the Company reassesses the need for a valuation allowance on its net deferred tax assets by weighting all available and objectively verifiable negative and positive evidence, including projected future reversals of existing taxable temporary differences, committed contractual backlog (“Backlog”), projected future taxable income, including the impact of enacted legislation, tax-planning strategies, and recent operating results.
The Company intends to maintain a valuation allowance on the Company’s U.S. and U.K. net deferred tax assets until sufficient evidence exists 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 June 30,
Six Months Ended June 30,
(in thousands, except per share amounts)
2023
2022
2023
2022
Net (loss)
$
(46,804)
$
(286,296)
$
(67,578)
$
(286,675)
Weighted-average common shares outstanding
83,039
81,847
82,823
81,764
(Loss) per share, basic
$
(0.56)
$
(3.50)
$
(0.82)
$
(3.51)
Net (loss)
$
(46,804)
$
(286,296)
$
(67,578)
$
(286,675)
Weighted-average common shares outstanding, assuming dilution (1) (2) (3)
83,039
81,847
82,823
81,764
(Loss) per share, diluted
$
(0.56)
$
(3.50)
$
(0.82)
$
(3.51)
Outstanding anti-dilutive stock options and RSUs (4)
1,354
3,569
1,351
3,873
(1) All dilutive securities are excluded in periods of loss 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 3.7 million shares as of June 30, 2023.
(3) The Company’s Capped Call Transactions represent the equivalent of approximately 3.7 million shares of the Company’s common stock (representing the number of shares for which the Notes are initially convertible) as of June 30, 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.
17
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 15. COMMITMENTS AND CONTINGENCIES
Commitments
See "Note 7. Leases" for additional information.
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 June 30, 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 in the Court of Appeals of Virginia is completed. The Court of Appeals of Virginia has not yet set a date for oral arguments in the appeal. 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 Company’s motion to dismiss took place on May 17, 2023. After hearing argument from both sides, the Court denied the Company’s motion from the bench and stated that a written opinion would follow. On June 30, 2023, the Company filed its Answer to the complaint. On July 24, 2023, the Court issued its written opinion denying the motion to dismiss as to the Company and Defendant Trefler but granting the motion without prejudice as to Mr. Stillwell. The Company believes it has strong defenses to the claims brought against the defendants 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 it has strong defenses to the claims asserted, its intent to defend against these claims, and there being no specified quantum of damages sought in the complaint.
18
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
In re Pegasystems Inc., Derivative Litigation
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 April 28, 2023, a lawsuit was filed in the United States District Court for the District of Massachusetts by Dag Sagfors, derivatively on behalf of nominal defendant Pegasystems Inc. asserting breach of fiduciary duty and related claims relating to the Virginia Appian litigation against the same defendants as the Larkin lawsuit. On May 17, 2023, the Larkin and Sagfors cases were consolidated and a joint motion to stay the consolidated case is pending before the Court. The Company also has received confidential demand letters raising substantially the same allegations set forth in the foregoing derivative complaints. On April 12, 2023, the Company’s board of directors (other than Mr. Trefler, who recused himself), formed a committee consisting solely of independent directors, to review, analyze, and investigate the matters raised in the demands and to determine in good faith what actions (if any) are reasonably believed to be appropriate under similar circumstances and reasonably believed to be in the best interests of the Company in response to the demand letters. The Company is unable to reasonably estimate possible damages or a range of possible damages in this matter given the stage of the lawsuit 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, intends to, projects, forecasts, guidance, likely, and usually or variations of such words and other similar expressions identify forward-looking statements, which speak only as of the date the statement was made and 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”).
Investors are cautioned not to place undue reliance on such forward-looking statements, and there are no assurances that the results included in such statements will be achieved. Although subsequent events may cause our view to change, except as required by applicable law, we do not undertake and expressly disclaim any obligation to publicly update or revise these forward-looking statements whether as the result of new information, future events, or otherwise.
The forward-looking statements in this Quarterly Report represent our views as of July 26, 2023.
NON-GAAP MEASURES
Our non-GAAP financial measures should only be read in conjunction with our consolidated financial statements prepared in accordance with GAAP. We believe these measures help investors understand our core operating results without the effect of often one-time charges and other items outside normal operations. They are not a substitute for financial measures prepared under U.S. GAAP.
A reconciliation of our GAAP to non-GAAP measures is located with each non-GAAP measure.
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.
20
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.
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.
Reconciliation of ACV and Constant Currency ACV
(in millions, except percentages)
Q2 22
Q3 22
Q4 22
Q1 23
Q2 23
1 Year Change
ACV
$
1,026
$
1,040
$
1,126
$
1,174
$
1,164
13
%
Impact of changes in foreign exchange rates
$
—
$
24
$
(1)
$
(5)
$
(5)
Constant Currency ACV
$
1,026
$
1,064
$
1,125
$
1,169
$
1,159
13
%
Note: Constant currency ACV is calculated by applying the Q2 2022 foreign exchange rates to all periods shown.
21
Cash flow
(in thousands, except percentages)
Six Months Ended June 30,
2023
2022
Change
Cash provided by (used in) operating activities
$
113,752
$
(5,069)
*
Investment in property and equipment
(13,933)
(11,863)
Legal fees
2,950
26,437
Restructuring
17,521
—
Interest on convertible senior notes
2,250
2,250
Other
—
167
Free cash flow
$
122,540
$
11,922
928
%
Total revenue
$
623,740
$
650,644
Free cash flow margin
20
%
2
%
* not meaningful
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 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.
•Other: We have excluded fees incurred due to the cancellation of in-person sales and marketing events, and incremental expenses incurred from the integration of acquisitions. We believe excluding these amounts from our non-GAAP financial measures is useful to investors as the types of events giving rise to them are not representative of our core business operations and ongoing operating performance.
22
Remaining performance obligations (“Backlog”)
Reconciliation of Backlog and Constant Currency Backlog (Non-GAAP)
(in millions, except percentages)
Q2 2023
1 Year Growth Rate
Backlog
$
1,266
12
%
Impact of changes in foreign exchange rates
(8)
—
%
Backlog - Constant Currency
$
1,258
12
%
Note: Constant currency Backlog is calculated by applying the Q2 2022 foreign exchange rates to all periods shown.
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.
23
RESULTS OF OPERATIONS
Revenue
(Dollars in thousands)
Three Months Ended June 30,
Change
Six Months Ended June 30,
Change
2023
2022
2023
2022
Pega Cloud
$
115,063
39
%
$
93,506
34
%
$
21,557
23
%
$
222,942
36
%
$
183,823
28
%
$
39,119
21
%
Maintenance
82,042
27
%
78,326
29
%
3,716
5
%
161,672
26
%
158,042
24
%
3,630
2
%
Subscription services
197,105
66
%
171,832
63
%
25,273
15
%
384,614
62
%
341,865
52
%
42,749
13
%
Subscription license
41,197
14
%
41,600
15
%
(403)
(1)
%
125,724
20
%
179,133
28
%
(53,409)
(30)
%
Subscription
238,302
80
%
213,432
78
%
24,870
12
%
510,338
82
%
520,998
80
%
(10,660)
(2)
%
Consulting
58,387
19
%
58,639
21
%
(252)
—
%
111,420
18
%
119,940
19
%
(8,520)
(7)
%
Perpetual license
1,579
1
%
2,266
1
%
(687)
(30)
%
1,982
—
%
9,706
1
%
(7,724)
(80)
%
$
298,268
100
%
$
274,337
100
%
$
23,931
9
%
$
623,740
100
%
$
650,644
100
%
$
(26,904)
(4)
%
•The increases in Pega Cloud revenue for the three and six months ended June 30, 2023, were primarily due to continued growth of the installed client base.
•The decrease in subscription license revenue in the six months ended June 30, 2023 was primarily due to several large software license contracts recognized in revenue in the six months ended June 30, 2022.
•The decreases in perpetual license revenue in the three and six months ended June 30, 2023 were primarily due to our strategy of promoting subscription-based arrangements.
•The decreases in consulting revenue in the three and six months ended June 30, 2023 were primarily due to lower realization rates.
Gross profit
(Dollars in thousands)
Three Months Ended June 30,
Change
Six Months Ended June 30,
Change
2023
2022
2023
2022
Pega Cloud
$
84,761
74
%
$
62,259
67
%
$
22,502
36
%
$
162,390
73
%
$
125,677
68
%
$
36,713
29
%
Maintenance
75,561
92
%
73,040
93
%
2,521
3
%
148,577
92
%
147,625
93
%
952
1
%
Subscription services
160,322
81
%
135,299
79
%
25,023
18
%
310,967
81
%
273,302
80
%
37,665
14
%
Subscription license
40,574
98
%
40,927
98
%
(353)
(1)
%
124,382
99
%
177,838
99
%
(53,456)
(30)
%
Subscription
200,896
84
%
176,226
83
%
24,670
14
%
435,349
85
%
451,140
87
%
(15,791)
(4)
%
Consulting
(323)
(1)
%
766
1
%
(1,089)
*
(7,638)
(7)
%
6,556
5
%
(14,194)
*
Perpetual license
1,555
98
%
2,230
98
%
(675)
(30)
%
1,955
99
%
9,636
99
%
(7,681)
(80)
%
$
202,128
68
%
$
179,222
65
%
$
22,906
13
%
$
429,666
69
%
$
467,332
72
%
$
(37,666)
(8)
%
* not meaningful
•The increases in Pega Cloud gross profit percent in the three and six months ended June 30, 2023 were primarily due to increased cost efficiency, particularly for hosting services, as Pega Cloud continues to grow and scale.
•The decrease in maintenance gross profit percent in the three months ended June 30, 2023 was primarily due to an increase in compensation and benefits due to an increase in headcount.
•The decrease in consulting gross profit percent in the three months ended June 30, 2023 was primarily due to lower consultant realization rates. The decrease in consulting revenue in the six months ended June 30, 2023 was primarily due to lower consultant realization and utilization rates.
24
Operating expenses
(Dollars in thousands)
Three Months Ended June 30,
Change
Six Months Ended June 30,
Change
2023
2022
2023
2022
Selling and marketing
$
143,858
$
157,198
$
(13,340)
(8)
%
$
293,655
$
319,434
$
(25,779)
(8)
%
% of Revenue
48
%
57
%
47
%
49
%
Research and development
$
73,931
$
74,341
$
(410)
(1)
%
$
149,307
$
145,831
$
3,476
2
%
% of Revenue
25
%
27
%
24
%
22
%
General and administrative
$
23,462
$
32,723
$
(9,261)
(28)
%
$
46,572
$
68,487
$
(21,915)
(32)
%
% of Revenue
8
%
12
%
7
%
11
%
Restructuring
$
2,167
$
—
$
2,167
100
%
$
3,628
$
—
$
3,628
100
%
% of Revenue
1
%
—
%
1
%
—
%
•The decreases in selling and marketing during the three and six months ended June 30, 2023, were primarily due to decreases in compensation and benefits totaling $14.2 million and $26.4 million, respectively. The decreases are due to reduced headcount associated with the optimization of our go-to-market strategy. For additional information, see "Note 9. Restructuring" in Part I, Item 1 of this Quarterly Report.
•The decrease in research and development for the three months ended June 30, 2023, was primarily due to a $1.2 million decrease in hosting services costs from cost-efficiency gains as the Company’s use of hosting services grows.
•The increase in research and development for the six months ended June 30, 2023, was primarily due to additional investments in our products and services.
•The decreases in general and administrative in the three and six months ended June 30, 2023 were primarily due to decreases of $7.7 million and $23.6 million, in legal fees and related expenses arising from proceedings outside the ordinary course of business. In the six months ended June 30, 2023 the decrease was partially offset by a $4.2 million increase in compensation and benefits due to an increase in equity compensation. 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 increases in restructuring expenses during the three and six months ended June 30, 2023, were primarily due to a $1.6 million restructuring expense related to the optimization of our go-to-market organization in the U.S. in the three months ended June 30, 2023 and $1.2 million primarily due to the closure of leased office space in Poland in the three months ended March 31, 2023.
Other income and expenses
(Dollars in thousands)
Three Months Ended June 30,
Change
Six Months Ended June 30,
Change
2023
2022
2023
2022
Foreign currency transaction (loss) gain
$
(3,290)
$
1,713
$
(5,003)
*
$
(5,965)
$
4,589
$
(10,554)
*
Interest income
1,814
309
1,505
487
%
3,299
516
2,783
539
%
Interest expense
(1,778)
(1,944)
166
9
%
(3,696)
(3,890)
194
5
%
(Loss) income on capped call transactions
(1,361)
(18,945)
17,584
93
%
1,845
(49,505)
51,350
*
Other income, net
5,702
3,785
1,917
51
%
12,285
6,526
5,759
88
%
$
1,087
$
(15,082)
$
16,169
*
$
7,768
$
(41,764)
$
49,532
*
* not meaningful
•The changes in foreign currency transaction (loss) gain in the three and six months ended June 30, 2023 were 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 increases in interest income in the three and six months ended June 30, 2023 was primarily due to increases in market interest rates.
•The decreases in interest expense in the three and six months ended June 30, 2023 were due to our repurchases of our Convertible Senior Notes. For additional information, see "Note 8. Debt" in Part I, Item 1 of this Quarterly Report.
•The changes in (loss) income on capped call transactions in the three and six months ended June 30, 2023 were due to fair value adjustments for our capped call transactions.
•The increases in other income, net in the three and six months ended June 30, 2023 were due to gains from repurchases of our convertible senior notes and our venture investments portfolio.
25
Provision for income taxes
Six Months Ended June 30,
(Dollars in thousands)
2023
2022
Provision for income taxes
$
11,850
$
178,491
Effective income tax rate
(21)
%
(165)
%
The effective income tax rate in the six months ended June 30, 2023 was impacted by the valuation allowance on our deferred tax assets in the U.S. and U.K. Also, impacted by current taxes payable in the U.S. due to projected taxable income partially offset by net operating losses and available tax credits.
LIQUIDITY AND CAPITAL RESOURCES
Six Months Ended June 30,
(in thousands)
2023
2022
Cash provided by (used in):
Operating activities
$
113,752
$
(5,069)
Investing activities
15,979
(1,523)
Financing activities
(86,988)
(41,191)
Effect of exchange rate changes on cash, cash equivalents, and restricted cash
1,010
(2,907)
Net increase (decrease) in cash, cash equivalents, and restricted cash
$
43,753
$
(50,690)
(in thousands)
June 30, 2023
December 31, 2022
Held by U.S. entities
$
232,524
$
248,389
Held by foreign entities
80,289
48,832
Total cash, cash equivalents, and marketable securities
$
312,813
$
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, estimating the amount of taxes we would have to pay is impracticable.
Operating activities
The change in cash provided by (used in) operating activities in the six months ended June 30, 2023 was primarily due to growth in client collections and the impact of our cost-efficiency initiatives. In addition, in the six months ended June 30, 2023 and 2022, we paid $3.0 million and $26.4 million in legal fees and related expenses arising from proceedings that originated outside the ordinary course of business. We expect to continue to incur additional costs for these proceedings. For additional information, see "Note 15. Commitments and Contingencies" in Part I, Item 1 of this Quarterly Report.
Investing activities
The change in cash provided by (used in) investing activities in the six months ended June 30, 2023 was primarily due to our investments in
financial instruments
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 six months ended June 30, 2023, we paid $89 million to repurchase $97.7 million in aggregate principal amount of convertible senior notes. As of June 30, 2023, we had $502 million in aggregate principal amount of convertible senior notes outstanding due on March 1, 2025. For additional information, see "Note 8. Debt" in Part I, Item 1 of this Quarterly Report.
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 June 30, 2023 and December 31, 2022, we had $27.3 million in outstanding letters of credit, which reduced the Company’s available borrowing capacity under the Credit Facility and no outstanding cash borrowings under the Credit Facility. For additional information, see "Note 8. Debt" in Part I, Item 1 of this Quarterly Report.
26
Stock repurchase program
Changes in the remaining stock repurchase authority:
(in thousands)
Six Months Ended June 30, 2023
December 31, 2022
$
58,075
Authorizations (1)
1,925
June 30, 2023
$
60,000
(1) 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.
Common stock repurchases
Six Months Ended June 30,
2023
2022
(in thousands)
Shares
Amount
Shares
Amount
Stock repurchase program
—
—
279
24,508
Tax withholdings for net settlement of equity awards
34
1,422
196
15,379
34
$
1,422
475
$
39,887
In the six months ended June 30, 2023 and 2022, instead of receiving cash from the equity holders, we withheld shares with a value of $0.9 million and $8.3 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.
Six Months Ended June 30,
(in thousands)
2023
2022
Dividend payments to stockholders
$
4,962
$
4,908
Contractual obligations
As of June 30, 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)
$
1,998
$
3,767
$
504,154
$
—
$
—
$
—
$
—
$
509,919
Purchase obligations (2)
68,729
135,345
123,104
117,550
133,500
14
—
578,242
Operating lease obligations
8,596
18,024
14,869
10,940
9,882
39,461
—
101,772
Investment commitments
1,000
—
—
—
—
—
—
1,000
Liability for uncertain tax positions (3)
—
—
—
—
—
—
3,989
3,989
$
80,323
$
157,136
$
642,127
$
128,490
$
143,382
$
39,475
$
3,989
$
1,194,922
(1) Includes principal and interest.
(2) Represents the fixed amount owed for purchase obligations of software licenses, 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.
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, partially offsetting our foreign currency exposure.
27
A hypothetical 10% strengthening in the U.S. dollar against other currencies would have resulted in the following:
Six Months Ended June 30,
2023
2022
(Decrease) in revenue
(4)
%
(3)
%
Increase (decrease) in net income
(1)
%
3
%
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:
Six Months Ended June 30,
(in thousands)
2023
2022
Foreign currency (loss)
$
(9,869)
$
(7,185)
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures
Our management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)) as of June 30, 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 June 30, 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 June 30, 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 June 30, 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
April 1, 2023 - April 30, 2023
—
$
—
—
$
60,000
May 1, 2023 - May 31, 2023
8
45.29
—
$
60,000
June 1, 2023 - June 30, 2023
5
48.79
—
$
60,000
13
$
46.54
—
(1) For additional information, see "Liquidity and Capital Resources" in Part I, Item 2 of this Quarterly Report.
(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
Rule 10b5-1 and non-rule 10b5-1 trading arrangements
During the three months ended June 30, 2023, no director or officer of the Company adopted or terminated a “Rule 10b5-1 trading arrangement” or “non-Rule 10b5-1 trading arrangement,” as each term is defined in Item 408(a) of Regulation S-K.
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.
29
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Pegasystems Inc.
Dated:
July 26, 2023
By:
/s/ KENNETH STILLWELL
Kenneth Stillwell
Chief Operating Officer and Chief Financial Officer
