What changed in this filing

/stocks — the workspaceLOADING

Item 2. Management’s Discussion and Analysis

2021-10-27 compared with 2021-07-28 · 86 added, 88 removed, 164 unchanged (51% of the section changed)

26 unchanged sentences

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.

The forward-looking statements contained in this Quarterly Report represent our views as of October 27, 2021.

BUSINESS OVERVIEW

We develop, market, license, host, and support enterprise software applications that help organizations simplify business complexity.

Our intelligent technology and scalable architecture enables the world’s leading brands and government agencies to solve problems quickly and transform for tomorrow.

Our intelligent technology and scalable architecture enable the world’s leading brands and government agencies to solve problems quickly and transform for tomorrow.

Our clients are able to make better decisions and get work done using real-time artificial intelligence (“AI”) and intelligent automation on applications built on the low-code, cloud-native Pega Platform™, enabling our clients to streamline service, increase customer lifetime value, and boost efficiency.

4 unchanged sentences

Cloud Transition

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 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.

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

Until we substantially complete our Cloud Transition, which we expect 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 each period can fluctuate based on client preferences for our perpetual and subscription offerings.

See the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2020 for additional information.

Coronavirus (“COVID-19”)

As of June 30, 2021, COVID-19 has not had a material impact on our results of operations or financial condition.

As of September 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.

Performance metrics

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 22% since June 30, 2020

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

We use performance metrics to analyze and assess our overall performance, make operating decisions, and forecast and plan for future periods, including:

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

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

The contract's total value is divided by its duration in years to calculate ACV for term license and Pega Cloud contracts.

3 unchanged sentences

Foreign currency exchange rate changes contributed 1-2% to total ACV growth in 2021.

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 53% since the six months ended June 30, 2020

• Pega Cloud revenue is revenue under U.S.

GAAP for cloud contracts.

Remaining performance obligations (“Backlog”) | Increased 23% since September 30, 2020

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

CRITICAL ACCOUNTING POLICIES

2 unchanged sentences

We base our estimates and judgments on historical experience, knowledge of current conditions, and expectations of what could occur in the future given the available information.

For more information regarding our critical accounting policies, we encourage you to read the discussion in the following locations in our Annual Report on Form 10-K for the year ended December 31, 2020:

For more information about our critical accounting policies, we encourage you to read the discussion in the following locations in our Annual Report on Form 10-K for the year ended December 31, 2020:

• “Critical Accounting Estimates and Significant Judgments” in Item 7;

4 unchanged sentences

Cloud Transition

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

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

Revenue growth has been slower because of this transition.

Revenue from Pega Cloud and maintenance arrangements is typically recognized over the contract term.

In contrast, revenue from license sales is recognized when the license rights become effective, typically upfront.

Revenue from Pega Cloud and maintenance arrangements is typically recognized over the contract term while revenue from license sales is recognized when the license rights become effective, typically upfront.

(Dollars in thousands) Three Months Ended

June 30, Change

Six Months Ended

June 30, Change

September 30, Change

Nine Months Ended

September 30, Change

2021 2020 2021 2020

3 unchanged sentences

Term license 35,421 14% 35,932 16% (511) (1)% 251,226 28% 170,455 24% 80,771 47%

Subscription (1)

Cloud subscription (1)

$ 196,978 77 % $ 165,378 73 % $ 31,600 19 % $ 708,277 79 % $ 538,122 75 % $ 170,155 32 %

3 unchanged sentences

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

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

The revenue changes in the three and nine months ended September 30, 2021 generally reflect our Cloud Transition.

Other factors impacting our revenue include:

• The increases in perpetual and term license revenue were primarily due to several large software license contracts recognized in revenue in the nine months ended September 30, 2021.

• 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 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.

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 upon the effectiveness of the license rights as term license revenue.

In the three months ended September 30, 2021, multi-year committed maintenance contributed $4.8 million to maintenance revenue growth and reduced term revenue growth by $1.0 million.

In the nine months ended September 30, 2021, multi-year committed maintenance contributed $12.6 million to maintenance revenue growth and reduced term revenue growth by $22.0 million.

• Maintenance renewal rates of higher than 90%.

• 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.

• The changes in consulting revenue in the three and nine months ended September 30, 2021 were primarily due to changes 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

June 30, Change

Six Months Ended

June 30, Change

September 30, Change

Nine Months Ended

September 30, Change

(Dollars in thousands) 2021 2020 2021 2020

Software license $ 116,236 99 % $ 52,344 98 % $ 63,892 122 % $ 232,547 99 % $ 145,576 99 % $ 86,971 60 %

Maintenance 73,787 94 % 66,631 92 % 7,156 11 % 143,562 93 % 134,750 92 % 8,812 7 %

Pega Cloud $ 52,845 67 % $ 35,059 64 % $ 17,786 51 % $ 147,388 67 % $ 90,842 62 % $ 56,546 62 %

Maintenance 77,895 94 % 69,192 93 % 8,703 13 % 221,457 93 % 203,942 92 % 17,515 9 %

Software license 37,639 98 % 39,093 98 % (1,454) (4) % 270,186 99 % 184,669 99 % 85,517 46 %

Consulting 3,667 6 % 4,808 8 % (1,141) (24) % 5,238 3 % 5,446 3 % (208) (4) %

$ 172,046 67 % $ 148,152 66 % $ 23,894 16 % $ 644,269 72 % $ 484,899 67 % $ 159,370 33 %

• 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.

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

• The decrease in consulting gross profit percent in the three months ended September 30, 2021 was due to a decrease in consultant utilization in North America.

Operating expenses

(Dollars in thousands) Three Months Ended

June 30, Change Six Months Ended

June 30, Change

September 30, Change Nine Months Ended

September 30, Change

2021 2020 2021 2020

3 unchanged sentences

General and administrative $ 20,176 8 % $ 17,907 8 % $ 2,269 13 % $ 57,607 6 % $ 49,192 7 % $ 8,415 17 %

• 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 increases in selling and marketing in the three and nine months ended September 30, 2021 were primarily due to increases in compensation and benefits of $15.8 million and $63.8 million, attributable to increases in headcount, sales commissions, 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.

• The increases in research and development in the three and nine months ended September 30, 2021 were primarily due to increases in compensation and benefits of $5.1 million and $16.9 million, attributable to increases in headcount.

• The increases in general and administrative in the three and nine months ended September 30, 2021 were primarily due to increases in compensation and benefits of $0.4 million and $3.8 million, attributable to increases in headcount and equity compensation, and increases in legal and other professional services fees of $2.7 million and $6.1 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 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.

This agreement was the primary contributor to decreases in facilities expenses of $2.1 million and $5.5 million in selling and marketing, $2.0 million and $5.6 million in research and development, and $1.0 million and $2.8 million in general and administrative, in the three and nine months ended September 30, 2021.

Other income (expense), net

(Dollars in thousands) Three Months Ended

June 30, Change Six Months Ended

June 30, Change

September 30, Change Nine Months Ended

September 30, Change

2021 2020 2021 2020

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

Foreign currency transaction gain (loss) $ 518 $ 4,236 $ (3,718) (88) % $ (4,983) $ 2,545 $ (7,528) *

Interest income 166 243 (77) (32) % 555 1,092 (537) (49) %

Interest expense (1,908) (5,956) 4,048 68 % (5,747) (13,791) 8,044 58 %

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

(Loss) income on capped call transactions (14,735) 18,989 (33,724) * (7,543) 19,816 (27,359) *

Other income, net 2 — 2 * 108 1,374 (1,266) (92) %

1 unchanged sentence

* 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.

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

• The decreases in interest expense in the three and nine months ended September 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.

1 unchanged sentence

Three Months Ended

June 30, Change Six Months Ended

June 30, Change

September 30, Change Nine Months Ended

September 30, Change

(in thousands) 2021 2020 2021 2020

4 unchanged sentences

$ 1,802 $ 5,497 $ (3,695) $ 5,400 $ 13,105 $ (7,705)

• 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.

• The decreases in the (loss) income on capped call transactions in the three and nine months ended September 30, 2021, were due to fair value adjustments driven by changes in our stock price.

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

(Benefit from) income taxes

Three Months Ended

June 30, Six Months Ended

September 30, Nine Months Ended

September 30,

(Dollars in thousands) 2021 2020 2021 2020

1 unchanged sentence

Effective income tax benefit rate 68 % 48 %

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.

During the nine months ended September 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 (loss) before income taxes in the nine months ended September 30, 2020.

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.

The impact of stock-based compensation on a given period depends on our profitability, the attributes of our stock compensation awards we grant, and award holders' exercise behavior.

The impact on our effective tax rate in each period depends on our profitability and the tax deductions from our stock compensation activity, which depend upon our stock price and the award holders' exercise behavior.

LIQUIDITY AND CAPITAL RESOURCES

Six Months Ended

Nine Months Ended

September 30,

(in thousands) 2021 2020

6 unchanged sentences

(in thousands)

June 30, 2021 December 31, 2020

September 30, 2021 December 31, 2020

$ 267,378 $ 399,138

4 unchanged sentences

We believe that our current cash, cash flow from operations, and borrowing capacity will be sufficient to fund our operations, stock repurchases, and quarterly cash dividends for at least the next 12 months.

Whether these resources are adequate to meet our liquidity needs beyond that period will depend on our future growth, operating results, and the investments required to support our operations.

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

Whether these resources are adequate to meet our liquidity needs beyond that period will depend on our future growth, operating results, and the investments needed to support our operations.

If we require additional capital resources to grow our business, we may utilize available funds or additional external financing.

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

and foreign taxes upon repatriation.

1 unchanged sentence

Operating activities

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

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

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

1 unchanged sentence

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 six months ended June 30, 2021 was primarily due to a significant increase in client collections.

The change in cash (used in) operating activities in the nine months ended September 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.

In February 2021, we agreed to accelerate our exit from our previous corporate headquarters to October 1, 2021, in exchange for a one-time payment from our landlord of $18 million, which was paid in October 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.

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

The 4.5 year lease includes a base rent of $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.

On July 6, 2021, we entered into an office space lease for 131 thousand square feet in Waltham, Massachusetts.

The lease term of 11 years began on August 1, 2021.

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

Rent first becomes payable on August 1, 2022.

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

In addition, we will receive an improvement allowance from the landlord of up to $11.8 million as part of the lease.

This lease increased our lease liabilities and lease-related right of use assets by $42.1 million on August 1, 2021.

Investing activities

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.

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

Financing activities

In February 2020, we issued $600 million in aggregate principal amount of convertible senior notes due March 1, 2025.

Debt financing

In February 2020, we issued $600 million in aggregate principal amount of convertible senior notes which mature on March 1, 2025.

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

As of September 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) Six Months Ended

June 30, 2021

(in thousands) Nine Months Ended

September 30, 2021

December 31, 2020 $ 37,726

1 unchanged sentence

Repurchases (2)

June 30, 2021 $ 56,801

September 30, 2021 $ 44,005

(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.

(2) All purchases under this program have been made on the open market.

Common stock repurchases

Six Months Ended

Nine Months Ended

September 30,

(in thousands) Shares Amount Shares Amount

2 unchanged sentences

710 $ 92,007 803 $ 78,441

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.

During the nine months ended September 30, 2021 and 2020, instead of receiving cash from the equity holders, we withheld shares with a value of $47.1 million and $49.5 million, respectively, for the exercise price of options.

These amounts are not included in the table above.

1 unchanged sentence

However, the Board of Directors may terminate or modify the dividend program at any time without prior notice.

Six Months Ended

Nine Months Ended

September 30,

(in thousands) 2021 2020

1 unchanged sentence

Contractual obligations

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

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

Payments due by period

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

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

Convertible senior notes (1)

3 unchanged sentences

Operating lease obligations 961 9,948 19,607 16,482 13,607 58,381 — 118,986

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

Liability for uncertain tax positions (3)

3 unchanged sentences

(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.

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

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