What changed in this filing

/stocks — the workspaceLOADING

Item 2. Management’s Discussion and Analysis

2022-04-28 compared with 2021-10-27 · 99 added, 133 removed, 117 unchanged (66% of the section changed)

10 unchanged sentences

• variation in demand for our products and services, including among clients in the public sector;

• the impact of actual or threatened public health emergencies, such as the Coronavirus (“COVID-19”);

• reliance on third-party service providers;

• reliance on key personnel;

• global economic and political conditions and uncertainty, including continued impacts from the ongoing COVID-19 pandemic and the war in Ukraine;

• reliance on third-party service providers, including hosting providers;

• compliance with our debt obligations and covenants;

• the potential impact of our convertible senior notes and Capped Call Transactions;

• reliance on key personnel;

• the relocation of our corporate headquarters;

• the continued uncertainties in the global economy;

• foreign currency exchange rates;

• the potential legal and financial liabilities and reputation damage due to cyber-attacks;

• the potential legal and financial liabilities and damage to our reputation due to cyber-attacks;

• security breaches and security flaws;

• our ability to protect our intellectual property rights and costs associated with defending such rights;

• our ability to protect our intellectual property rights, costs associated with defending such rights, as well as intellectual property rights claims and other related claims by third parties;

• our client retention rate;

• management of our growth.

These risks and others that may cause actual results to differ materially from those expressed in such forward-looking statements are described further in Part I of our Annual Report on Form 10-K for the year ended December 31, 2020, and other filings we make with the U.S.

Securities and Exchange Commission (“SEC”).

Except as required by applicable law, we do not undertake and expressly disclaim any obligation to update or revise these forward-looking statements publicly, whether from new information, future events, or otherwise.

The forward-looking statements contained in this Quarterly Report represent our views as of October 27, 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 due to new information, future events, or otherwise.

The forward-looking statements in this Quarterly Report represent our views as of April 28, 2022.

BUSINESS OVERVIEW

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

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.

Our consulting and client success teams, along with our world-class partners, leverage our Pega Express™ methodology and low code to allow clients to design and deploy critical applications quickly and collaboratively.

Our target clients are Global 3000 organizations and government agencies that require applications to differentiate themselves in the markets they serve.

Our applications achieve and facilitate differentiation by increasing business agility, driving growth, improving productivity, attracting and retaining customers, and reducing risk.

We deliver applications tailored to our clients’ specific industry needs.

Cloud Transition

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.

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

Our powerful low-code platform for workflow automation and AI-powered decisioning enables the world’s leading brands and government agencies to hyper-personalize customer experiences, streamline customer service, and automate mission-critical business processes and workflows.

With Pega, our clients can leverage our intelligent technology and scalable architecture to accelerate their digital transformation.

In addition, our client success teams, world-class partners, and clients themselves leverage our Pega Express™ methodology to design and deploy mission-critical applications quickly and collaboratively.

Our target clients are Global 3000 organizations and government agencies that require solutions to distinguish themselves in the markets they serve.

Our solutions achieve and facilitate differentiation by increasing business agility, driving growth, improving productivity, attracting and retaining customers, and reducing risk.

Along with our partners, we deliver solutions tailored to our clients’ specific industry needs.

Subscription transition

We are transitioning our business to sell software primarily through subscription arrangements.

Until we fully complete our subscription transition, which we expect will occur in 2023, our revenue and operating cash flow may be impacted.

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

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Coronavirus (“COVID-19”)

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

As of March 31, 2022, COVID-19 has not had a material impact on our results of operations or financial condition.

See “Coronavirus (“COVID-19”)” in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2021 for additional information.

Our direct financial exposure to Ukraine, Russia, and Belarus is not material.

In 2021, before Russia's invasion of Ukraine, we made a business decision to stop pursuing new clients in Russia and closed our local office.

For the year ended December 31, 2021 total revenue from clients located in Ukraine, Russia, and Belarus was less than $4.0 million.

However, the ultimate impact of Russia’s invasion of Ukraine on our business will depend on future developments, including the duration and spread of the conflict, the impact on our people, partners, clients, and vendors in neighboring countries, and globally, all of which are uncertain and unpredictable.

Performance metrics

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

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

Annual contract value (“ACV”) | Increased 21% since March 31, 2021

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

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

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

Maintenance revenue for the quarter then ended is multiplied by four to calculate ACV for maintenance.

Client Cloud ACV is composed of maintenance ACV and term license ACV.

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

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

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

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

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

Foreign currency exchange rate changes were a 1% to 2% headwind to ACV growth since March 31, 2021.

Remaining performance obligations (“Backlog”) | Increased 20% since March 31, 2021

Expected future revenue from existing non-cancellable contracts:

CRITICAL ACCOUNTING POLICIES

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Significant Accounting Policies” in Item 8.

There have been no significant changes other than those disclosed in “Note 2.

New Accounting Pronouncements” in Item 1 of this Quarterly Report on Form 10-Q to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2020.

There have been no significant changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021.

RESULTS OF OPERATIONS

Cloud Transition

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

Revenue growth has been slower because of this transition.

Subscription transition

We are transitioning our business to sell software primarily through subscription arrangements.

This transition has impacted revenue growth as revenue is recognized differently for subscription services than license sales.

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

(Dollars in thousands) Three Months Ended

September 30, Change

Nine Months Ended

September 30, Change

2021 2020 2021 2020

March 31, Change

Pega Cloud $ 90,317 24 % $ 67,858 22 % $ 22,459 33 %

Client Cloud $ 118,609 46 % $ 110,602 49 % $ 8,007 7 % $ 488,757 54 % $ 391,042 55 % $ 97,715 25 %

Maintenance 79,716 21 % 75,561 23 % 4,155 5 %

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

Cloud subscription (1)

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

Subscription services 170,033 45 % 143,419 45 % 26,614 19 %

Subscription license 137,533 37 % 111,509 36 % 26,024 23 %

Subscription 307,566 82 % 254,928 81 % 52,638 21 %

Perpetual license 7,440 2 % 5,452 2 % 1,988 36 %

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$ 376,307 100 % $ 313,499 100 % $ 62,808 20 %

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

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

The revenue changes in the three months ended March 31, 2022 generally reflect the impact of our subscription transition.

Other factors impacting our revenue include:

• The 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 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 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

September 30, Change

Nine Months Ended

September 30, Change

(Dollars in thousands) 2021 2020 2021 2020

• The increase in perpetual revenue in the three months ended March 31, 2022 was primarily due to license rights becoming effective in the three months ended March 31, 2022 related to software license contracts entered into in prior years.

• The increase in consulting revenue in the three months ended March 31, 2022 was primarily due to an increase in consultant billable hours in North America.

(Dollars in thousands) Three Months Ended

March 31, Change

Pega Cloud $ 63,418 70 % $ 45,301 67 % $ 18,117 40 %

Maintenance 74,585 94 % 69,775 92 % 4,810 7 %

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

Subscription services 138,003 81 % 115,076 80 % 22,927 20 %

Subscription license 136,911 100 % 110,889 99 % 26,022 23 %

Subscription 274,914 89 % 225,965 89 % 48,949 22 %

Perpetual license 7,406 100 % 5,422 99 % 1,984 37 %

Consulting 5,790 9 % (335) (1) % 6,125 *

$ 288,110 77 % $ 231,052 74 % $ 57,058 25 %

• 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.

* not meaningful

• The increases in gross profit and gross profit percent in the three months ended March 31, 2022 were primarily due to the impact of our subscription transition, revenue growth, and cost-efficiency gains as Pega Cloud grows and scales.

• The increase in consulting gross profit percent in the three months ended March 31, 2022 was due to an increase in consultant realization rates in North America.

Operating expenses

(Dollars in thousands) Three Months Ended

September 30, Change Nine Months Ended

September 30, Change

2021 2020 2021 2020

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

March 31, Change

% of Revenue % of Revenue

Selling and marketing $ 162,236 43 % $ 148,739 47 % $ 13,497 9 %

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General and administrative $ 35,764 10 % $ 18,270 6 % $ 17,494 96 %

• 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 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 $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

• The increase in selling and marketing in the three months ended March 31, 2022 was primarily due to an increase in compensation and benefits of $8.9 million and an increase in employee travel and entertainment of $2.6 million.

• The increase in research and development in the three months ended March 31, 2022 was primarily due to an increase in compensation and benefits of $5.7 million, attributable to increases in headcount and incentive compensation.

The increase in headcount reflects additional investments in developing our solutions, particularly for Pega Cloud.

• The increase in general and administrative in the three months ended March 31, 2022 was primarily due to an increase of $15.4 million in legal fees and related expenses arising from proceedings outside the ordinary course of business.

We have incurred and expect to continue to incur additional expenses for these proceedings in 2022.

See "Note 14.

Commitments and Contingencies" in Part I, Item 1 and “Risk Factors” in Part II, Item 1A of this Quarterly Report for additional information.

Other income and expenses

(Dollars in thousands) Three Months Ended

September 30, Change Nine Months Ended

September 30, Change

2021 2020 2021 2020

March 31, Change

Foreign currency transaction gain (loss) $ 2,876 $ (5,098) $ 7,974 *

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Interest expense (1,946) (1,880) (66) (4) %

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

(Loss) on capped call transactions (30,560) (19,117) (11,443) (60) %

Other income, net 2,741 106 2,635 2,486 %

1 unchanged sentence

* not meaningful

• 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.

Interest expense related to the Notes:

Three Months Ended

September 30, Change Nine Months Ended

September 30, Change

(in thousands) 2021 2020 2021 2020

Contractual interest expense (0.75% coupon)

$ 1,125 $ 1,125 $ — $ 3,375 $ 2,700 $ 675

Amortization of debt discount — 3,807 (3,807) — 9,060 (9,060)

Amortization of issuance costs 677 565 112 2,025 1,345 680

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

• 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.

• The increase in foreign currency transaction gain (loss) in the three months ended March 31, 2022 was primarily due to the impact of fluctuations in foreign currency exchange rates associated with our foreign currency-denominated cash, receivables, and intercompany balances held by our subsidiary in the United Kingdom.

• The increase in interest income in the three months ended March 31, 2022 was primarily due to increases in market interest rates.

• The increase in the (loss) on capped call transactions in the three months ended March 31, 2022, was due to fair value adjustments for our capped call transactions.

Fair Value Measurements" in Part I, Item 1 of this Quarterly Report for additional information.

• The increase in other income, net in the three months ended March 31, 2022, was due to fair value adjustments on equity securities held in our venture investments portfolio in the three months ended March 31, 2021.

(Benefit from) income taxes

Three Months Ended

September 30, Nine Months Ended

September 30,

(Dollars in thousands) 2022 2021

1 unchanged sentence

Effective income tax benefit rate 95 % 73 %

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.

During the three months ended March 31, 2022, the change in our effective income tax benefit rate was primarily due to the impact of discrete tax items which were proportionately larger on a lower loss before income taxes.

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

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LIQUIDITY AND CAPITAL RESOURCES

Nine Months Ended

September 30,

Three Months Ended

(in thousands) 2022 2021

6 unchanged sentences

(in thousands)

September 30, 2021 December 31, 2020

March 31, 2022 December 31, 2021

$ 251,554 $ 274,813

3 unchanged sentences

$ 332,172 $ 362,779

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

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.

We may utilize available funds or seek additional external financing if we require additional capital resources.

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

and foreign taxes upon repatriation.

Due to the complexity of income tax laws and regulations, it is impracticable to estimate the amount of taxes we would have to pay.

However, due to the complexity of income tax laws and regulations, it is impracticable to estimate the amount of taxes we would have to pay.

Operating activities

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.

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 (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 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 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 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.

We are transitioning our business to sell software primarily through subscription arrangements.

This transition has impacted and is expected to continue impacting our billings and cash collections, as the timing of billings and cash collections generally differs between our subscription and perpetual license arrangements.

Subscription licenses and services are generally billed and collected over the contract term, while perpetual license arrangements usually are billed and collected upfront when the license rights become effective.

The change in cash provided by operating activities in the three months ended March 31, 2022 was primarily due to our subscription transition and increased costs as we made investments in our Pega Cloud offering and selling and marketing activities to support future growth.

In addition, in the three months ended March 31, 2022 we incurred $17.4 million in legal fees and related expenses arising from proceedings that originated outside of the ordinary course of business.

We expect to continue to incur additional expenses for these proceedings.

See "Note 14.

Commitments and Contingencies" in Part I, Item 1 of this Quarterly Report for additional information.

Investing activities

The change in cash 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.

The change in cash (used in) provided by investing activities in the three months ended March 31, 2022 was primarily driven by our investments in financial instruments and an acquisition in 2021.

Financing activities

1 unchanged sentence

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

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

(in thousands) Amount

Principal $ 600,000

issuance costs (14,527)

Capped Call Transactions (51,900)

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

As of March 31, 2022, we had no outstanding borrowings under the Credit Facility.

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

Stock repurchase program

Changes in the remaining stock repurchase authority:

(in thousands) Nine Months Ended

September 30, 2021

(in thousands) Three Months Ended

March 31, 2022

December 31, 2021 $ 22,583

1 unchanged sentence

Repurchases (2)

September 30, 2021 $ 44,005

March 31, 2022 $ —

(1) On June 8, 2021, we announced that our Board of Directors extended the current stock repurchase program’s expiration date to June 30, 2022 and increased the remaining common stock repurchase authority to $60 million.

1 unchanged sentence

Common stock repurchases

Nine Months Ended

September 30,

Three Months Ended

(in thousands) Shares Amount Shares Amount

Tax withholdings for net settlement of equity awards 462 $ 59,819 599 $ 59,613

Repurchases paid 242 $ 22,583 67 $ 8,846

Repurchases unpaid at period end — — 3 300

Stock repurchase program 242 22,583 70 9,146

Tax withholdings for net settlement of equity awards 141 12,128 197 25,509

383 $ 34,711 267 $ 34,655

During the 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.

During the three months ended March 31, 2022 and 2021, instead of receiving cash from the equity holders, we withheld shares with a value of $6.1 million and $10.1 million, respectively, for the exercise price of options.

These amounts are not included in the table above.

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.

Nine Months Ended

September 30,

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

Three Months Ended

(in thousands) 2022 2021

1 unchanged sentence

Contractual obligations

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

As of March 31, 2022, our contractual obligations were:

Payments due by period

12 unchanged sentences

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