What changed in this filing

/stocks — the workspaceLOADING

Item 1. Financial Statements

2021-04-28 compared with 2020-10-28 · 214 added, 220 removed, 341 unchanged (56% of the section changed)

3 unchanged sentences

(in thousands)

September 30, 2020 December 31, 2019

March 31, 2021 December 31, 2020

Current assets:

27 unchanged sentences

81,246 and 80,890 shares issued and outstanding at

September 30, 2020 and December 31, 2019, respectively

March 31, 2021 and December 31, 2020, respectively

Additional paid-in capital 140,558 204,432

8 unchanged sentences

Three Months Ended

September 30, Nine Months Ended

September 30,

2020 2019 2020 2019

Software license $ 116,961 $ 93,916

15 unchanged sentences

Total operating expenses 229,451 210,381

(Loss) from operations ( 61,832 ) ( 46,767 ) ( 137,597 ) ( 133,133 )

Foreign currency transaction gain (loss) 4,236 ( 1,970 ) 2,545 ( 3,577 )

Income (loss) from operations 1,601 ( 24,318 )

Foreign currency transaction (loss) ( 5,098 ) ( 5,947 )

Interest income 153 607

Interest expense ( 1,880 ) ( 2,306 )

Gain on capped call transactions 18,989 — 19,816 —

(Loss) on capped call transactions ( 19,117 ) ( 18,592 )

Other income, net 106 1,374

13 unchanged sentences

Three Months Ended

September 30, Nine Months Ended

September 30,

2020 2019 2020 2019

Net (loss) $ ( 6,617 ) $ ( 25,372 )

Other comprehensive (loss) income, net of tax

Unrealized (loss) gain on available-for-sale securities ( 166 ) ( 216 ) ( 66 ) 396

Other comprehensive income (loss), net of tax

Unrealized gain on available-for-sale securities 1,010 100

Foreign currency translation adjustments ( 730 ) ( 514 )

Total other comprehensive (loss) income, net of tax $ ( 53 ) $ ( 2,417 ) $ 1,561 $ ( 587 )

Total other comprehensive income (loss), net of tax 280 ( 414 )

Comprehensive (loss) $ ( 6,337 ) $ ( 25,786 )

7 unchanged sentences

December 31, 2019 79,599 $ 796 $ 140,523 $ 410,919 $ ( 13,228 ) $ 539,010

Repurchase of common stock ( 144 ) ( 1 ) ( 7,586 ) — — ( 7,587 )

Issuance of common stock for share-based compensation plans 514 5 ( 14,843 ) — — ( 14,838 )

Stock-based compensation — — 18,406 — — 18,406

Cash dividends declared ($ 0.03 per share)

— — — ( 2,367 ) — ( 2,367 )

Other comprehensive income — — — — 2,001 2,001

Net (loss) — — — ( 28,717 ) — ( 28,717 )

March 31, 2019 78,896 $ 789 $ 119,182 $ 479,779 $ ( 11,321 ) $ 588,429

Repurchase of common stock ( 88 ) ( 1 ) ( 6,301 ) — — ( 6,302 )

Issuance of common stock for share-based compensation plans 320 3 ( 11,217 ) — — ( 11,214 )

Issuance of common stock under the employee stock purchase plan 16 — 1,103 — — 1,103

Stock-based compensation — — 20,113 — — 20,113

Cash dividends declared ($ 0.03 per share)

— — — ( 2,375 ) — ( 2,375 )

Other comprehensive (loss) — — — — ( 171 ) ( 171 )

Net (loss) — — — ( 32,296 ) — ( 32,296 )

June 30, 2019 79,144 $ 791 $ 122,880 $ 445,108 $ ( 11,492 ) $ 557,287

Repurchase of common stock ( 88 ) ( 1 ) ( 6,396 ) — — ( 6,397 )

Issuance of common stock for share-based compensation plans 268 3 ( 8,804 ) — — ( 8,801 )

Stock-based compensation — — 21,879 — — 21,879

Cash dividends declared ($ 0.03 per share)

— — — ( 2,381 ) — ( 2,381 )

Other comprehensive (loss) — — — — ( 2,417 ) ( 2,417 )

Net (loss) — — — ( 30,338 ) — ( 30,338 )

September 30, 2019 79,324 $ 793 $ 129,559 $ 412,389 $ ( 13,909 ) $ 528,832

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands, except per share amounts)

Paid-In Capital Retained Earnings Accumulated Other Comprehensive (Loss)

Stockholders’ Equity

of Shares Amount

December 31, 2019 79,599 $ 796 $ 140,523 $ 410,919 $ ( 13,228 ) $ 539,010

Equity component of convertible senior notes, net — — 61,604 — — 61,604

Repurchase of common stock ( 87 ) ( 1 ) ( 5,999 ) — — ( 6,000 )

Issuance of common stock for share-based compensation plans 564 6 ( 23,017 ) — — ( 23,011 )

Issuance of common stock for stock compensation plans 564 6 ( 23,017 ) — — ( 23,011 )

Stock-based compensation — — 23,199 — — 23,199

4 unchanged sentences

March 31, 2020 80,076 $ 801 $ 196,310 $ 383,142 $ ( 13,642 ) $ 566,611

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 share-based compensation plans 349 3 ( 14,085 ) — — ( 14,082 )

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

4 unchanged sentences

Net (loss) — — — ( 6,617 ) — ( 6,617 )

June 30, 2020 80,420 $ 804 $ 207,103 $ 359,989 $ ( 11,614 ) $ 556,282

Repurchase of common stock ( 94 ) ( 1 ) ( 10,628 ) — — ( 10,629 )

Issuance of common stock for share-based compensation plans 371 4 ( 22,524 ) — — ( 22,520 )

Stock-based compensation — — 27,931 — — 27,931

Cash dividends declared ($ 0.03 per share)

— — — ( 2,422 ) — ( 2,422 )

Other comprehensive (loss) — — — — ( 53 ) ( 53 )

Net (loss) — — — ( 19,267 ) — ( 19,267 )

September 30, 2020 80,697 $ 807 $ 201,882 $ 338,300 $ ( 11,667 ) $ 529,322

March 31, 2021 81,246 $ 812 $ 140,558 $ 340,223 $ ( 2,668 ) $ 478,925

See notes to unaudited condensed consolidated financial statements.

2 unchanged sentences

(in thousands)

Nine Months Ended

September 30,

Three Months Ended

Operating activities

Net (loss) $ ( 6,617 ) $ ( 25,372 )

Adjustments to reconcile net (loss) to cash (used in) operating activities

Adjustments to reconcile net (loss) to cash provided by (used in) operating activities

Stock-based compensation 30,100 23,175

(Gain) on capped call transactions ( 19,816 ) —

Loss on capped call transactions 19,117 18,592

Deferred income taxes ( 15,068 ) ( 9,231 )

Amortization of deferred commissions 11,496 8,497

Lease expense 11,997 10,454

Amortization of debt discount and issuance costs 673 1,719

1 unchanged sentence

Amortization of investments 1,019 —

Foreign currency transaction (gain) loss ( 2,545 ) 3,577

Foreign currency transaction loss 5,098 5,947

Other non-cash ( 556 ) 2,478

Change in operating assets and liabilities, net ( 30,618 ) ( 49,047 )

Cash (used in) operating activities ( 26,257 ) ( 13,462 )

Cash provided by (used in) operating activities 21,650 ( 18,323 )

Investing activities

4 unchanged sentences

Investment in property and equipment ( 1,784 ) ( 12,496 )

Cash (used in) provided by investing activities ( 210,701 ) 53,448

Cash provided by (used in) investing activities 15,489 ( 12,562 )

Financing activities

2 unchanged sentences

Payment of debt issuance costs — ( 14,527 )

Dividend payments to shareholders ( 7,206 ) ( 7,105 )

Proceeds from employee stock purchase plan 2,288 —

Dividend payments to stockholders ( 2,427 ) ( 2,388 )

Common stock repurchases ( 34,655 ) ( 29,011 )

Cash provided by (used in) financing activities 449,630 ( 61,941 )

Cash (used in) provided by financing activities ( 34,794 ) 502,174

Effect of exchange rate changes on cash and cash equivalents ( 1,536 ) ( 1,510 )

Net increase (decrease) in cash and cash equivalents 212,855 ( 22,318 )

Net increase in cash and cash equivalents 809 469,779

Cash and cash equivalents, beginning of period 171,899 68,363

7 unchanged sentences

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, 2019.

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.

The financial statements should be read in conjunction with the Company’s audited financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2020.

In the opinion of management, the Company has prepared the accompanying unaudited condensed consolidated financial statements on the same basis as its audited financial statements, and these financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented.

All intercompany transactions and balances have been eliminated in consolidation.

All intercompany transactions and balances were eliminated in consolidation.

The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year 2021.

4 unchanged sentences

The standard eliminates the liability and equity separation model for convertible instruments with a cash conversion feature.

As a result, after adoption, entities will no longer separately present in equity an embedded conversion feature for such debt.

Additionally, the embedded conversion feature will no longer be amortized into income as interest expense over the instrument’s life.

As a result, after adoption, entities will no longer separately present in stockholders’ equity an embedded conversion feature for such debt.

Additionally, the debt discount resulting from the separation of the embedded conversion feature will no longer be amortized into income as interest expense over the instrument’s life.

Instead, entities will account for a convertible debt instrument wholly as debt unless (1) a convertible instrument contains features that require bifurcation as a derivative under ASC Topic 815, Derivatives and Hedging, or (2) a convertible debt instrument was issued at a substantial premium.

Additionally, the standard requires applying the if-converted method to calculate convertible instruments’ impact on diluted earnings per share (“EPS”).

The standard is effective for fiscal years beginning after December 15, 2021, with early adoption permitted for fiscal years beginning after December 15, 2020.

It can be adopted on either a full retrospective or modified retrospective basis.

The Company is currently evaluating the effect this ASU will have on its consolidated financial statements and related disclosures.

The Company expects to early adopt the new standard on January 1, 2021.

Financial instruments

In June 2016, the FASB issued ASU No.

2016-13, “Financial Instruments - Credit Losses (Topic 326):

Measurement of Credit Losses on Financial Instruments,” which requires measurement and recognition of expected credit losses for financial assets measured at amortized cost, including accounts receivable, upon initial recognition of that financial asset using a forward-looking expected loss model, rather than an incurred loss model.

Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses when the fair value is below the asset’s amortized cost, removing the concept of “other-than-temporary” impairments.

The Company adopted this standard effective January 1, 2020.

The adoption of this standard did not have a material effect on the Company’s financial position or results of operations.

The standard also requires the convertible instruments’ impact on diluted earnings per share (“EPS”) be determined using the if-converted method.

The Company adopted ASU 2020-06 using the modified retrospective approach on January 1, 2021.

Upon adoption, the book value of the Company’s Convertible Senior Notes (the “Notes”) increased by $ 69.5 million to $ 587.7 million, and retained earnings increased by $ 9.4 million.

The retained earnings adjustment reflects the tax effected difference between the value of the Notes and the embedded conversion feature before adoption and the combined convertible instrument's amortized cost after adoption.

Debt" for additional information.

MARKETABLE SECURITIES

September 30, 2020

(in thousands) Amortized Cost Unrealized Gains Unrealized Losses Fair Value

March 31, 2021 December 31, 2020

(in thousands) Amortized Cost Unrealized Gains Unrealized Losses Fair Value Amortized Cost Unrealized Gains Unrealized Losses Fair Value

Government debt $ 13,000 $ 1 $ — $ 13,001 $ 39,996 $ — $ ( 8 ) $ 39,988

1 unchanged sentence

$ 270,003 $ 16 $ ( 369 ) $ 269,650 $ 293,341 $ 88 $ ( 160 ) $ 293,269

As of September 30, 2020, maturities of marketable securities ranged from October 2020 to September 2023, with a weighted-average remaining maturity of approximately 1.3 years.

As of December 31, 2019, the Company did not hold any marketable securities.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

As of March 31, 2021, marketable securities’ maturities ranged from April 2021 to January 2024, with a weighted-average remaining maturity of approximately 1.4 years.

RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE

(in thousands)

September 30, 2020 December 31, 2019

March 31, 2021 December 31, 2020

Accounts receivable $ 159,324 $ 215,827

2 unchanged sentences

$ 495,975 $ 536,260

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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 are expected to be billed in the future as follows:

Unbilled receivables by expected billing date:

(Dollars in thousands)

September 30, 2020

March 31, 2021

1 year or less $ 228,603 68 %

2 unchanged sentences

$ 336,651 100 %

Unbilled receivables based upon contract effective date:

Unbilled receivables by contract effective date:

(Dollars in thousands)

September 30, 2020

March 31, 2021

2021 $ 46,625 14 %

5 unchanged sentences

Major clients

Clients accounting for 10% or more of the Company’s receivables:

September 30, 2020 December 31, 2019

Client A 11 % *

* Client accounted for less than 10% of total receivables.

Contract assets and deferred revenue

No client represented 10% or more of the Company’s total receivables as of March 31, 2021 or December 31, 2020.

Contract assets

Contract assets are client-committed amounts for which revenue recognized exceeds the amount billed to the client, and billing is subject to conditions other than the passage of time, such as completing a related performance obligation.

(in thousands)

September 30, 2020 December 31, 2019

March 31, 2021 December 31, 2020

Contract assets (1)

2 unchanged sentences

$ 20,738 $ 23,073

(1) Included in other current assets.

(2) Included in other long-term assets.

Deferred revenue

Deferred revenue consists of billings and payments received in advance of revenue recognition.

(in thousands)

March 31, 2021 December 31, 2020

Deferred revenue $ 244,170 $ 232,865

Long-term deferred revenue (1)

$ 251,735 $ 241,856

(1) Included in other current assets.

(2) Included in other long-term assets.

(1) Included in other long-term liabilities.

Contract assets are client committed amounts for which revenue recognized exceeds the amount billed to the client and the right to payment is subject to conditions other than the passage of time, such as the completion of a related performance obligation.

Deferred revenue consists of billings and payments received in advance of revenue recognition.

Contract assets and deferred revenue are netted at the contract level for each reporting period.

The change in deferred revenue in the nine months ended September 30, 2020 was primarily due to new billings in advance of revenue recognition, and $ 170.5 million of revenue recognized during the period that was included in deferred revenue at December 31, 2019.

The change in deferred revenue in the three months ended March 31, 2021 was primarily due to new billings in advance of revenue recognition offset by $ 107.0 million of revenue recognized that was included in deferred revenue as of December 31, 2020.

DEFERRED COMMISSIONS

(in thousands)

September 30, 2020 December 31, 2019

March 31, 2021 December 31, 2020

Deferred commissions (1)

1 unchanged sentence

(1) Included in other long-term assets.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Three Months Ended

September 30, Nine Months Ended

September 30,

(in thousands) 2021 2020

2 unchanged sentences

(1) Included in selling and marketing expense .

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

GOODWILL AND OTHER INTANGIBLES

Change in goodwill:

Three Months Ended

(in thousands)

January 1, $ 79,231 $ 79,039

Acquisition 2,701 —

Currency translation adjustments 105 ( 541 )

March 31, $ 82,037 $ 78,498

Intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives.

March 31, 2021

(in thousands) Useful Lives Cost Accumulated Amortization Net Book Value (1)

Client-related

$ 63,180 $ ( 56,260 ) $ 6,920

67,142 ( 57,014 ) 10,128

5,361 ( 5,361 ) —

$ 135,683 $ ( 118,635 ) $ 17,048

(1) Included in other long-term assets.

December 31, 2020

(in thousands) Useful Lives Cost Accumulated Amortization Net Book Value (1)

Client-related 4 - 10 years

$ 63,168 $ ( 55,877 ) $ 7,291

Technology 2 - 10 years

64,843 ( 56,386 ) 8,457

Other 1 - 5 years

5,361 ( 5,361 ) —

$ 133,372 $ ( 117,624 ) $ 15,748

(1) Included in other long-term assets.

Amortization of intangible assets:

Three Months Ended

(in thousands) 2021 2020

Cost of revenue

Selling and marketing

$ 1,002 $ 1,018

Future estimated intangibles assets amortization:

(in thousands)

March 31, 2021

2026 and thereafter 1,201

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Corporate headquarters

In February 2021, the Company agreed to accelerate its exit from its Cambridge, Massachusetts headquarters to October 1, 2021, in exchange for a one-time payment from the Company’s landlord of $ 18 million.

Upon modification, the Company reduced its lease liabilities by $ 21.1 million and accelerated depreciation of property, plant, and equipment related to the corporate headquarters.

Three Months Ended

(in thousands) 2021 2020

Fixed lease costs $ 300 $ 4,818

Short-term lease costs 459 455

Variable lease costs 1,387 1,278

$ 2,146 $ 6,551

Right of use assets and lease liabilities

(in thousands) March 31, 2021 December 31, 2020

Right of use assets (1)

$ 44,330 $ 67,651

Lease liabilities (2)

$ 14,161 $ 18,541

Long-term lease liabilities $ 36,471 $ 59,053

(1) Represents the Company’s right to use the leased asset during the lease term.

Included in other long-term assets.

(2) Included in other current liabilities.

Weighted-average remaining lease term and discount rate for the Company’s leases were:

March 31, 2021 December 31, 2020

Weighted-average remaining lease term 5.1 years 4.7 years

Weighted-average discount rate (1)

(1) The rates implicit in most of the Company’s leases are not readily determinable.

Therefore, the Company uses its incremental borrowing rate as the discount rate when measuring operating lease liabilities.

The incremental borrowing rate represents an estimate of the interest rate the Company would incur to borrow an amount equal to the lease payments on a collateralized basis over the lease term in a similar economic environment.

Maturities of lease liabilities:

(in thousands) March 31, 2021

1 year or less $ 13,216

1-2 years 11,538

2-3 years 10,896

3-4 years 7,571

Greater than 4 years 14,274

Total lease payments 57,495

imputed interest (1)

(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

(in thousands) 2021 2020

Cash paid for leases $ 6,716 $ 5,520

Right of use assets recognized for new leases and amendments (non-cash) $ 714 $ 551

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Convertible senior notes and capped calls

Convertible senior notes

In February 2020, the Company issued Convertible Senior Notes (the "Notes") with an aggregate principal amount of $ 600 million, due March 1, 2025, in a private placement.

The proceeds from the Notes were used or are anticipated to be used for the Capped Call Transactions (described below), working capital, and other general corporate purposes.

There are no required principal payments prior to the maturity of the Notes.

In February 2020, the Company issued Convertible Senior Notes (the "Notes") with an aggregate principal of $ 600 million, due March 1, 2025, in a private placement.

No principal payments are required before maturity.

The Notes accrue interest at an annual rate of 0.75 %, payable semi-annually in arrears on March 1 and September 1, beginning on September 1, 2020.

Proceeds from the Notes and Capped Call Transactions:

(in thousands) Amount

Principal $ 600,000

issuance costs ( 14,527 )

Capped Call Transactions ( 51,900 )

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 approximately $ 135.05 per share of common stock.

The Company will settle conversions by paying or delivering, as applicable, 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 the occurrence of certain events, including spin-offs, tender offers, exchange offers, and certain stockholder distributions.

The conversion rate is 7.4045 shares of common stock per $ 1,000 principal amount of the Notes, representing an initial conversion price of $ 135.05 per share of common stock.

The Company will settle conversions by paying or delivering cash, shares of its common stock, or a combination of cash and shares of its common stock, at the Company’s election, based on the applicable conversion rate.

The conversion rate will be adjusted upon certain events, including spin-offs, tender offers, exchange offers, and certain stockholder distributions.

Beginning on September 1, 2024, noteholders may convert their Notes at any time at their election.

Before September 1, 2024, noteholders may convert their Notes in the following circumstances:

• During any calendar quarter commencing after the calendar quarter ending on June 30, 2020 (and only during such calendar quarter), if the last reported sale price per share of the Company’s common stock exceeds one hundred and thirty percent ( 130 %) of the conversion price for each of at least twenty ( 20 ) trading days (whether or not consecutive) during the thirty ( 30 ) consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter.

• During any calendar quarter commencing after June 30, 2020 (and only during such calendar quarter), if the last reported sale price per share of the Company’s common stock exceeds 130 % of the conversion price for each of at least 20 trading days (whether or not consecutive) during the 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter.

• During the five consecutive business days immediately after any five consecutive trading day period (the “Measurement Period”), if the trading price per $1,000 principal amount of Notes for each trading day of the Measurement Period was less than 98 % of the product of the last reported sale price per share of common stock on such trading day and the conversion rate on such trading day.

• Upon the occurrence of certain corporate events or distributions, or if the Company calls all or any Notes for redemption, then the noteholder of any Note may convert such Note at any time 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 due on such redemption date in full, at any time until the Company pays such redemption price in full).

As of September 30, 2020, no Notes were eligible for conversion at the noteholders’ election.

• 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, 2021, the Notes were not eligible for conversion at the noteholders’ election.

Repurchase rights

On or after March 1, 2023 and on or before the 40th scheduled trading day immediately before the maturity date, the Company may redeem for cash all or part of the Notes at a repurchase price equal to 100 % of the principal amount, plus accrued and unpaid interest, if the last reported sale price of the Company’s common stock exceeded 130 % of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period ending on, and including, the trading day immediately preceding the date on which the Company provides a redemption notice.

If certain corporate events that constitute a “Fundamental Change” (as described below) occur at any time, each noteholder will have the right, at such noteholder’s option, 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 an integral 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 events such as mergers, changes in control of the Company, liquidation/dissolution of the Company, or the delisting of the Company’s common stock.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

If certain corporate events that constitute a “Fundamental Change” occur, each noteholder will have the right to require the Company to repurchase for cash all of such noteholder’s Notes, or any portion of the principal thereof that is equal to $1,000 or a multiple of $1,000, at a repurchase price equal to 100 % of the principal amount thereof, plus accrued and unpaid interest.

A Fundamental Change relates to mergers, changes in control of the Company, liquidation/dissolution of the Company, or the delisting of the Company’s common stock.

Impact of the Notes

In accounting for the transaction, the Notes have been separated into liability and equity components.

The Company adopted ASU 2020-06 using the modified retrospective approach on January 1, 2021.

The standard eliminates the liability and equity separation model for convertible instruments with a cash conversion feature.

New Accounting Pronouncements" for additional information.

Until January 1, 2021, the Notes were separated into liability and equity components.

• The initial carrying amount of the liability component was calculated by measuring a similar debt instrument’s fair value that does not have an associated conversion feature.

The excess of the Notes’ principal amount over the initial carrying amount of the liability component, the debt discount, is amortized as interest expense over the Notes’ contractual term.

• The equity component was recorded as an increase to additional paid-in capital and is not remeasured as long as it continues to meet the conditions for equity classification.

The Company incurred issuance costs of $ 14.5 million related to the Notes, allocated between the Notes’ liability and equity components proportionate to the initial carrying amount of the liability and equity components.

• Issuance costs attributable to the liability component are recorded as an offset to the Notes’ principal balance.

They are amortized as interest expense using the effective interest method over the contractual term of the Notes.

• Issuance costs attributable to the equity component are recorded as an offset to the equity component in additional paid-in capital and are not amortized.

Net carrying amount of the liability component:

(in thousands) September 30, 2020

The excess of the Notes’ principal amount over the initial carrying amount of the liability component, the debt discount, was amortized as interest expense over the Notes’ contractual term.

• The equity component was recorded as an increase to additional paid-in capital and not remeasured.

Upon adoption of ASU 2020-06, the book value of the Company’s Convertible Senior Notes (the “Notes”) increased by $ 69.5 million to $ 587.7 million, and retained earnings increased by $ 9.4 million.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Carrying value of the Notes:

(in thousands) March 31, 2021 December 31, 2020

Principal $ 600,000 $ 600,000

1 unchanged sentence

Unamortized issuance costs ( 11,582 ) ( 10,575 )

Net carrying amount of the equity component, included in additional paid-in capital:

(in thousands) September 30, 2020

Convertible senior notes, net $ 588,418 $ 518,203

Conversion options $ — $ 84,120

(1) Net of issuance costs and taxes.

Issuance costs — ( 2,037 )

Deferred taxes — ( 20,479 )

Additional paid-in capital $ — $ 61,604

Interest expense related to the Notes:

Three Months Ended

September 30, Nine Months Ended

September 30,

(in thousands) 2021 2020

2 unchanged sentences

Amortization of debt discount

3,807 — 9,060 —

Amortization of issuance costs

$ 1,798 $ 2,169

$ 5,497 $ — $ 13,105 $ —

(1) Amortized based upon an effective interest rate of 4.31 %.

Weighted-average effective interest rate 1.2 % 4.3 %

Future payments of principal and contractual interest:

September 30, 2020

March 31, 2021

(in thousands) Principal Interest Total

5 unchanged sentences

$ 600,000 $ 17,238 $ 617,238

$ 600,000 $ 19,488 $ 619,488

Capped call transactions

1 unchanged sentence

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.

They are generally expected to reduce potential dilution to the common stock upon any conversion of Notes and/or offset any potential cash payments the Company is required to make in excess of the principal amount of converted Notes, as the case may be, with such reduction and/or offset subject to a cap.

The cap price of the Capped Call Transactions is $ 196.44 , subject to adjustment upon the occurrence of specified extraordinary events affecting the Company, including merger events and tender offers.

The Capped Call Transactions are generally expected to reduce common stock dilution and/or offset any potential cash payments the Company is required to make, other than for principal and interest, upon conversion of the Notes, with such reduction and/or offset subject to a cap of $ 196.44 .

The cap price of the Capped Call Transactions is subject to adjustment upon the occurrence of specified extraordinary events affecting the Company, including mergers and tender offers.

The Capped Call Transactions are accounted for as derivative instruments and do not qualify for the Company’s own equity scope exception in ASC 815 since, in some cases of early settlement, the settlement value of the Capped Call Transactions, calculated in accordance with the governing documents, may not represent a fair value measurement.

The Capped Call Transactions are classified as “other long-term assets” and remeasured to fair value at the end of each reporting period, resulting in a non-operating gain or loss.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The Capped Call Transactions are accounted for as derivative instruments.

The Capped Call Transactions do not qualify for the Company’s own equity scope exception in ASC 815 since, in some cases of early settlement, the settlement value of the Capped Call Transactions, calculated in accordance with the governing documents, may not represent a fair value measurement.

The Capped Call Transactions are classified as “other long term assets” and remeasured to fair value at the end of each reporting period, resulting in a non-operating gain or loss.

Change in value of Capped Call Transactions:

(in thousands) Nine Months Ended

September 30, 2020

Value at issuance $ 51,900

Change in capped call transactions:

Three Months Ended

(in thousands) 2021 2020

January 1, $ 83,597 $ —

Issuance — 51,900

Fair value adjustment ( 19,117 ) ( 18,592 )

Balance as of September 30, $ 71,716

March 31, $ 64,480 $ 33,308

Credit facility

In November 2019, and as amended in February 2020, July 2020, and October 2020, the Company entered into a five-year $ 100 million senior secured revolving credit agreement (the “Credit Facility”) with PNC Bank, National Association (“PNC”).

In November 2019, and as amended as of February 2020, July 2020, and September 2020, the Company entered into a five-year $ 100 million senior secured revolving credit agreement (the “Credit Facility”) with PNC Bank, National Association (“PNC”).

The Company may use borrowings to finance working capital needs and for general corporate purposes.

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• Beginning with the quarter ended on March 31, 2022 a maximum net consolidated leverage ratio of 3.5 to 1.0 (with a step-up in the event of certain acquisitions) and a minimum consolidated interest coverage ratio of 3.5 to 1.0.

As of September 30, 2020 and December 31, 2019, we had no outstanding borrowings under the Credit Facility.

As of March 31, 2021 and December 31, 2020, the Company had no outstanding borrowings under the Credit Facility.

FAIR VALUE MEASUREMENTS

Assets and liabilities measured at fair value on a recurring basis

The Company records its cash equivalents, Capped Call Transactions, and venture investments 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.

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The fair value of the Capped Call Transactions at the end of each reporting period is determined using a Black-Scholes option-pricing model.

The valuation models use various market-based inputs, including stock price, remaining contractual term, expected volatility, risk-free interest rate, and expected dividend yield, as applicable.

The Company applies judgment in its determination of expected volatility.

The Company considers both historical and implied volatility levels of the underlying equity security and, to a lesser extent, historical peer group volatility levels.

The Company’s venture investments are recorded at fair value based on valuation methods using the observable transaction price and other unobservable inputs, including the volatility, rights, and obligations of the securities the Company holds.

The Company’s assets and liabilities measured at fair value on a recurring basis:

September 30, 2020 December 31, 2019

The valuation models use various market-based inputs, including stock price, remaining contractual term, expected volatility, risk-free interest rate, and expected dividend yield.

The Company applies judgment when determining expected volatility.

The Company considers both historical and implied volatility levels of the underlying equity security.

The Company’s venture investments are recorded at fair value based on valuation methods, including observable public companies and transaction prices and unobservable inputs, including the volatility, rights, and obligations of the securities the Company holds.

Assets and liabilities measured at fair value on a recurring basis:

March 31, 2021 December 31, 2020

(in thousands) Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total

Cash equivalents $ 26,657 $ — $ — $ 26,657 $ 42,339 $ 14,000 $ — $ 56,339

$ 212,917 $ — $ — $ 212,917 $ — $ — $ — $ —

Marketable securities $ — $ 269,650 $ — $ 269,650 $ — $ 293,269 $ — $ 293,269

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$ — $ — $ 9,756 $ 9,756 $ — $ — $ 8,345 $ 8,345

(1) Investments in money market funds.

(1) Included in other long-term assets.

Debt" for additional information.

(2) Investments in privately-held companies.

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Change in venture investments:

(in thousands) Nine Months Ended

September 30, 2020

December 31, 2019 $ 4,871

Three Months Ended

(in thousands) 2021 2020

January 1, $ 8,345 $ 4,871

New investments 500 1,490

Sales of investments ( 400 ) ( 1,424 )

Fair value adjustment 1,474

September 30, 2020 $ 7,927

The carrying value of certain other financial instruments, including receivables and accounts payable, approximates fair value due to the relatively short maturity of these items.

Changes in foreign exchange rates ( 9 ) ( 73 )

Changes in fair value:

included in other income 100 1,374

included in other comprehensive income 1,220 100

March 31, $ 9,756 $ 6,338

The carrying value of certain other financial instruments, including receivables and accounts payable, approximates fair value due to these items’ relatively short maturity.

Fair value of the Notes

The fair value of the Company’s Notes was recorded at $ 515.9 million upon issuance, which reflected the principal amount of the Notes less the fair value of the conversion feature.

The fair value of the debt component was determined based on a discounted cash flow model.

The discount rate used reflected both the time value of money and credit risk inherent in the Notes.

The carrying value of the Notes will be accreted, over the remaining term to maturity, to their principal value of $ 600 million.

The Notes’ fair value (inclusive of the conversion feature, which is embedded in the Notes) was $ 680 million as of September 30, 2020.

The Notes’ fair value (inclusive of the conversion feature embedded in the Notes) was $ 665.9 million as of March 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.

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Three Months Ended

September 30, Nine Months Ended

September 30,

(Dollars in thousands)

$ 194,568 62 % $ 172,417 65 %

$ 120,971 53 % $ 123,447 57 % $ 436,199 61 % $ 347,120 55 %

Other Americas 11,901 4 % 15,342 6 %

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Three Months Ended

September 30, Nine Months Ended

September 30,

(in thousands)

2020 2019 2020 2019

Perpetual license $ 5,452 $ 3,659

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(in thousands) Three Months Ended

September 30, Nine Months Ended

September 30,

2020 2019 2020 2019

Pega Cloud $ 67,858 $ 43,466

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Remaining performance obligations ("Backlog")

Expected future revenue on existing contracts:

September 30, 2020

Expected future revenue on existing non-cancellable contracts:

March 31, 2021

(Dollars in thousands)

5 unchanged sentences

$ 10,278 $ 58,331 $ 322,637 $ 564,316 $ 24,248 $ 979,810 100 %

September 30, 2019

March 31, 2020

(Dollars in thousands)

7 unchanged sentences

Three Months Ended

September 30, Nine Months Ended

September 30,

(in thousands) 2021 2020

2 unchanged sentences

Selling and marketing

12,658 8,317 33,968 24,055

Research and development

5,765 4,858 17,066 13,990

General and administrative

$ 30,100 $ 23,175

$ 27,925 $ 21,846 $ 76,755 $ 60,242

Income tax benefit

$ ( 5,991 ) $ ( 4,582 )

As of September 30, 2020, the Company had $ 115.0 million of unrecognized stock-based compensation expense, net of estimated forfeitures, which is expected to be recognized over a weighted-average period of 2.2 years.

The Company granted the following stock-based compensation awards:

Nine Months Ended

September 30, 2020

As of March 31, 2021, the Company had $ 183.4 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.

Three Months Ended

March 31, 2021

(in thousands) Shares Total Fair Value

1,026 $ 92,456

Non-qualified stock options

1,248 $ 47,380

Common stock 6 $ 701

PEGASYSTEMS INC.

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Three Months Ended

September 30, Nine Months Ended

September 30,

(Dollars in thousands) 2021 2020

(Benefit from) income taxes $ ( 17,618 ) $ ( 23,810 )

Effective income tax rate 48 % 32 %

During the nine months ended September 30, 2020, the Company’s effective income tax rate benefit increased primarily due to the excess tax benefits from stock-based compensation and a carryback claim benefit as a result of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) .

Effective income tax benefit rate 73 % 48 %

The increase in the Company’s effective income tax benefit rate was primarily due to excess tax benefits from stock-based compensation and fair value adjustments for the capped call transactions, which were proportionally larger on a lower loss before income taxes.

(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 the conversion spread of the Company’s convertible senior notes.

Calculation of the basic and diluted earnings per share:

Calculation of (loss) per share:

Three Months Ended

September 30, Nine Months Ended

September 30,

(in thousands, except per share amounts) 2021 2020

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Outstanding anti-dilutive stock options and RSUs (4)

6,622 5,953 6,166 5,923

(1) The Company expects to settle the principal amount of the Notes in cash.

As a result, only the amount by which the conversion value exceeds the aggregated principal amount of the Notes is included in the diluted earnings per share computation under the treasury stock method.

The conversion spread has a dilutive impact on diluted net income per share when the average market price of the Company’s common stock for a given period exceeds the initial conversion price of $ 135.05 per share for the Notes.

In connection with the Notes’ issuance, the Company entered into Capped Call Transactions, which were not included in calculating the number of diluted shares outstanding, as their effect would have been anti-dilutive.

(1) In periods of loss, all dilutive securities are excluded as their inclusion would be anti-dilutive.

(3) Certain outstanding stock options and RSUs were excluded from the computation of diluted earnings per share because they were anti-dilutive in the period presented.

(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 4.4 million shares.

(3) The Company’s Capped Call Transactions cover 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 excluded 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.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 1. Financial Statements