Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2022
OR
☐
Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number: 1-11859
____________________________
PEGASYSTEMS INC.
(Exact name of Registrant as specified in its charter)
____________________________
Massachusetts
04-2787865
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)
One Main Street, Cambridge, MA02142
(Address of principal executive offices, including zip code)
(617) 374-9600
(Registrant’s telephone number, including area code)
____________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading symbol(s)
Name of each exchange on which registered
Common Stock, $.01 par value per share
PEGA
NASDAQ Global Select Market
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx No ¨
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files). Yesx No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
☐
Emerging growth company
☐
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐No ☒
There were 81,818,454 shares of the Registrant’s common stock, $0.01 par value per share, outstanding on April 19, 2022.
Common stock, 200,000 shares authorized; 81,802 and 81,712 shares issued and outstanding at
March 31, 2022 and December 31, 2021, respectively
818
817
Additional paid-in capital
141,771
145,810
Retained earnings
273,615
276,449
Accumulated other comprehensive (loss)
(9,536)
(6,988)
Total stockholders’ equity
406,668
416,088
Total liabilities and stockholders’ equity
$
1,538,480
$
1,593,531
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,
2022
2021
Revenue
Subscription services
$
170,033
$
143,419
Subscription license
137,533
111,509
Perpetual license
7,440
5,452
Consulting
61,301
53,119
Total revenue
376,307
313,499
Cost of revenue
Subscription services
32,030
28,343
Subscription license
622
620
Perpetual license
34
30
Consulting
55,511
53,454
Total cost of revenue
88,197
82,447
Gross profit
288,110
231,052
Operating expenses
Selling and marketing
162,236
148,739
Research and development
71,490
62,442
General and administrative
35,764
18,270
Total operating expenses
269,490
229,451
Income from operations
18,620
1,601
Foreign currency transaction gain (loss)
2,876
(5,098)
Interest income
207
153
Interest expense
(1,946)
(1,880)
(Loss) on capped call transactions
(30,560)
(19,117)
Other income, net
2,741
106
(Loss) before (benefit from) income taxes
(8,062)
(24,235)
(Benefit from) income taxes
(7,683)
(17,618)
Net (loss)
$
(379)
$
(6,617)
(Loss) per share
Basic
$
0.00
$
(0.08)
Diluted
$
0.00
$
(0.08)
Weighted-average number of common shares outstanding
Basic
81,680
81,004
Diluted
81,680
81,004
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,
2022
2021
Net (loss)
$
(379)
$
(6,617)
Other comprehensive (loss) income, net of tax
Unrealized gain on available-for-sale securities
222
1,010
Foreign currency translation adjustments
(2,770)
(730)
Total other comprehensive (loss) income, net of tax
$
(2,548)
$
280
Comprehensive (loss)
$
(2,927)
$
(6,337)
See notes to unaudited condensed consolidated financial statements.
5
PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (in thousands, except per share amounts)
Common Stock
Additional Paid-In Capital
Retained Earnings
Accumulated Other Comprehensive (Loss)
Total Stockholders’ Equity
Number of Shares
Amount
December 31, 2020
80,890
$
809
$
204,432
$
339,879
$
(2,948)
$
542,172
Cumulative-effect adjustment from adoption of ASU 2020-06, net
—
—
(61,604)
9,399
—
(52,205)
Repurchase of common stock
(70)
(1)
(9,145)
—
—
(9,146)
Issuance of common stock for stock compensation plans
402
4
(25,513)
—
—
(25,509)
Issuance of common stock under the employee stock purchase plan
24
—
2,288
—
—
2,288
Stock-based compensation
—
—
30,100
—
—
30,100
Cash dividends declared ($0.03 per share)
—
—
—
(2,438)
—
(2,438)
Other comprehensive income
—
—
—
—
280
280
Net (loss)
—
—
—
(6,617)
—
(6,617)
March 31, 2021
81,246
$
812
$
140,558
$
340,223
$
(2,668)
$
478,925
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
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,
2022
2021
Operating activities
Net (loss)
$
(379)
$
(6,617)
Adjustments to reconcile net (loss) to cash provided by operating activities
Stock-based compensation
28,227
30,100
Deferred income taxes
(9,295)
(15,068)
Loss on capped call transactions
30,560
19,117
Amortization of deferred commissions
17,221
11,496
Lease expense
3,919
3,238
Amortization of intangible assets and depreciation
4,171
7,006
Foreign currency transaction (gain) loss
(2,876)
5,098
Other non-cash
(1,100)
1,634
Change in operating assets and liabilities, net
(55,332)
(34,354)
Cash provided by operating activities
15,116
21,650
Investing activities
Purchases of investments
(33,690)
(21,051)
Proceeds from maturities and called investments
20,915
40,867
Sales of investments
13,350
2,450
Payments for acquisitions, net of cash acquired
—
(4,993)
Investment in property and equipment
(6,657)
(1,784)
Cash (used in) provided by investing activities
(6,082)
15,489
Financing activities
Proceeds from employee stock purchase plan
2,446
2,288
Dividend payments to stockholders
(2,454)
(2,427)
Common stock repurchases
(35,910)
(34,655)
Cash (used in) financing activities
(35,918)
(34,794)
Effect of exchange rate changes on cash and cash equivalents
(310)
(1,536)
Net (decrease) increase in cash and cash equivalents
(27,194)
809
Cash and cash equivalents, beginning of period
159,965
171,899
Cash and cash equivalents, end of period
$
132,771
$
172,708
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, 2021.
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 2022.
Certain prior period amounts reported in our condensed consolidated financial statements and notes thereto have been reclassified to conform to the current year presentation. Such reclassifications did not affect total revenues, operating income, or net income.
NOTE 2. MARKETABLE SECURITIES
March 31, 2022
December 31, 2021
(in thousands)
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
Government debt
$
2,000
$
—
$
(47)
$
1,953
$
2,000
$
—
$
(10)
$
1,990
Corporate debt
200,371
7
(2,930)
197,448
201,659
2
(837)
200,824
$
202,371
$
7
$
(2,977)
$
199,401
$
203,659
$
2
$
(847)
$
202,814
As of March 31, 2022, marketable securities’ maturities ranged from April 2022 to September 2024, with a weighted-average remaining maturity of 1.02 years.
NOTE 3. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE
Receivables
(in thousands)
March 31, 2022
December 31, 2021
Accounts receivable
$
171,181
$
182,717
Unbilled receivables
226,052
226,714
Long-term unbilled receivables
135,975
129,789
$
533,208
$
539,220
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, 2022
1 year or less
$
226,052
62
%
1-2 years
88,003
25
%
2-5 years
47,972
13
%
$
362,027
100
%
Unbilled receivables by contract effective date:
(Dollars in thousands)
March 31, 2022
2022
$
72,143
20
%
2021
163,869
45
%
2020
77,585
21
%
2019
27,163
8
%
2018 and prior
21,267
6
%
$
362,027
100
%
8
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Major clients
Clients accounting for 10% or more of the Company’s total receivables:
March 31, 2022
December 31, 2021
Client A
Accounts receivable
4
%
1
%
Unbilled receivables
15
%
15
%
Total receivables
11
%
10
%
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, 2022
December 31, 2021
Contract assets (1)
$
11,765
$
12,530
Long-term contract assets (2)
10,292
10,643
$
22,057
$
23,173
(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, 2022
December 31, 2021
Deferred revenue
$
290,873
$
275,844
Long-term deferred revenue (1)
6,612
5,655
$
297,485
$
281,499
(1) Included in other long-term liabilities.
The change in deferred revenue in the three months ended March 31, 2022 was primarily due to new billings in advance of revenue recognition and $124.9 million of revenue recognized during the period that was included in deferred revenue as of December 31, 2021.
NOTE 4. DEFERRED COMMISSIONS
(in thousands)
March 31, 2022
December 31, 2021
Deferred commissions (1)
$
125,220
$
135,911
(1) Included in other long-term assets.
Three Months Ended March 31,
(in thousands)
2022
2021
Amortization of deferred commissions (1)
$
17,221
$
11,496
(1) Included in selling and marketing expense.
9
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 5. GOODWILL AND OTHER INTANGIBLES
Goodwill
Change in goodwill:
Three Months Ended March 31,
(in thousands)
2022
January 1,
$
81,923
Acquisition
—
Currency translation adjustments
108
March 31,
$
82,031
Intangibles
Intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives.
March 31, 2022
(in thousands)
Useful Lives
Cost
Accumulated Amortization
Net Book Value (1)
Client-related
4-10 years
$
63,142
$
(57,662)
$
5,480
Technology
2-10 years
67,142
(59,531)
7,611
Other
1-5 years
5,361
(5,361)
—
$
135,645
$
(122,554)
$
13,091
(1) Included in other long-term assets.
December 31, 2021
(in thousands)
Useful Lives
Cost
Accumulated Amortization
Net Book Value (1)
Client-related
4-10 years
$
63,165
$
(57,342)
$
5,823
Technology
2-10 years
67,142
(58,902)
8,240
Other
1-5 years
5,361
(5,361)
—
$
135,668
$
(121,605)
$
14,063
(1) Included in other long-term assets.
Amortization of intangible assets:
Three Months Ended March 31,
(in thousands)
2022
2021
Cost of revenue
$
629
$
629
Selling and marketing
343
373
$
972
$
1,002
Future estimated intangibles assets amortization:
(in thousands)
March 31, 2022
Remainder of 2022
$
2,914
2023
3,618
2024
2,849
2025
2,509
2026
874
2027
327
$
13,091
NOTE 6. OTHER ASSETS AND LIABILITIES
Other current assets
(in thousands)
March 31, 2022
December 31, 2021
Income tax receivables
$
27,679
$
25,691
Contract assets
11,765
12,530
Other
34,964
29,787
$
74,408
$
68,008
10
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Other long-term assets
(in thousands)
March 31, 2022
December 31, 2021
Deferred income taxes
$
188,155
$
180,656
Deferred commissions
125,220
135,911
Right of use assets
87,212
87,521
Capped call transactions
29,404
59,964
Property and equipment
28,603
26,837
Intangible assets
13,091
14,063
Contract assets
10,292
10,643
Other
34,684
26,006
$
516,661
$
541,601
Other current liabilities
(in thousands)
March 31, 2022
December 31, 2021
Operating lease liabilities
$
4,855
$
6,989
Dividends payable
2,454
2,454
$
7,309
$
9,443
Other long-term liabilities
(in thousands)
March 31, 2022
December 31, 2021
Deferred revenue
$
6,612
$
5,655
Other
8,046
7,844
$
14,658
$
13,499
NOTE 7. LEASES
Corporate headquarters
In February 2021, the Company agreed to accelerate its exit from its previous corporate headquarters to October 1, 2021, in exchange for a one-time payment from its landlord of $18 million, which was amortized over the remaining lease term. The exit accelerated depreciation on the related leasehold improvements and reduced the Company’s future lease liabilities by $21.1 million and right of use assets by $20.3 million. On March 31, 2021 the Company leased office space at One Main Street, Cambridge, Massachusetts, to serve as its corporate headquarters. The 4.5 year lease includes a base rent of $2 million per year.
New Waltham Office
On July 6, 2021, the Company entered into an office space lease for 131 thousand square feet in Waltham, Massachusetts. The lease term of 11 years began on August 1, 2021. The annual rent equals the base rent plus a portion of building operating costs and real estate taxes. Rent first becomes payable on August 1, 2022. Base rent for the first year is approximately $6 million and will increase by 3% annually. In addition, the Company will receive an improvement allowance from the landlord of up to $11.8 million. This lease increased the Company’s lease liabilities and lease-related right of use assets by $42.1 million on August 1, 2021.
Expense
Three Months Ended March 31,
(in thousands)
2022
2021
Fixed lease costs (1)
$
5,093
$
300
Short-term lease costs
806
459
Variable lease costs
764
1,387
$
6,663
$
2,146
(1) The lower fixed lease costs in the three months ended March 31, 2021 was due to the modification of the corporate headquarters lease.
11
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Right of use assets and lease liabilities
(in thousands)
March 31, 2022
December 31, 2021
Right of use assets (1)
$
87,212
$
87,521
Operating lease liabilities (2)
$
4,855
$
6,989
Long-term operating lease liabilities
$
90,699
$
87,818
(1) Represents the Company’s right to use the leased asset during the lease term. Included in other long-term assets.
(2) Included in other current liabilities.
Weighted-average remaining lease term and discount rate for the Company’s leases were:
March 31, 2022
December 31, 2021
Weighted-average remaining lease term
7.5 years
7.7 years
Weighted-average discount rate (1)
4.3
%
4.4
%
(1) The rates implicit in most of the Company’s leases are not readily determinable. Therefore, the Company uses its incremental borrowing rate as the discount rate when measuring operating lease liabilities. The incremental borrowing rate represents an estimate of the interest rate the Company would incur to borrow an amount equal to the lease payments on a collateralized basis over the lease term in a similar economic environment.
Maturities of lease liabilities:
(in thousands)
March 31, 2022
Remainder of 2022
$
3,887
2023
20,317
2024
17,141
2025
14,352
2026
10,664
2027 and thereafter
48,381
Total lease payments
114,742
Less: imputed interest (1)
(19,188)
$
95,554
(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)
2022
2021
Cash paid for leases
$
3,650
$
6,716
Right of use assets recognized for new leases and amendments (non-cash)
$
3,854
$
714
NOTE 8. DEBT
Convertible senior notes and capped calls
Convertible senior notes
In February 2020, the Company issued Convertible Senior Notes (the "Notes") with an aggregate principal of $600 million, due March 1, 2025, in a private placement. No principal payments are due before maturity. The Notes accrue interest at an annual rate of 0.75%, payable semi-annually in arrears on March 1 and September 1, beginning on September 1, 2020.
Conversion rights
The conversion rate is 7.4045 shares of common stock per $1,000 principal amount of the Notes, representing an initial conversion price of $135.05 per share of common stock. The Company will settle conversions by paying or delivering cash, shares of its common stock, or a combination of cash and shares of its common stock, at the Company’s election, based on the applicable conversion rate. The conversion rate will be adjusted upon certain events, including spin-offs, tender offers, exchange offers, and certain stockholder distributions.
Beginning on September 1, 2024, noteholders may convert their Notes at any time at their election.
Before September 1, 2024, noteholders may convert their Notes in the following circumstances:
12
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
•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, 2022, 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, 2022
December 31, 2021
Principal
$
600,000
$
600,000
Unamortized issuance costs
(8,560)
(9,278)
Convertible senior notes, net
$
591,440
$
590,722
Interest expense related to the Notes:
Three Months Ended March 31,
(in thousands)
2022
2021
Contractual interest expense (0.75% coupon)
$
1,125
$
1,125
Amortization of issuance costs
719
673
$
1,844
$
1,798
13
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
The effective interest rate for the Notes:
Three Months Ended March 31,
2022
2021
Weighted-average effective interest rate
1.2
%
1.2
%
Future payments of principal and contractual interest:
March 31, 2022
(in thousands)
Principal
Interest
Total
Remainder of 2022
$
—
$
2,250
$
2,250
2023
—
4,500
4,500
2024
—
4,500
4,500
2025
600,000
2,250
602,250
$
600,000
$
13,500
$
613,500
Capped call transactions
In February 2020, the Company entered into privately negotiated capped call transactions (the “Capped Call Transactions”) with certain financial institutions. The Capped Call Transactions cover approximately 4.4 million shares (representing the number of shares for which the Notes are initially convertible) of the Company’s common stock. The Capped Call Transactions are 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)
2022
2021
January 1,
$
59,964
$
83,597
Fair value adjustment
(30,560)
(19,117)
March 31,
$
29,404
$
64,480
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, the Credit Facility allows the Company to increase the aggregate commitment to $200 million. The commitments expire on November 4, 2024, and any outstanding loans will be payable on such date. The Credit Facility, as amended, contains customary covenants, including, but not limited to, those relating to additional indebtedness, liens, asset divestitures, and affiliate transactions.
The Company is 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, 2022, Pegasystems Inc. must maintain at least $200 million in cash, investments, and availability under the Revolving Credit Loan.
•Beginning with the quarter ended March 31, 2023, 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, 2022 and December 31, 2021, the Company had no outstanding borrowings under the Credit Facility.
NOTE 9. FAIR VALUE MEASUREMENTS
Assets and liabilities measured at fair value on a recurring basis
The Company records its cash equivalents, marketable securities, Capped Call Transactions, and venture investments at fair value on a recurring basis. Fair value is an exit price, representing the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants based on assumptions that market participants would use in pricing an asset or liability.
14
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
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 use various market-based inputs, including stock price, remaining contractual term, expected volatility, risk-free interest rate, and expected dividend yield. The Company applies judgment when determining expected volatility. The Company considers both historical and implied volatility levels of the underlying equity security. The Company’s venture investments are recorded at fair value based on 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, 2022
December 31, 2021
(in thousands)
Level 1
Level 2
Level 3
Total
Level 1
Level 2
Level 3
Total
Cash equivalents
$
19,626
$
—
$
—
$
19,626
$
3,216
$
—
$
—
$
3,216
Marketable securities
$
—
$
199,401
$
—
$
199,401
$
—
$
202,814
$
—
$
202,814
Capped Call Transactions (1)
$
—
$
29,404
$
—
$
29,404
$
—
$
59,964
$
—
$
59,964
Venture investments (1) (2)
$
—
$
—
$
12,830
$
12,830
$
—
$
—
$
7,648
$
7,648
(1) Included in other long-term assets. (2) Investments in privately-held companies.
Changes in venture investments:
Three Months Ended March 31,
(in thousands)
2022
2021
January 1,
$
7,648
$
8,345
New investments
—
500
Sales of investments
—
(400)
Changes in foreign exchange rates
(61)
(9)
Changes in fair value:
included in other income
2,741
100
included in other comprehensive income
2,502
1,220
March 31,
$
12,830
$
9,756
The carrying value of certain other financial instruments, including receivables and accounts payable, approximates fair value due to these items’ short maturity.
Fair value of the Notes
The Notes’ fair value (including the conversion feature embedded in the Notes) was $573.0 million as of March 31, 2022 and $642.0 million as of December 31, 2021. 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 10. REVENUE
Geographic revenue
Three Months Ended March 31,
(Dollars in thousands)
2022
2021
U.S.
$
217,272
58
%
$
194,568
62
%
Other Americas
45,751
12
%
11,901
4
%
United Kingdom (“U.K.”)
30,932
8
%
28,212
9
%
Europe (excluding U.K.), Middle East, and Africa
49,136
13
%
51,659
16
%
Asia-Pacific
33,216
9
%
27,159
9
%
$
376,307
100
%
$
313,499
100
%
15
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Revenue streams
Three Months Ended March 31,
(in thousands)
2022
2021
Perpetual license
$
7,440
$
5,452
Subscription license
137,533
111,509
Revenue recognized at a point in time
144,973
116,961
Maintenance
79,716
75,561
Pega Cloud
90,317
67,858
Consulting
61,301
53,119
Revenue recognized over time
231,334
196,538
Total revenue
$
376,307
$
313,499
Three Months Ended March 31,
(in thousands)
2022
2021
Pega Cloud
$
90,317
$
67,858
Maintenance
79,716
75,561
Subscription services
170,033
143,419
Subscription license
137,533
111,509
Subscription
307,566
254,928
Perpetual license
7,440
5,452
Consulting
61,301
53,119
$
376,307
$
313,499
Remaining performance obligations ("Backlog")
Expected future revenue from existing non-cancellable contracts:
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
%
As of March 31, 2021:
(Dollars in thousands)
Subscription services
Subscription license
Perpetual license
Consulting
Total
Maintenance
Pega Cloud
1 year or less
$
220,100
$
252,104
$
41,025
$
9,649
$
21,068
$
543,946
55
%
1-2 years
52,366
187,456
9,874
629
914
251,239
26
%
2-3 years
33,337
91,861
7,055
—
1,756
134,009
14
%
Greater than 3 years
16,834
32,895
377
—
510
50,616
5
%
$
322,637
$
564,316
$
58,331
$
10,278
$
24,248
$
979,810
100
%
16
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 11. STOCK-BASED COMPENSATION
Expense
Three Months Ended March 31,
(in thousands)
2022
2021
Cost of revenue
$
6,378
$
5,925
Selling and marketing
10,958
13,720
Research and development
7,346
6,770
General and administrative
3,545
3,685
$
28,227
$
30,100
Income tax benefit
$
(5,311)
$
(5,991)
As of March 31, 2022, the Company had $200.8 million of unrecognized stock-based compensation expense, net of estimated forfeitures, which is expected to be recognized over a weighted-average period of 2.3 years.
Grants
Three Months Ended March 31, 2022
(in thousands)
Shares
Total Fair Value
Restricted stock units
1,096
$
94,538
Non-qualified stock options
2,212
$
60,514
NOTE 12. INCOME TAXES
Effective income tax rate
Three Months Ended March 31,
(Dollars in thousands)
2022
2021
(Benefit from) income taxes
$
(7,683)
$
(17,618)
Effective income tax benefit rate
95
%
73
%
The change in the effective income tax benefit rate was primarily due to the impact of discrete tax items which were proportionately larger on a lower loss before income taxes.
Stock-based compensation increases the variability of our effective tax rates. The impact of stock-based compensation on a given period depends on our profitability, the attributes of the stock compensation awards the Company grants, and award holders' exercise behavior.
NOTE 13. (LOSS) PER SHARE
Basic (loss) per share is calculated using the weighted-average number of common shares outstanding during the period. Diluted (loss) per share is calculated using the weighted-average number of common shares outstanding during the period, plus the dilutive effect of outstanding stock options, RSUs, and convertible senior notes.
Calculation of (loss) per share:
Three Months Ended March 31,
(in thousands, except per share amounts)
2022
2021
Net (loss)
$
(379)
$
(6,617)
Weighted-average common shares outstanding
81,680
81,004
(Loss) per share, basic
$
0.00
$
(0.08)
Net (loss)
$
(379)
$
(6,617)
Weighted-average common shares outstanding, assuming dilution (1) (2) (3)
81,680
81,004
(Loss) per share, diluted
$
0.00
$
(0.08)
Outstanding anti-dilutive stock options and RSUs (4)
4,178
6,465
(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 an additional approximately 4.4 million shares.
17
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(3) The Company’s Capped Call Transactions represent the equivalent of approximately 4.4 million shares of the Company’s common stock (representing the number of shares for which the Notes are initially convertible). The Capped Call Transactions are 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 14. 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 our estimates will change in the near term and the effect may be material.
As of March 31, 2022 and December 31, 2021, the Company has no accrued losses for litigation.
Pegasystems Inc. v. Appian Corp. & Business Process Management Inc.
On July 3, 2019, the Company filed suit in Massachusetts federal court against Appian Corp. (“Appian”) and Business Process Management, Inc. (“BPM”) relating to a BPM “Market Report” that Appian had used to promote itself against the Company. Pegasystems Inc. v. Appian Corp. & Business Process Management Inc., No. 1:19-cv-11461 (D. Mass). On April 15, 2022, each of the parties filed motions for summary judgment with the court. The Company continues to believe the counterclaims brought by Appian against the Company are without merit, and the Company intends to vigorously pursue its claims against Appian and defend against the counterclaims brought against the Company in this matter. The Company is unable to reasonably estimate possible damages or a range of possible damages in this matter given the Company’s belief that the damages claimed by Appian fail to satisfy the required legal standard, the status of the proceeding, and due to the uncertainty as to how a jury may rule if this ultimately proceeds to trial.
Appian Corp. v. Pegasystems Inc. & Youyong Zou
As previously reported, the Company is a defendant in litigation brought by Appian that is currently being tried in Virginia (the “Court”) titled Appian Corp. v. Pegasystems Inc. & Youyong Zou, No. 2020-07216 (Fairfax Cty. Ct.). The jury trial began on March 21, 2022. On April 13, 2022, Appian withdrew its claim against the Company for tortious interference with business expectancy. On that same day, in the course of making determinations on various motions, the Court stated that if the jury finds that the Company misappropriated information that constituted Appian trade secrets and finds that the Company incorporated those trade secrets into the Company’s products or the Company’s marketing materials, the burden will then shift to the Company to prove that the sales Appian seeks as damages were not the result of the alleged misappropriation and use of the alleged trade secrets. This legal standard has not previously been adopted by the Virginia courts. The Company continues to believe that its sales of the products at issue were not caused by, or the result of, the alleged misappropriation of trade secrets, and is submitting evidence to the jury to that effect. The Company is unable to reasonably estimate possible damages because, among other things, of the uncertainty as to how a jury may decide and the parties’ existing grounds for appeal based on rulings to date in the proceeding.
18
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q (“Quarterly Report”) contains or incorporates forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.
Words such as expects, anticipates, intends, plans, believes, will, could, should, estimates, may, targets, strategies, projects, forecasts, guidance, likely, and usually, or variations of such words and other similar expressions identify forward-looking statements, which are based on current expectations and assumptions.
Forward-looking statements deal with future events and are subject to risks and uncertainties that are difficult to predict, including, but not limited to:
•our future financial performance and business plans;
•the adequacy of our liquidity and capital resources;
•the continued payment of our quarterly dividends;
•the timing of revenue recognition;
•management of our transition to a more subscription-based business model;
•variation in demand for our products and services, including among clients in the public sector;
•reliance on key personnel;
•global economic and political conditions and uncertainty, including continued impacts from the ongoing COVID-19 pandemic 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, as well as intellectual property rights claims and other related claims by third parties;
•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, 2021, 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 28, 2022.
BUSINESS OVERVIEW
We develop, market, license, host, and support enterprise software that helps organizations simplify business complexity. Our powerful low-code platform for workflow automation and AI-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 themselves leverage our Pega Express™ methodology to design and deploy mission-critical applications quickly and collaboratively.
Our target clients are Global 3000 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 our clients’ specific industry needs.
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 revenue and operating cash flow may be impacted. Operating performance and the actual mix of revenue and new arrangements in each period can fluctuate based on client preferences for our perpetual and subscription offerings. See the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2021 for additional information.
19
Coronavirus (“COVID-19”)
As of March 31, 2022, COVID-19 has not had a material impact on our results of operations or financial condition. See “Coronavirus (“COVID-19”)” in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2021 for additional information.
Ukraine
Our direct financial exposure to Ukraine, Russia, and Belarus is not material.
In 2021, before Russia's invasion of Ukraine, we made a business decision to stop pursuing new clients in Russia and closed our local office. For the year ended December 31, 2021 total revenue from clients located in Ukraine, Russia, and Belarus was less than $4.0 million. However, the ultimate impact of Russia’s invasion of Ukraine on our business will depend on future developments, including the duration and spread of the conflict, the impact on our people, partners, clients, and vendors in neighboring countries, and globally, all of which are uncertain and unpredictable.
Performance metrics
We use performance metrics to analyze and assess our overall performance, make operating decisions, and forecast and plan for future periods, including:
Annual contract value (“ACV”) | Increased 21% since March 31, 2021
ACV represents the annualized value of our active contracts as of the measurement date. The contract's total value is divided by its duration in years to calculate ACV for subscription license and Pega Cloud contracts. Maintenance revenue for the quarter then ended is multiplied by four to calculate ACV for maintenance. ACV is a performance measure that we believe provides useful information to our management and investors, particularly during our subscription transition.
Foreign currency exchange rate changes were a 1% to 2% headwind to ACV growth since March 31, 2021.
20
Remaining performance obligations (“Backlog”) | Increased 20% since March 31, 2021
Expected future revenue from existing non-cancellable contracts:
CRITICAL ACCOUNTING POLICIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our unaudited condensed consolidated financial statements, which have been prepared following accounting principles generally accepted in the United States and the rules and regulations of the SEC for interim financial reporting. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, knowledge of current conditions, and expectations of what could occur in the future given the available information.
For more information about our critical accounting policies, we encourage you to read the discussion in the following locations in our Annual Report on Form 10-K for the year ended December 31, 2021:
•“Critical Accounting Estimates and Significant Judgments” in Item 7; and
•“Note 2. Significant Accounting Policies” in Item 8.
There have been no significant changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021.
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 is recognized differently for subscription services than license sales. Revenue from Pega Cloud and maintenance arrangements is typically recognized over the contract term, while revenue from license sales is recognized when the license rights become effective, typically upfront.
21
(Dollars in thousands)
Three Months Ended March 31,
Change
2022
2021
Pega Cloud
$
90,317
24
%
$
67,858
22
%
$
22,459
33
%
Maintenance
79,716
21
%
75,561
23
%
4,155
5
%
Subscription services
170,033
45
%
143,419
45
%
26,614
19
%
Subscription license
137,533
37
%
111,509
36
%
26,024
23
%
Subscription
307,566
82
%
254,928
81
%
52,638
21
%
Perpetual license
7,440
2
%
5,452
2
%
1,988
36
%
Consulting
61,301
16
%
53,119
17
%
8,182
15
%
$
376,307
100
%
$
313,499
100
%
$
62,808
20
%
The revenue changes in the three months ended March 31, 2022 generally reflect the impact of our subscription transition. Other factors impacting our revenue include:
•The increase in perpetual revenue in the three months ended March 31, 2022 was primarily due to license rights becoming effective in the three months ended March 31, 2022 related to software license contracts entered into in prior years.
•The increase in consulting revenue in the three months ended March 31, 2022 was primarily due to an increase in consultant billable hours in North America.
Gross profit
(Dollars in thousands)
Three Months Ended March 31,
Change
2022
2021
Pega Cloud
$
63,418
70
%
$
45,301
67
%
$
18,117
40
%
Maintenance
74,585
94
%
69,775
92
%
4,810
7
%
Subscription services
138,003
81
%
115,076
80
%
22,927
20
%
Subscription license
136,911
100
%
110,889
99
%
26,022
23
%
Subscription
274,914
89
%
225,965
89
%
48,949
22
%
Perpetual license
7,406
100
%
5,422
99
%
1,984
37
%
Consulting
5,790
9
%
(335)
(1)
%
6,125
*
$
288,110
77
%
$
231,052
74
%
$
57,058
25
%
* not meaningful
•The increases in gross profit and gross profit percent in the three months ended March 31, 2022 were primarily due to the impact of our subscription transition, revenue growth, and cost-efficiency gains as Pega Cloud grows and scales.
•The increase in consulting gross profit percent in the three months ended March 31, 2022 was due to an increase in consultant realization rates in North America.
Operating expenses
(Dollars in thousands)
Three Months Ended March 31,
Change
2022
2021
% of Revenue
% of Revenue
Selling and marketing
$
162,236
43
%
$
148,739
47
%
$
13,497
9
%
Research and development
$
71,490
19
%
$
62,442
20
%
$
9,048
14
%
General and administrative
$
35,764
10
%
$
18,270
6
%
$
17,494
96
%
•The increase in selling and marketing in the three months ended March 31, 2022 was primarily due to an increase in compensation and benefits of $8.9 million and an increase in employee travel and entertainment of $2.6 million.
•The increase in research and development in the three months ended March 31, 2022 was primarily due to an increase in compensation and benefits of $5.7 million, attributable to increases in headcount and incentive compensation. The increase in headcount reflects additional investments in developing our solutions, particularly for Pega Cloud.
•The increase in general and administrative in the three months ended March 31, 2022 was primarily due to an increase of $15.4 million in legal fees and related expenses arising from proceedings outside the ordinary course of business. We have incurred and expect to continue to incur additional expenses for these proceedings in 2022. See "Note 14. Commitments and Contingencies" in Part I, Item 1 and “Risk Factors” in Part II, Item 1A of this Quarterly Report for additional information.
22
Other income and expenses
(Dollars in thousands)
Three Months Ended March 31,
Change
2022
2021
Foreign currency transaction gain (loss)
$
2,876
$
(5,098)
$
7,974
*
Interest income
207
153
54
35
%
Interest expense
(1,946)
(1,880)
(66)
(4)
%
(Loss) on capped call transactions
(30,560)
(19,117)
(11,443)
(60)
%
Other income, net
2,741
106
2,635
2,486
%
$
(26,682)
$
(25,836)
$
(846)
(3)
%
* not meaningful
•The increase in foreign currency transaction gain (loss) in the three months ended March 31, 2022 was primarily due to the impact of fluctuations in foreign currency exchange rates associated with our foreign currency-denominated cash, receivables, and intercompany balances held by our subsidiary in the United Kingdom.
•The increase in interest income in the three months ended March 31, 2022 was primarily due to increases in market interest rates.
•The increase in the (loss) on capped call transactions in the three months ended March 31, 2022, was due to fair value adjustments for our capped call transactions. See "Note 9. Fair Value Measurements" in Part I, Item 1 of this Quarterly Report for additional information.
•The increase in other income, net in the three months ended March 31, 2022, was due to fair value adjustments on equity securities held in our venture investments portfolio in the three months ended March 31, 2021.
(Benefit from) income taxes
Three Months Ended March 31,
(Dollars in thousands)
2022
2021
(Benefit from) income taxes
$
(7,683)
$
(17,618)
Effective income tax benefit rate
95
%
73
%
During the three months ended March 31, 2022, the change in our effective income tax benefit rate was primarily due to the impact of discrete tax items which were proportionately larger on a lower loss before income taxes.
Stock-based compensation increases the variability of our effective tax rates. The impact on our effective tax rate in each period depends on our profitability and the tax deductions from our stock compensation activity, which depend upon our stock price and the award holders' exercise behavior.
LIQUIDITY AND CAPITAL RESOURCES
Three Months Ended March 31,
(in thousands)
2022
2021
Cash provided by (used in):
Operating activities
$
15,116
$
21,650
Investing activities
(6,082)
15,489
Financing activities
(35,918)
(34,794)
Effect of exchange rates on cash and cash equivalents
(310)
(1,536)
Net (decrease) increase in cash and cash equivalents
$
(27,194)
$
809
(in thousands)
March 31, 2022
December 31, 2021
Held by U.S. entities
$
251,554
$
274,813
Held by foreign entities
80,618
87,966
Total cash, cash equivalents, and marketable securities
$
332,172
$
362,779
We believe that our current cash, cash flow from operations, and borrowing capacity will be sufficient to fund our operations, stock repurchases, and quarterly cash dividends for at least the next 12 months 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 additional external financing if we require additional capital resources.
If it becomes necessary to repatriate foreign funds, we may have to pay U.S. and foreign 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.
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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, as the timing of billings and cash collections generally differs between our subscription and perpetual license arrangements. Subscription licenses and services are generally billed and collected over the contract term, while perpetual license arrangements usually are 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, 2022 was primarily due to our subscription transition and increased costs as we made investments in our Pega Cloud offering and selling and marketing activities to support future growth. In addition, in the three months ended March 31, 2022 we incurred $17.4 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 expenses for these proceedings. See "Note 14. Commitments and Contingencies" in Part I, Item 1 of this Quarterly Report for additional information.
Investing activities
The change in cash (used in) provided by investing activities in the three months ended March 31, 2022 was primarily driven by our investments in financial instruments and an acquisition in 2021.
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 thousands)
Amount
Principal
$
600,000
Less: issuance costs
(14,527)
Less: Capped Call Transactions
(51,900)
$
533,573
In November 2019, and as since amended, we entered into a five-year $100 million senior secured revolving credit agreement with PNC Bank, National Association. As of March 31, 2022, we had no outstanding borrowings under the Credit Facility. 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, 2022
December 31, 2021
$
22,583
Authorizations (1)
—
Repurchases (2)
(22,583)
March 31, 2022
$
—
(1) On June 8, 2021, we announced that our Board of Directors extended the current stock repurchase program’s expiration date to June 30, 2022 and increased the remaining common stock repurchase authority to $60 million.
(2) All purchases under this program have been made on the open market.
Common stock repurchases
Three Months Ended March 31,
2022
2021
(in thousands)
Shares
Amount
Shares
Amount
Repurchases paid
242
$
22,583
67
$
8,846
Repurchases unpaid at period end
—
—
3
300
Stock repurchase program
242
22,583
70
9,146
Tax withholdings for net settlement of equity awards
141
12,128
197
25,509
383
$
34,711
267
$
34,655
During the three months ended March 31, 2022 and 2021, instead of receiving cash from the equity holders, we withheld shares with a value of $6.1 million and $10.1 million, respectively, for the exercise price of options. These amounts are not included in the table above.
24
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)
2022
2021
Dividend payments to stockholders
$
2,454
$
2,427
Contractual obligations
As of March 31, 2022, our contractual obligations were:
Payments due by period
(in thousands)
Remainder of 2022
2023
2024
2025
2026
2027 and thereafter
Other
Total
Convertible senior notes (1)
$
2,250
$
4,500
$
4,500
$
602,250
$
—
$
—
$
—
$
613,500
Purchase obligations (2)
49,936
14,311
9,198
13,072
13,750
—
—
100,267
Operating lease obligations
3,887
20,317
17,141
14,352
10,664
48,381
—
114,742
Liability for uncertain tax positions (3)
—
—
—
—
—
—
1,705
1,705
$
56,073
$
39,128
$
30,839
$
629,674
$
24,414
$
48,381
$
1,705
$
830,214
(1) Includes principal and interest.
(2) Represents the fixed or minimum amounts due under purchase obligations for hosting services and sales and marketing programs.
(3) We are unable to reasonably estimate the timing of this cash outflow due to uncertainties in the timing of the effective settlement of tax positions.
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,
2022
2021
(Decrease) increase in revenue
(3)
%
(4)
%
Increase (decrease) in net income
186
%
20
%
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)
2022
2021
Foreign currency gain (loss)
$
(7,937)
$
(7,522)
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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, 2022. 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, 2022.
(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, 2022 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The following information contains an update to the description of our pending legal proceedings with Appian Corp., as described in our Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on February 16, 2022.
Pegasystems Inc. v. Appian Corp. & Business Process Management Inc.
On July 3, 2019, the Company filed suit in Massachusetts federal court against Appian Corp. (“Appian”) and Business Process Management, Inc. (“BPM”) relating to a BPM “Market Report” that Appian had used to promote itself against the Company. Pegasystems Inc. v. Appian Corp. & Business Process Management Inc., No. 1:19-cv-11461 (D. Mass). On April 15, 2022, each of the parties filed motions for summary judgment with the court. The Company continues to believe the counterclaims brought by Appian against the Company are without merit, and the Company intends to vigorously pursue its claims against Appian and defend against the counterclaims brought against the Company in this matter. The Company is unable to reasonably estimate possible damages or a range of possible damages in this matter given the Company’s belief that the damages claimed by Appian fail to satisfy the required legal standard, the status of the proceeding, and due to the uncertainty as to how a jury may rule if this ultimately proceeds to trial.
Appian Corp. v. Pegasystems Inc. & Youyong Zou
As previously reported, the Company is a defendant in litigation brought by Appian that is currently being tried in Virginia (the “Court”) titled Appian Corp. v. Pegasystems Inc. & Youyong Zou, No. 2020-07216 (Fairfax Cty. Ct.). The jury trial began on March 21, 2022. On April 13, 2022, Appian withdrew its claim against the Company for tortious interference with business expectancy. On that same day, in the course of making determinations on various motions, the Court stated that if the jury finds that the Company misappropriated information that constituted Appian trade secrets and finds that the Company incorporated those trade secrets into the Company’s products or the Company’s marketing materials, the burden will then shift to the Company to prove that the sales Appian seeks as damages were not the result of the alleged misappropriation and use of the alleged trade secrets. This legal standard has not previously been adopted by the Virginia courts. The Company continues to believe that its sales of the products at issue were not caused by, or the result of, the alleged misappropriation of trade secrets, and is submitting evidence to the jury to that effect. The Company is unable to reasonably estimate possible damages because, among other things, of the uncertainty as to how a jury may decide and the parties’ existing grounds for appeal based on rulings to date in the proceeding.
ITEM 1A. RISK FACTORS
The risk factors set forth below update the risk factors in our Annual Report on Form 10-K filed with the SEC on February 16, 2022.
In addition to the risk factors set forth below, 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, 2021, 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.
We face risks related to intellectual property claims or appropriation of our intellectual property rights.
We rely primarily on a combination of patent, copyright, trademark, and trade secrets laws, as well as intellectual property and confidentiality agreements to protect our proprietary rights. We also try to control access to and distribution of our technologies and other proprietary information. We have obtained patents in strategically important global markets relating to the architecture of our systems. We cannot be certain that such patents will not be challenged, invalidated, or circumvented, or that rights granted thereunder, or the claims contained therein will provide us with competitive advantages. Moreover, despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our software or to obtain the use of information that we regard as proprietary. Although we generally enter into intellectual property and confidentiality agreements with our employees and strategic partners, despite our efforts our former employees may seek employment with our business partners, clients, or competitors, and there can be no assurance that the confidential nature of our proprietary information will be maintained. In addition, the laws of some foreign countries do not protect our proprietary rights as effectively as they do in the U.S. There can be no assurance that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop similar technology.
Other companies or individuals have obtained proprietary rights covering a variety of designs, processes, and systems. Third parties have claimed and may in the future claim that we have infringed or otherwise violated their intellectual property. We are currently party to litigation with Appian Corp. - see Part II, Item 1 “Legal Proceedings” and Note 14 in the “Notes to Unaudited Condensed Consolidated Financial Statements” included in Part I, Item 1 of this Quarterly Report, and Part I, Item 3 “Legal Proceedings” and Note 19 in the “Notes to Consolidated Financial Statements” included in Part II, Item 8 of our Annual Report filed with the SEC on February 16, 2022.
27
Although we attempt to limit the amount and type of our contractual liability for infringement or other violation of the proprietary rights of third parties and assert ownership of work product and intellectual property rights as appropriate, there are often exceptions, and limitations may not be applicable and enforceable in all cases. Even if limitations are found to be applicable and enforceable, our liability to our clients for these types of claims could be material given the size of certain of our transactions. We expect that software product developers will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Any such claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment and delivery delays, require us to enter into royalty or licensing agreements, or preclude us from making and selling the infringing software, if such proprietary rights are found to be valid. Royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all. These claims could also subject us to significant liability for damages, potentially including treble damages if we are found to have willfully infringed patents or copyrights. Even if a license were available, we could be required to pay significant royalties, which would increase our operating expenses. As a result, we may be required to develop alternative non-infringing technology, which could require substantial effort and cost. If we cannot license or develop technology for any infringing aspect of our business, we would be forced to limit or stop sales of our software and may be unable to compete effectively, which could have a material effect upon our business, operating results, and financial condition.
Intellectual property rights claims by third parties are extremely costly to defend, could require us to pay significant damages, and could limit our ability to use certain technologies.
Companies in the software and technology industries, including some of our current and potential competitors, own large numbers of patents, copyrights, trademarks, and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. In addition, many of these companies can dedicate greater resources to enforce their intellectual property rights and to defend claims that may be brought against them. The litigation may involve patent holding companies or other adverse patent owners that have no relevant product revenues and against which our patents may, therefore, provide little or no deterrence. Third parties have claimed and may claim in the future that we have misappropriated, misused, or infringed other parties' intellectual property rights, and, to the extent we gain greater market visibility, we face a higher risk of being the subject of intellectual property claims. We are currently party to litigation with Appian Corp. - see Part II, Item 1 “Legal Proceedings” and Note 14 in the “Notes to Unaudited Condensed Consolidated Financial Statements” included in Part I, Item 1 of this Quarterly Report, and Part I, Item 3 “Legal Proceedings” and Note 19 in the “Notes to Consolidated Financial Statements” included in Part II, Item 8 of our Annual Report filed with the SEC on February 16, 2022.
Any litigation regarding intellectual property could be costly and time-consuming and could divert the attention of our management and key personnel from our business operations. Significant judgments are required for the determination of probability and the range of the outcomes in any legal dispute, and the estimates are based only on the information available to us at the time. Due to the inherent uncertainties involved in claims, legal proceedings, and in estimating the losses that may arise, actual outcomes may differ from our estimates. Contingencies deemed not probable or for which losses were not estimable in one period may become probable, or losses may become estimable in later periods which may have a material impact on our results of operations and financial position. Intellectual property disputes could subject us to significant liabilities, require us to enter into royalty and licensing arrangements on unfavorable terms, prevent us from manufacturing or licensing certain of our products, cause severe disruptions to our operations or the markets in which we compete, or require us to satisfy indemnification commitments to our customers. Any of these could seriously harm our business.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer purchases of equity securities
Common stock repurchased in the three months ended March 31, 2022:
(in thousands, except per share amounts)
Total Number of Shares Purchased (1) (2)
Average
Price Paid
per Share (1) (2)
Total Number of Shares Purchased as Part of Publicly Announced Share Repurchase Program (2)
Approximate Dollar Value of Shares That May Yet Be Purchased at Period End Under Publicly Announced Share Repurchase Programs (2)
January 1, 2022 - January 31, 2022
118
$
99.46
101
$
12,584
February 1, 2022 - February 28, 2022
141
90.97
103
$
3,085
March 1, 2022 - March 31, 2022
196
82.52
38
$
—
455
$
89.54
242
(1) Shares withheld to cover the option exercise price and tax withholding obligations under the net settlement provisions of our stock compensation awards have been included in these amounts.
(2) On June 8, 2021, we announced that our Board of Directors extended the current stock repurchase program’s expiration date to June 30, 2022 and increased the remaining stock repurchase authority to $60 million. See "Liquidity and Capital Resources" in Part I, Item 2 of this Quarterly Report for additional information.
ITEM 5. OTHER INFORMATION
Effective on March 31, 2022, 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”). 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 and transitions the Credit Agreement from the U.S. dollar London Interbank Offered Rate (“LIBOR”) to the Secured Overnight Financing Rate (“SOFR”) for floating rate loan commitments under the Credit Agreement.
28
The description of the Credit Agreement contained herein is qualified in its entirety by reference to the Credit Agreement, a copy of which is filed as Exhibit 10.1 to this Quarterly Report on Form 10-Q.
Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
X
++ Indicates that the exhibit is being furnished with this report and is not filed as a part of it.
** Certain portions of this exhibit are considered confidential and have been omitted as allowed under SEC rules and regulations.
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:
April 28, 2022
By:
/s/ KENNETH STILLWELL
Kenneth Stillwell
Chief Operating Officer and Chief Financial Officer
