What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-07-28 compared with 2021-04-28 · 95 added, 50 removed, 157 unchanged (48% of the section changed)

25 unchanged sentences

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 as the result of new information, future events, or otherwise.

The forward-looking statements contained in this Quarterly Report represent our views as of April 28, 2021.

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 from new information, future events, or otherwise.

The forward-looking statements contained in this Quarterly Report represent our views as of July 28, 2021.

BUSINESS OVERVIEW

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We are in the process of transitioning our business to sell software primarily through subscription arrangements, particularly Pega Cloud.

Until we substantially complete our Cloud Transition, which we anticipate will occur in late 2022 or early 2023, we may experience lower revenue growth and lower operating cash flow growth or negative cash flow.

Until we substantially complete our Cloud Transition, which we anticipate will occur in 2023, we may experience lower revenue growth and lower operating cash flow growth or negative cash flow.

Operating performance and the actual mix of revenue and new arrangements in a given period can fluctuate based on client preferences for our perpetual and subscription offerings.

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Coronavirus (“COVID-19”)

As of March 31, 2021, COVID-19 has not had a material impact on our results of operations or financial condition.

As of June 30, 2021, 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, 2020 for additional information.

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We utilize 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 20% since March 31, 2020

Annual contract value (“ACV”) | Increased 22% since June 30, 2020

• ACV, as reported, represents the annualized value of our active contracts as of the measurement date.

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ACV is a performance measure that we believe provides useful information to our management and investors, particularly during our Cloud Transition.

Reported amounts have not been adjusted for changes in foreign exchange rates.

* Foreign currency exchange rate changes contributed 3-4% to total ACV growth in 2021.

Remaining performance obligations (“Backlog”) | Increased 30% since March 31, 2020

Remaining performance obligations (“Backlog”) | Increased 26% since June 30, 2020

• Backlog represents expected future revenue on existing non-cancellable contracts.

Year to date Pega Cloud revenue | Increased 56% since the three months ended March 31, 2020

Year to date Pega Cloud revenue | Increased 53% since the six months ended June 30, 2020

• Pega Cloud revenue is revenue under U.S.

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(Dollars in thousands) Three Months Ended

March 31, Change

June 30, Change

Six Months Ended

June 30, Change

2021 2020 2021 2020

Pega Cloud $ 73,293 23 % $ 48,838 21 % $ 24,455 50 % $ 141,151 22 % $ 92,304 19 % $ 48,847 53 %

Client Cloud $ 183,078 56 % $ 116,488 52 % $ 66,590 57 % $ 370,148 58 % $ 280,440 57 % $ 89,708 32 %

Maintenance 78,782 24 % 72,222 33 % 6,560 9 % 154,343 24 % 145,917 30 % 8,426 6 %

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(1) Reflects client arrangements subject to renewal (Pega Cloud, maintenance, and term license).

The total revenue change in the three months ended March 31, 2021 generally reflects our Cloud Transition.

The total revenue changes in the three and six months ended June 30, 2021 generally reflect our Cloud Transition.

Other factors impacting our revenue include:

• An increasing portion of our term license contracts include multi-year committed maintenance periods instead of annually renewable maintenance periods.

• An increasing portion of our term license contracts include multi-year committed maintenance periods instead of annually renewable maintenance.

Under multi-year committed maintenance arrangements, a larger portion of the total contract value is recognized as maintenance revenue over the contract term rather than as term license revenue upon the effectiveness of the license rights.

In the three months ended March 31, 2021, multi-year committed maintenance contributed $3.4 million to maintenance revenue growth and reduced term revenue growth by $5.5 million.

In the three months ended June 30, 2021, multi-year committed maintenance contributed $4.3 million to maintenance revenue growth and reduced term revenue growth by $15.4 million.

In the six months ended June 30, 2021, multi-year committed maintenance contributed $7.8 million to maintenance revenue growth and reduced term revenue growth by $20.9 million.

• Maintenance renewal rates of higher than 90%.

• The decrease in consulting revenue in the three months ended March 31, 2021 was primarily due to a decrease in billable travel expenses as a result of COVID-19.

• The increases in term license revenue in the three and six months ended June 30, 2021 were driven by a large, existing customer that expanded their use of our software, renewed an existing multi-year contract, and extended the term of the agreement earlier in the year than anticipated.

• The increases in perpetual license revenue were primarily due to several large perpetual license contracts recognized in revenue in the three and six months ended June 30, 2021.

• The increases in consulting revenue in the three and six months ended June 30, 2021 were primarily due to increases in billable hours.

As part of our long-term strategy, we intend to continue growing and leveraging our ecosystem of partners on implementation projects, potentially reducing our future consulting revenue growth.

Three Months Ended

March 31, Change

June 30, Change

Six Months Ended

June 30, Change

(Dollars in thousands) 2021 2020 2021 2020

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$ 241,171 74 % $ 150,684 66 % $ 90,487 60 % $ 472,223 74 % $ 336,747 68 % $ 135,476 40 %

• The changes in gross profit in the three months ended March 31, 2021 were primarily due to our Cloud Transition, revenue growth, and cost-efficiency gains as Pega Cloud grows and scales.

• The increase in consulting gross profit in the three months ended March 31, 2021 was primarily due to an increase in consultant utilization.

Consultant utilization is impacted by several factors, including the timing and scope of new implementation projects and the extent of our involvement compared to our consulting partners and enabled clients.

• The changes in gross profit in the three and six months ended June 30, 2021 were primarily due to our Cloud Transition, revenue growth, and cost-efficiency gains as Pega Cloud grows and scales.

Operating expenses

(Dollars in thousands) Three Months Ended

March 31, Change

% of Revenue % of Revenue

June 30, Change Six Months Ended

June 30, Change

2021 2020 2021 2020

% of Revenue % of Revenue % of Revenue % of Revenue

Selling and marketing $ 156,423 48 % $ 127,607 56 % $ 28,816 23 % $ 305,162 48 % $ 263,631 53 % $ 41,531 16 %

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General and administrative $ 19,161 6 % $ 15,655 7 % $ 3,506 22 % $ 37,431 6 % $ 31,285 6 % $ 6,146 20 %

• The increase in selling and marketing in the three months ended March 31, 2021 was primarily due to an increase in compensation and benefits of $25.4 million, attributable to increases in headcount and equity compensation, partially offset by decreases in travel and entertainment of $6.0 million and sales and marketing events of $7.9 million due to COVID-19.

The increase in headcount reflect our efforts to increase our sales capacity to deepen relationships with existing clients and target new accounts.

• The increase in research and development in the three months ended March 31, 2021 was primarily due to an increase in compensation and benefits of $4.6 million, attributable to increases in headcount and equity compensation.

• The increase in general and administrative in the three months ended March 31, 2021 was primarily due to an increase in compensation and benefits of $1.1 million, attributable to increases in headcount and equity compensation, and an increase in professional services fees of $1.6 million.

• The increases in selling and marketing in the three and six months ended June 30, 2021 were primarily due to increases in compensation and benefits of $22.6 million and $48.0 million, attributable to increases in headcount and equity compensation.

The increase in headcount reflects our efforts to increase our sales capacity to deepen relationships with existing clients and target new accounts.

• The increases in research and development in the three and six months ended June 30, 2021 were primarily due to increases in compensation and benefits of $7.2 million and $11.8 million, attributable to increases in headcount and equity compensation.

• The increases in general and administrative in the three and six months ended June 30, 2021 were primarily due to increases in compensation and benefits of $2.2 million and $3.5 million, attributable to increases in headcount and equity compensation, and increases in professional services fees of $1.8 million and $3.4 million.

• In February 2021, we agreed to accelerate our exit from our Cambridge, Massachusetts headquarters to October 1, 2021, in exchange for a one-time payment from our landlord of $18 million.

This agreement was the primary contributor to a decrease in facilities expense of $2.1 million in selling and marketing, $1.7 million in research and development, and $0.3 million in general and administrative in the three months ended March 31, 2021.

This agreement was the primary contributor to decreases in facilities expenses of $2.1 million and $3.3 million in selling and marketing, $2.4 million and $3.6 million in research and development, and $1.1 million and $1.6 million in general and administrative, in the three and six months ended June 30, 2021.

Other income (expense), net

(Dollars in thousands) Three Months Ended

March 31, Change

Foreign currency transaction (loss) $ (5,098) $ (5,947) $ 849 14 %

June 30, Change Six Months Ended

June 30, Change

2021 2020 2021 2020

Foreign currency transaction (loss) gain $ (403) $ 4,256 $ (4,659) * $ (5,501) $ (1,691) $ (3,810) (225) %

Interest income 236 242 (6) (2) % 389 849 (460) (54) %

Interest expense (1,959) (5,529) 3,570 65 % (3,839) (7,835) 3,996 51 %

(Loss) on capped call transactions (19,117) (18,592) (525) (3) %

Gain on capped call transactions 26,309 19,419 6,890 35 % 7,192 827 6,365 770 %

Other income, net — — — * 106 1,374 (1,268) (92) %

$ 24,183 $ 18,388 $ 5,795 32 % $ (1,653) $ (6,476) $ 4,823 74 %

• The change in foreign currency transaction (loss) in the three months ended March 31, 2021 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 decrease in interest income in the three months ended March 31, 2021 was primarily due to a decrease in market interest rates.

• The decrease in interest expense in the three months ended March 31, 2021 was primarily due to our adoption of ASU 2020-06 on January 1, 2021.

* not meaningful

• The changes in foreign currency transaction (loss) gain in the three and six months ended June 30, 2021 were 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 decreases in interest income in the three and six months ended June 30, 2021 were primarily due to declines in market interest rates.

• The decreases in interest expense in the three and six months ended June 30, 2021 were primarily due to our adoption of ASU 2020-06 on January 1, 2021.

New Accounting Pronouncements" in Item 1 of this Quarterly Report for additional information.

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Three Months Ended

March 31, Change

June 30, Change Six Months Ended

June 30, Change

(in thousands) 2021 2020 2021 2020

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$ 1,800 $ 5,440 $ (3,640) $ 3,598 $ 7,608 $ (4,010)

• The increase in the (loss) on capped call transactions in the three months ended March 31, 2021 was due to fair value adjustments.

• The decrease in other income, net in the three months ended March 31, 2021 was due to an increase in the value of our venture investments portfolio in the three months ended March 31, 2020.

• The increases in the gain on capped call transactions in the three and six months ended June 30, 2021, were due to fair value adjustments driven by increases in our stock price.

• The decrease in other income, net in the six months ended June 30, 2021, was due to larger fair value adjustments on equity securities held in our venture investments portfolio in the six months ended June 30, 2020.

(Benefit from) income taxes

Three Months Ended

June 30, Six Months Ended

(Dollars in thousands) 2021 2020 2021 2020

1 unchanged sentence

Effective income tax benefit rate (2,591) % 44 %

During the three months ended March 31, 2021, the increase in our 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.

During the six months ended June 30, 2021, the change in our effective income tax benefit rate was primarily due to the impact of discrete tax items on a proportionately larger income (loss) before income taxes in the prior period.

The most significant discrete items were excess tax benefits from stock-based compensation and the impact of changes in statutory tax rates applicable to our U.K.-based deferred tax assets.

Stock-based compensation increases the variability of our effective tax rates.

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LIQUIDITY AND CAPITAL RESOURCES

Three Months Ended

Six Months Ended

(in thousands) 2021 2020

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Effect of exchange rates on cash and cash equivalents (1,207) (942)

Net increase in cash and cash equivalents $ 809 $ 469,779

Net (decrease) increase in cash and cash equivalents $ (32,021) $ 443,748

(in thousands)

March 31, 2021 December 31, 2020

June 30, 2021 December 31, 2020

$ 306,754 $ 399,138

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If we require additional capital resources to grow our business, we may seek to finance our operations from available funds or additional external financing.

If it became necessary to repatriate foreign funds, we may be required to pay U.S.

If it becomes necessary to repatriate foreign funds, we may be required to pay U.S.

and foreign taxes upon repatriation.

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We are in the process of transitioning our business to sell software primarily through subscription arrangements, particularly Pega Cloud.

This transition has and is expected to continue to impact our billings and timing of cash collections.

This transition has impacted and is expected to continue to impact the timing of our billings and cash collections.

Pega Cloud, term license, and maintenance arrangements are generally billed and collected over the contract term, while perpetual license arrangements are generally billed and collected upfront when the license rights become effective.

As client preferences shift in favor of Pega Cloud arrangements, we could experience slower operating cash flow growth, or negative cash flow, in the near term.

The change in cash provided by (used in) operating activities in the three months ended March 31, 2021 was primarily due to a significant increase in client collections.

In February 2021, we agreed to accelerate our exit from our Cambridge, Massachusetts headquarters to October 1, 2021, in exchange for a one-time payment from our landlord of $18 million, which is expected to be paid in the last quarter of 2021.

The change in cash provided by (used in) operating activities in the six months ended June 30, 2021 was primarily due to a significant increase in client collections.

Corporate headquarters

In February 2021, we agreed to accelerate our exit from our existing Cambridge, Massachusetts corporate headquarters to October 1, 2021, in exchange for a one-time payment from our landlord of $18 million, which is expected to be paid in the last quarter of 2021.

The accelerated exit from this lease reduced our future lease liabilities by $21.1 million.

On March 31, 2021 we leased office space at One Main Street, Cambridge, Massachusetts, to serve as our future corporate headquarters.

The approximately 4.5 year lease includes base rent of approximately $2 million per year.

New Waltham Office

On July 6, 2021, we entered into an office space lease (the “Lease”) for 131 thousand square feet in Waltham, Massachusetts.

The lease term of approximately 11 years is expected to commence on August 1, 2021 (the “Lease Commencement Date”), subject to certain adjustments for the initial occupancy date.

The annual rent equals the base rent plus our portion of building operating costs and real estate taxes.

Rent first becomes payable on August 1, 2022, subject to adjustment based on the Lease Commencement Date.

Base rent for the first year is $6 million and will increase by 3% annually.

In addition, we will receive an improvement allowance from the landlord of $11.8 million.

Investing activities

The change in cash provided by (used in) investing activities in the three months ended March 31, 2021 was primarily driven by investments in financial instruments, an acquisition, and a decrease in office space related capital expenditures.

The change in cash provided by (used in) investing activities in the six months ended June 30, 2021 was primarily driven by investments in financial instruments, an acquisition, and a decrease in office space related capital expenditures.

Financing activities

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In November 2019, and as amended as of February 2020, July 2020, and September 2020, we entered into a five-year $100 million senior secured revolving credit agreement with PNC Bank, National Association.

As of March 31, 2021, we had no outstanding borrowings under the Credit Facility.

As of June 30, 2021, we had no outstanding borrowings under the Credit Facility.

Debt" in Item 1 of this Quarterly Report for additional information.

1 unchanged sentence

Changes in the remaining stock repurchase authority:

(in thousands) Three Months Ended

March 31, 2021

(in thousands) Six Months Ended

June 30, 2021

December 31, 2020 $ 37,726

Authorizations (1)

Repurchases (2)

March 31, 2021 $ 28,580

June 30, 2021 $ 56,801

(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) Purchases under this program have been made on the open market.

Common stock repurchases

Three Months Ended

Six Months Ended

(in thousands) Shares Amount Shares Amount

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479 $ 61,098 521 $ 45,292

During the three months ended March 31, 2021 and 2020, instead of receiving cash from the equity holders, we withheld shares with a value of $10.1 million and $15.3 million, respectively, for the exercise price of options.

These amounts have been excluded from the table above.

During the six months ended June 30, 2021 and 2020, instead of receiving cash from the equity holders, we withheld shares with a value of $27.8 million and $31.2 million, respectively, for the exercise price of options.

These amounts are not included in the table above.

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 at any time without prior notice.

Three Months Ended

Six Months Ended

(in thousands) 2021 2020

Dividend payments to stockholders $ 4,865 $ 4,793

Contractual obligations

As of June 30, 2021, our contractual obligations were:

Payments due by period

(in thousands) 2021 2022 2023 2024 2025 2026 and thereafter Other Total

Convertible senior notes (1)

$ 2,250 $ 4,500 $ 4,500 $ 4,500 $ 601,488 $ — $ — $ 617,238

Purchase obligations (2)

28,215 60,242 12,539 1,938 429 — — 103,363

Operating lease obligations (3)

8,783 13,888 13,300 10,021 6,913 9,823 — 62,728

Liability for uncertain tax positions (4)

— — — — — — 1,665 1,665

$ 39,248 $ 78,630 $ 30,339 $ 16,459 $ 608,830 $ 9,823 $ 1,665 $ 784,994

(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) Excludes the Waltham lease, which we entered into on July 6, 2021.

See "Note 14.

Subsequent Events" in Item 1 of this Quarterly Report for additional information.

(4) We are unable to reasonably estimate the timing of the cash outflow due to uncertainties in the timing of the effective settlement of tax positions.

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 2. Management’s Discussion and Analysis