PEGASYSTEMS INC 10-Q

ITEM 1. FINANCIAL STATEMENTS PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) March 31, 2021 December 31, 2020 Assets Current assets: Cash and cash equivalents $ 172,708 $ 171,899 Marketable securities 269,650 293,269 Total cash, cash equivalents, and marketable securities 442,358 465,168 Accounts receivable 159,324 215,827 Unbilled receivables 228,603 207,155 Other current assets 91,868 88,760 Total current assets 922,153 976,910 Unbilled receivables 108,048 113,278 Goodwill 82,037 79,231 Other long-term assets 416,265 434,843 Total assets $ 1,528,503 $ 1,604,262 Liabilities and stockholders’ equity Current liabilities: Accounts payable $ 24,426 $ 24,028 Accrued expenses 59,765 59,261 Accrued compensation and related expenses 59,490 123,012 Deferred revenue 244,170 232,865 Other current liabilities 16,599 20,969 Total current liabilities 404,450 460,135 Convertible senior notes, net 588,418 518,203 Operating lease liabilities 36,471 59,053 Other long-term liabilities 20,239 24,699 Total liabilities 1,049,578 1,062,090 Stockholders’ equity: Preferred stock, 1,000 shares authorized; none issued — — Common stock, 200,000 shares authorized; 81,246 and 80,890 shares issued and outstanding at March 31, 2021 and December 31, 2020, respectively 812 809 Additional paid-in capital 140,558 204,432 Retained earnings 340,223 339,879 Accumulated other comprehensive (loss) ( 2,668 ) ( 2,948 ) Total stockholders’ equity 478,925 542,172 Total liabilities and stockholders’ equity $ 1,528,503 $ 1,604,262 See notes to unaudited condensed consolidated financial statements. 3 PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts) Three Months Ended March 31, 2021 2020 Revenue Software license $ 116,961 $ 93,916 Maintenance 75,561 73,695 Pega Cloud 67,858 43,466 Consulting 53,119 54,514 Total revenue 313,499 265,591 Cost of revenue Software license 650 684 Maintenance 5,786 5,576 Pega Cloud 22,557 17,533 Consulting 53,454 55,735 Total cost of revenue 82,447 79,528 Gross profit 231,052 186,063 Operating expenses Selling and marketing 148,739 136,024 Research and development 62,442 58,727 General and administrative 18,270 15,630 Total operating expenses 229,451 210,381 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 ) (Loss) on capped call transactions ( 19,117 ) ( 18,592 ) Other income, net 106 1,374 (Loss) before (benefit from) income taxes ( 24,235 ) ( 49,182 ) (Benefit from) income taxes ( 17,618 ) ( 23,810 ) Net (loss) $ ( 6,617 ) $ ( 25,372 ) (Loss) per share Basic $ ( 0.08 ) $ ( 0.32 ) Diluted $ ( 0.08 ) $ ( 0.32 ) Weighted-average number of common shares outstanding Basic 81,004 79,808 Diluted 81,004 79,808 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, 2021 2020 Net (loss) $ ( 6,617 ) $ ( 25,372 ) 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 income (loss), net of tax 280 ( 414 ) Comprehensive (loss) $ ( 6,337 ) $ ( 25,786 ) See notes to unaudited condensed consolidated financial statements. 5 PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (in thousands, except per share amounts) Common Stock Additional Paid-In Capital Retained Earnings Accumulated Other Comprehensive (Loss) Total Stockholders’ Equity Number of Shares Amount December 31, 2019 79,599 $ 796 $ 140,523 $ 410,919 $ ( 13,228 ) $ 539,010 Equity component of convertible senior notes, net — — 61,604 — — 61,604 Repurchase of common stock ( 87 ) ( 1 ) ( 5,999 ) — — ( 6,000 ) Issuance of common stock for stock compensation plans 564 6 ( 23,017 ) — — ( 23,011 ) Stock-based compensation — — 23,199 — — 23,199 Cash dividends declared ($ 0.03 per share) — — — ( 2,405 ) — ( 2,405 ) Other comprehensive (loss) — — — — ( 414 ) ( 414 ) Net (loss) — — — ( 25,372 ) — ( 25,372 ) March 31, 2020 80,076 $ 801 $ 196,310 $ 383,142 $ ( 13,642 ) $ 566,611 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 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, 2021 2020 Operating activities Net (loss) $ ( 6,617 ) $ ( 25,372 ) Adjustments to reconcile net (loss) to cash provided by (used in) operating activities Stock-based compensation 30,100 23,175 Loss on capped call transactions 19,117 18,592 Deferred income taxes ( 15,068 ) ( 9,231 ) Amortization of deferred commissions 11,496 8,497 Amortization of debt discount and issuance costs 673 1,719 Amortization of intangible assets and depreciation 7,006 4,919 Amortization of investments 1,019 — 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 provided by (used in) operating activities 21,650 ( 18,323 ) Investing activities Purchases of investments ( 21,051 ) ( 1,490 ) Proceeds from maturities and called investments 40,867 — Sales of investments 2,450 1,424 Payments for acquisitions, net of cash acquired ( 4,993 ) — Investment in property and equipment ( 1,784 ) ( 12,496 ) Cash provided by (used in) investing activities 15,489 ( 12,562 ) Financing activities Proceeds from issuance of convertible senior notes — 600,000 Purchase of capped calls related to convertible senior notes — ( 51,900 ) Payment of debt issuance costs — ( 14,527 ) Proceeds from employee stock purchase plan 2,288 — Dividend payments to stockholders ( 2,427 ) ( 2,388 ) Common stock repurchases ( 34,655 ) ( 29,011 ) 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 in cash and cash equivalents 809 469,779 Cash and cash equivalents, beginning of period 171,899 68,363 Cash and cash equivalents, end of period $ 172,708 $ 538,142 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. 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 were eliminated in consolidation. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year 2021. NOTE 2. NEW ACCOUNTING PRONOUNCEMENTS Convertible debt In August 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2020-06, “Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity” (“ASU 2020-06”), which simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts in an entity’s own equity. The standard eliminates the liability and equity separation model for convertible instruments with a cash conversion feature. As a result, after adoption, entities will no longer separately present in stockholders’ equity an embedded conversion feature for such debt. Additionally, the debt discount resulting from 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. The standard also requires the convertible instruments’ impact on diluted earnings per share (“EPS”) be determined using the if-converted method. The Company adopted ASU 2020-06 using the modified retrospective approach on January 1, 2021. Upon adoption, the book value of the Company’s Convertible Senior Notes (the “Notes”) increased by $ 69.5 million to $ 587.7 million, and retained earnings increased by $ 9.4 million. The retained earnings adjustment reflects the tax effected difference between the value of the Notes and the embedded conversion feature before adoption and the combined convertible instrument's amortized cost after adoption. See "Note 8. Debt" for additional information. NOTE 3. MARKETABLE SECURITIES 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 Corporate debt 257,003 15 ( 369 ) 256,649 253,345 88 ( 152 ) 253,281 $ 270,003 $ 16 $ ( 369 ) $ 269,650 $ 293,341 $ 88 $ ( 160 ) $ 293,269 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. NOTE 4. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE Receivables (in thousands) March 31, 2021 December 31, 2020 Accounts receivable $ 159,324 $ 215,827 Unbilled receivables 228,603 207,155 Long-term unbilled receivables 108,048 113,278 $ 495,975 $ 536,260 8 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 by expected billing date: (Dollars in thousands) March 31, 2021 1 year or less $ 228,603 68 % 1-2 years 80,688 24 % 2-5 years 27,360 8 % $ 336,651 100 % Unbilled receivables by contract effective date: (Dollars in thousands) March 31, 2021 2021 $ 46,625 14 % 2020 163,226 48 % 2019 63,600 19 % 2018 28,885 9 % 2017 and prior 34,315 10 % $ 336,651 100 % Major clients 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) March 31, 2021 December 31, 2020 Contract assets (1) $ 13,454 $ 15,296 Long-term contract assets (2) 7,284 7,777 $ 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) 7,565 8,991 $ 251,735 $ 241,856 (1) Included in other long-term liabilities. 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. NOTE 5. DEFERRED COMMISSIONS (in thousands) March 31, 2021 December 31, 2020 Deferred commissions (1) $ 103,474 $ 108,624 (1) Included in other long-term assets. Three Months Ended March 31, (in thousands) 2021 2020 Amortization of deferred commissions (1) $ 11,496 $ 8,497 (1) Included in selling and marketing expense . 9 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 6. GOODWILL AND OTHER INTANGIBLES Goodwill Change in goodwill: Three Months Ended March 31, (in thousands) 2021 2020 January 1, $ 79,231 $ 79,039 Acquisition 2,701 — Currency translation adjustments 105 ( 541 ) March 31, $ 82,037 $ 78,498 Intangibles 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 4 - 10 years $ 63,180 $ ( 56,260 ) $ 6,920 Technology 2 - 10 years 67,142 ( 57,014 ) 10,128 Other 1 - 5 years 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 March 31, (in thousands) 2021 2020 Cost of revenue $ 629 $ 647 Selling and marketing 373 371 $ 1,002 $ 1,018 Future estimated intangibles assets amortization: (in thousands) March 31, 2021 2021 $ 2,985 2022 3,886 2023 3,618 2024 2,849 2025 2,509 2026 and thereafter 1,201 $ 17,048 10 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 7. LEASES 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. Expense Three Months Ended March 31, (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) 4.7 % 5.4 % (1) The rates implicit in most of the Company’s leases are not readily determinable. Therefore, the Company uses its incremental borrowing rate as the discount rate when measuring operating lease liabilities. The incremental borrowing rate represents an estimate of the interest rate the Company would incur to borrow an amount equal to the lease payments on a collateralized basis over the lease term in a similar economic environment. Maturities of lease liabilities: (in thousands) 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 Less: imputed interest (1) ( 6,863 ) $ 50,632 (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) 2021 2020 Cash paid for leases $ 6,716 $ 5,520 Right of use assets recognized for new leases and amendments (non-cash) $ 714 $ 551 11 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 8. DEBT Convertible senior notes and capped calls Convertible senior notes In February 2020, the Company issued Convertible Senior Notes (the "Notes") with an aggregate principal of $ 600 million, due March 1, 2025, in a private placement. No principal payments are 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. Conversion rights The conversion rate is 7.4045 shares of common stock per $ 1,000 principal amount of the Notes, representing an initial conversion price of $ 135.05 per share of common stock. The Company will settle conversions by paying or delivering cash, shares of its common stock, or a combination of cash and shares of its common stock, at the Company’s election, based on the applicable conversion rate. The conversion rate will be adjusted upon certain events, including spin-offs, tender offers, exchange offers, and certain stockholder distributions. Beginning on September 1, 2024, noteholders may convert their Notes at any time at their election. Before September 1, 2024, noteholders may convert their Notes in the following circumstances: • During any calendar quarter 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 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” occur, each noteholder will have the right to require the Company to repurchase for cash all of such noteholder’s Notes, or any portion of the principal thereof that is equal to $1,000 or a multiple of $1,000, at a repurchase price equal to 100 % of the principal amount thereof, plus accrued and unpaid interest. A Fundamental Change relates to mergers, changes in control of the Company, liquidation/dissolution of the Company, or the delisting of the Company’s common stock. Impact of the Notes The Company adopted ASU 2020-06 using the modified retrospective approach on January 1, 2021. The standard eliminates the liability and equity separation model for convertible instruments with a cash conversion feature. See "Note 2. New Accounting Pronouncements" for additional information. Until January 1, 2021, the Notes were separated into liability and equity components. • The initial carrying amount of the liability component was calculated by measuring a similar debt instrument’s fair value that does not have an associated conversion feature. The excess of the Notes’ principal amount over the initial carrying amount of the liability component, the debt discount, was amortized as interest expense over the Notes’ contractual term. • The equity component was recorded as an increase to additional paid-in capital and not remeasured. Upon adoption of ASU 2020-06, the book value of the 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. 12 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 Unamortized debt discount — ( 71,222 ) Unamortized issuance costs ( 11,582 ) ( 10,575 ) Convertible senior notes, net $ 588,418 $ 518,203 Conversion options $ — $ 84,120 Issuance costs — ( 2,037 ) Deferred taxes — ( 20,479 ) Additional paid-in capital $ — $ 61,604 Interest expense related to the Notes: Three Months Ended March 31, (in thousands) 2021 2020 Contractual interest expense ( 0.75 % coupon) $ 1,125 $ 450 Amortization of debt discount — 1,497 Amortization of issuance costs 673 222 $ 1,798 $ 2,169 Weighted-average effective interest rate 1.2 % 4.3 % Future payments of principal and contractual interest: March 31, 2021 (in thousands) Principal Interest Total 2021 $ — $ 2,250 $ 2,250 2022 — 4,500 4,500 2023 — 4,500 4,500 2024 — 4,500 4,500 2025 600,000 1,488 601,488 $ 600,000 $ 17,238 $ 617,238 Capped call transactions In February 2020, the Company entered into privately negotiated capped call transactions (“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 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. 13 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Change in capped call transactions: Three Months Ended March 31, (in thousands) 2021 2020 January 1, $ 83,597 $ — Issuance — 51,900 Fair value adjustment ( 19,117 ) ( 18,592 ) March 31, $ 64,480 $ 33,308 Credit facility In November 2019, and as amended as of February 2020, July 2020, and September 2020, the Company entered into a five-year $ 100 million senior secured revolving credit agreement (the “Credit Facility”) with PNC Bank, National Association (“PNC”). The Company may use borrowings to finance working capital needs and for general corporate purposes. Subject to specific conditions, the Credit Facility allows the Company to increase the aggregate commitment to $ 200 million. The commitments expire on November 4, 2024, and any outstanding loans will be payable on such date. The Credit Facility, as amended, contains customary covenants, including, but not limited to, those relating to additional indebtedness, liens, asset divestitures, and affiliate transactions. The Company is also required to comply with financial covenants, including: • Beginning with the fiscal quarter ended on September 30, 2020 and ending with the fiscal quarter ended December 31, 2021 at least $ 200 million in cash and investments held by Pegasystems Inc. • Beginning with the quarter ended 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 March 31, 2021 and December 31, 2020, 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. As a basis for classifying the fair value measurements, a three-tier fair value hierarchy, which classifies the fair value measurements based on the inputs used in measuring fair value, was established as follows: • Level 1 - observable inputs such as quoted prices in active markets for identical assets or liabilities; • Level 2 - significant other inputs that are observable either directly or indirectly; and • Level 3 - significant unobservable inputs on which there is little or no market data, which require the Company to develop its own assumptions. This hierarchy requires the Company to use observable market data, when available, and minimize unobservable inputs when determining fair value. The fair value of the Capped Call Transactions at the end of each reporting period is determined using a Black-Scholes option-pricing model. The valuation models use various market-based inputs, including stock price, remaining contractual term, expected volatility, risk-free interest rate, and expected dividend yield. The Company applies judgment when determining expected volatility. The Company considers both historical and implied volatility levels of the underlying equity security. The Company’s venture investments are recorded at fair value based on valuation methods, including observable public companies and transaction prices and unobservable inputs, including the volatility, rights, and obligations of the securities the Company holds. Assets and liabilities measured at fair value on a recurring basis: 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 Marketable securities $ — $ 269,650 $ — $ 269,650 $ — $ 293,269 $ — $ 293,269 Capped Call Transactions (1) $ — $ 64,480 $ — $ 64,480 $ — $ 83,597 $ — $ 83,597 Venture investments (1) (2) $ — $ — $ 9,756 $ 9,756 $ — $ — $ 8,345 $ 8,345 (1) Included in other long-term assets. (2) Investments in privately-held companies. 14 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Change in venture investments: Three Months Ended March 31, (in thousands) 2021 2020 January 1, $ 8,345 $ 4,871 New investments 500 1,490 Sales of investments ( 400 ) ( 1,424 ) 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 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. See "Note 8. Debt" for additional information. NOTE 10. REVENUE Geographic revenue Three Months Ended March 31, (Dollars in thousands) 2021 2020 U.S. $ 194,568 62 % $ 172,417 65 % Other Americas 11,901 4 % 15,342 6 % United Kingdom (“U.K.”) 28,212 9 % 21,837 8 % Europe (excluding U.K.), Middle East, and Africa 51,659 16 % 31,938 12 % Asia-Pacific 27,159 9 % 24,057 9 % $ 313,499 100 % $ 265,591 100 % Revenue streams Three Months Ended March 31, (in thousands) 2021 2020 Perpetual license $ 5,452 $ 3,659 Term license 111,509 90,257 Revenue recognized at a point in time 116,961 93,916 Maintenance 75,561 73,695 Pega Cloud 67,858 43,466 Consulting 53,119 54,514 Revenue recognized over time 196,538 171,675 $ 313,499 $ 265,591 15 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) (in thousands) Three Months Ended March 31, 2021 2020 Pega Cloud $ 67,858 $ 43,466 Maintenance 75,561 73,695 Term license 111,509 90,257 Subscription (1) 254,928 207,418 Perpetual license 5,452 3,659 Consulting 53,119 54,514 $ 313,499 $ 265,591 (1) Reflects client arrangements subject to renewal (Pega Cloud, maintenance, and term license). Remaining performance obligations ("Backlog") Expected future revenue on existing non-cancellable contracts: March 31, 2021 (Dollars in thousands) Perpetual license Term license Maintenance Pega Cloud Consulting Total 1 year or less $ 9,649 $ 41,025 $ 220,100 $ 252,104 $ 21,068 $ 543,946 55 % 1-2 years 629 9,874 52,366 187,456 914 251,239 26 % 2-3 years — 7,055 33,337 91,861 1,756 134,009 14 % Greater than 3 years — 377 16,834 32,895 510 50,616 5 % $ 10,278 $ 58,331 $ 322,637 $ 564,316 $ 24,248 $ 979,810 100 % March 31, 2020 (Dollars in thousands) Perpetual license Term license Maintenance Pega Cloud Consulting Total 1 year or less $ 3,995 $ 30,962 $ 205,083 $ 174,277 $ 18,945 $ 433,262 58 % 1-2 years 2,168 5,088 34,633 125,473 1,215 168,577 22 % 2-3 years — 6,504 19,411 81,187 107 107,209 14 % Greater than 3 years — 635 10,596 33,537 10 44,778 6 % $ 6,163 $ 43,189 $ 269,723 $ 414,474 $ 20,277 $ 753,826 100 % NOTE 11. STOCK-BASED COMPENSATION Expense Three Months Ended March 31, (in thousands) 2021 2020 Cost of revenue $ 5,925 $ 5,152 Selling and marketing 13,720 9,718 Research and development 6,770 5,496 General and administrative 3,685 2,809 $ 30,100 $ 23,175 Income tax benefit $ ( 5,991 ) $ ( 4,582 ) 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. Grants Three Months Ended March 31, 2021 (in thousands) Shares Total Fair Value RSUs 684 $ 89,291 Non-qualified stock options 1,248 $ 47,380 16 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 12. INCOME TAXES Effective income tax rate Three Months Ended March 31, (Dollars in thousands) 2021 2020 (Benefit from) income taxes $ ( 17,618 ) $ ( 23,810 ) 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. 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) 2021 2020 Net (loss) $ ( 6,617 ) $ ( 25,372 ) Weighted-average common shares outstanding 81,004 79,808 (Loss) per share, basic $ ( 0.08 ) $ ( 0.32 ) Net (loss) $ ( 6,617 ) $ ( 25,372 ) Weighted-average common shares outstanding, assuming dilution (1) (2) (3) 81,004 79,808 (Loss) per share, diluted $ ( 0.08 ) $ ( 0.32 ) Outstanding anti-dilutive stock options and RSUs (4) 6,465 5,948 (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 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 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 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. 17