PEGASYSTEMS INC 10-Q

ITEM 1. FINANCIAL STATEMENTS PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) March 31, 2022 December 31, 2021 Assets Current assets: Cash and cash equivalents $ 132,771 $ 159,965 Marketable securities 199,401 202,814 Total cash, cash equivalents, and marketable securities 332,172 362,779 Accounts receivable 171,181 182,717 Unbilled receivables 226,052 226,714 Other current assets 74,408 68,008 Total current assets 803,813 840,218 Unbilled receivables 135,975 129,789 Goodwill 82,031 81,923 Other long-term assets 516,661 541,601 Total assets $ 1,538,480 $ 1,593,531 Liabilities and stockholders’ equity Current liabilities: Accounts payable $ 18,628 $ 15,281 Accrued expenses 63,401 63,890 Accrued compensation and related expenses 54,804 120,946 Deferred revenue 290,873 275,844 Other current liabilities 7,309 9,443 Total current liabilities 435,015 485,404 Convertible senior notes, net 591,440 590,722 Operating lease liabilities 90,699 87,818 Other long-term liabilities 14,658 13,499 Total liabilities 1,131,812 1,177,443 Commitments and contingencies (Note 14) Stockholders’ equity: Preferred stock, 1,000 shares authorized; none issued — — Common stock, 200,000 shares authorized; 81,802 and 81,712 shares issued and outstanding at March 31, 2022 and December 31, 2021, respectively 818 817 Additional paid-in capital 141,771 145,810 Retained earnings 273,615 276,449 Accumulated other comprehensive (loss) ( 9,536 ) ( 6,988 ) Total stockholders’ equity 406,668 416,088 Total liabilities and stockholders’ equity $ 1,538,480 $ 1,593,531 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, 2022 2021 Revenue Subscription services $ 170,033 $ 143,419 Subscription license 137,533 111,509 Perpetual license 7,440 5,452 Consulting 61,301 53,119 Total revenue 376,307 313,499 Cost of revenue Subscription services 32,030 28,343 Subscription license 622 620 Perpetual license 34 30 Consulting 55,511 53,454 Total cost of revenue 88,197 82,447 Gross profit 288,110 231,052 Operating expenses Selling and marketing 162,236 148,739 Research and development 71,490 62,442 General and administrative 35,764 18,270 Total operating expenses 269,490 229,451 Income from operations 18,620 1,601 Foreign currency transaction gain (loss) 2,876 ( 5,098 ) Interest income 207 153 Interest expense ( 1,946 ) ( 1,880 ) (Loss) on capped call transactions ( 30,560 ) ( 19,117 ) Other income, net 2,741 106 (Loss) before (benefit from) income taxes ( 8,062 ) ( 24,235 ) (Benefit from) income taxes ( 7,683 ) ( 17,618 ) Net (loss) $ ( 379 ) $ ( 6,617 ) (Loss) per share Basic $ 0.00 $ ( 0.08 ) Diluted $ 0.00 $ ( 0.08 ) Weighted-average number of common shares outstanding Basic 81,680 81,004 Diluted 81,680 81,004 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, 2022 2021 Net (loss) $ ( 379 ) $ ( 6,617 ) Other comprehensive (loss) income, net of tax Unrealized gain on available-for-sale securities 222 1,010 Foreign currency translation adjustments ( 2,770 ) ( 730 ) Total other comprehensive (loss) income, net of tax $ ( 2,548 ) $ 280 Comprehensive (loss) $ ( 2,927 ) $ ( 6,337 ) 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, 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 December 31, 2021 81,712 $ 817 $ 145,810 $ 276,449 $ ( 6,988 ) $ 416,088 Repurchase of common stock ( 242 ) ( 2 ) ( 22,581 ) — — ( 22,583 ) Issuance of common stock for stock compensation plans 297 3 ( 12,131 ) — — ( 12,128 ) Issuance of common stock under the employee stock purchase plan 35 — 2,446 — — 2,446 Stock-based compensation — — 28,227 — — 28,227 Cash dividends declared ($ 0.03 per share) — — — ( 2,455 ) — ( 2,455 ) Other comprehensive (loss) — — — — ( 2,548 ) ( 2,548 ) Net (loss) — — — ( 379 ) — ( 379 ) March 31, 2022 81,802 $ 818 $ 141,771 $ 273,615 $ ( 9,536 ) $ 406,668 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, 2022 2021 Operating activities Net (loss) $ ( 379 ) $ ( 6,617 ) Adjustments to reconcile net (loss) to cash provided by operating activities Stock-based compensation 28,227 30,100 Deferred income taxes ( 9,295 ) ( 15,068 ) Loss on capped call transactions 30,560 19,117 Amortization of deferred commissions 17,221 11,496 Lease expense 3,919 3,238 Amortization of intangible assets and depreciation 4,171 7,006 Foreign currency transaction (gain) loss ( 2,876 ) 5,098 Other non-cash ( 1,100 ) 1,634 Change in operating assets and liabilities, net ( 55,332 ) ( 34,354 ) Cash provided by operating activities 15,116 21,650 Investing activities Purchases of investments ( 33,690 ) ( 21,051 ) Proceeds from maturities and called investments 20,915 40,867 Sales of investments 13,350 2,450 Payments for acquisitions, net of cash acquired — ( 4,993 ) Investment in property and equipment ( 6,657 ) ( 1,784 ) Cash (used in) provided by investing activities ( 6,082 ) 15,489 Financing activities Proceeds from employee stock purchase plan 2,446 2,288 Dividend payments to stockholders ( 2,454 ) ( 2,427 ) Common stock repurchases ( 35,910 ) ( 34,655 ) Cash (used in) financing activities ( 35,918 ) ( 34,794 ) Effect of exchange rate changes on cash and cash equivalents ( 310 ) ( 1,536 ) Net (decrease) increase in cash and cash equivalents ( 27,194 ) 809 Cash and cash equivalents, beginning of period 159,965 171,899 Cash and cash equivalents, end of period $ 132,771 $ 172,708 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 and should be read in conjunction with the Company’s audited financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2021. 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 do not necessarily indicate the expected results for the full year 2022. Certain prior period amounts reported in our condensed consolidated financial statements and notes thereto have been reclassified to conform to the current year presentation. Such reclassifications did not affect total revenues, operating income, or net income. NOTE 2. MARKETABLE SECURITIES March 31, 2022 December 31, 2021 (in thousands) Amortized Cost Unrealized Gains Unrealized Losses Fair Value Amortized Cost Unrealized Gains Unrealized Losses Fair Value Government debt $ 2,000 $ — $ ( 47 ) $ 1,953 $ 2,000 $ — $ ( 10 ) $ 1,990 Corporate debt 200,371 7 ( 2,930 ) 197,448 201,659 2 ( 837 ) 200,824 $ 202,371 $ 7 $ ( 2,977 ) $ 199,401 $ 203,659 $ 2 $ ( 847 ) $ 202,814 As of March 31, 2022, marketable securities’ maturities ranged from April 2022 to September 2024, with a weighted-average remaining maturity of 1.02 years. NOTE 3. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE Receivables (in thousands) March 31, 2022 December 31, 2021 Accounts receivable $ 171,181 $ 182,717 Unbilled receivables 226,052 226,714 Long-term unbilled receivables 135,975 129,789 $ 533,208 $ 539,220 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, 2022 1 year or less $ 226,052 62 % 1-2 years 88,003 25 % 2-5 years 47,972 13 % $ 362,027 100 % Unbilled receivables by contract effective date: (Dollars in thousands) March 31, 2022 2022 $ 72,143 20 % 2021 163,869 45 % 2020 77,585 21 % 2019 27,163 8 % 2018 and prior 21,267 6 % $ 362,027 100 % 8 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Major clients Clients accounting for 10% or more of the Company’s total receivables: March 31, 2022 December 31, 2021 Client A Accounts receivable 4 % 1 % Unbilled receivables 15 % 15 % Total receivables 11 % 10 % 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 the completion of a related performance obligation. (in thousands) March 31, 2022 December 31, 2021 Contract assets (1) $ 11,765 $ 12,530 Long-term contract assets (2) 10,292 10,643 $ 22,057 $ 23,173 (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, 2022 December 31, 2021 Deferred revenue $ 290,873 $ 275,844 Long-term deferred revenue (1) 6,612 5,655 $ 297,485 $ 281,499 (1) Included in other long-term liabilities. The change in deferred revenue in the three months ended March 31, 2022 was primarily due to new billings in advance of revenue recognition and $ 124.9 million of revenue recognized during the period that was included in deferred revenue as of December 31, 2021. NOTE 4. DEFERRED COMMISSIONS (in thousands) March 31, 2022 December 31, 2021 Deferred commissions (1) $ 125,220 $ 135,911 (1) Included in other long-term assets. Three Months Ended March 31, (in thousands) 2022 2021 Amortization of deferred commissions (1) $ 17,221 $ 11,496 (1) Included in selling and marketing expense . 9 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 5. GOODWILL AND OTHER INTANGIBLES Goodwill Change in goodwill: Three Months Ended March 31, (in thousands) 2022 January 1, $ 81,923 Acquisition — Currency translation adjustments 108 March 31, $ 82,031 Intangibles Intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives. March 31, 2022 (in thousands) Useful Lives Cost Accumulated Amortization Net Book Value (1) Client-related 4 - 10 years $ 63,142 $ ( 57,662 ) $ 5,480 Technology 2 - 10 years 67,142 ( 59,531 ) 7,611 Other 1 - 5 years 5,361 ( 5,361 ) — $ 135,645 $ ( 122,554 ) $ 13,091 (1) Included in other long-term assets. December 31, 2021 (in thousands) Useful Lives Cost Accumulated Amortization Net Book Value (1) Client-related 4 - 10 years $ 63,165 $ ( 57,342 ) $ 5,823 Technology 2 - 10 years 67,142 ( 58,902 ) 8,240 Other 1 - 5 years 5,361 ( 5,361 ) — $ 135,668 $ ( 121,605 ) $ 14,063 (1) Included in other long-term assets. Amortization of intangible assets: Three Months Ended March 31, (in thousands) 2022 2021 Cost of revenue $ 629 $ 629 Selling and marketing 343 373 $ 972 $ 1,002 Future estimated intangibles assets amortization: (in thousands) March 31, 2022 Remainder of 2022 $ 2,914 2023 3,618 2024 2,849 2025 2,509 2026 874 2027 327 $ 13,091 NOTE 6. OTHER ASSETS AND LIABILITIES Other current assets (in thousands) March 31, 2022 December 31, 2021 Income tax receivables $ 27,679 $ 25,691 Contract assets 11,765 12,530 Other 34,964 29,787 $ 74,408 $ 68,008 10 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Other long-term assets (in thousands) March 31, 2022 December 31, 2021 Deferred income taxes $ 188,155 $ 180,656 Deferred commissions 125,220 135,911 Right of use assets 87,212 87,521 Capped call transactions 29,404 59,964 Property and equipment 28,603 26,837 Intangible assets 13,091 14,063 Contract assets 10,292 10,643 Other 34,684 26,006 $ 516,661 $ 541,601 Other current liabilities (in thousands) March 31, 2022 December 31, 2021 Operating lease liabilities $ 4,855 $ 6,989 Dividends payable 2,454 2,454 $ 7,309 $ 9,443 Other long-term liabilities (in thousands) March 31, 2022 December 31, 2021 Deferred revenue $ 6,612 $ 5,655 Other 8,046 7,844 $ 14,658 $ 13,499 NOTE 7. LEASES Corporate headquarters In February 2021, the Company agreed to accelerate its exit from its previous corporate headquarters to October 1, 2021, in exchange for a one-time payment from its landlord of $ 18 million, which was amortized over the remaining lease term. The exit accelerated depreciation on the related leasehold improvements and reduced the Company’s future lease liabilities by $ 21.1 million and right of use assets by $ 20.3 million. On March 31, 2021 the Company leased office space at One Main Street, Cambridge, Massachusetts, to serve as its corporate headquarters. The 4.5 year lease includes a base rent of $ 2 million per year. New Waltham Office On July 6, 2021, the Company 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, the Company will receive an improvement allowance from the landlord of up to $ 11.8 million. This lease increased the Company’s lease liabilities and lease-related right of use assets by $ 42.1 million on August 1, 2021. Expense Three Months Ended March 31, (in thousands) 2022 2021 Fixed lease costs (1) $ 5,093 $ 300 Short-term lease costs 806 459 Variable lease costs 764 1,387 $ 6,663 $ 2,146 (1) The lower fixed lease costs in the three months ended March 31, 2021 was due to the modification of the corporate headquarters lease. 11 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Right of use assets and lease liabilities (in thousands) March 31, 2022 December 31, 2021 Right of use assets (1) $ 87,212 $ 87,521 Operating lease liabilities (2) $ 4,855 $ 6,989 Long-term operating lease liabilities $ 90,699 $ 87,818 (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, 2022 December 31, 2021 Weighted-average remaining lease term 7.5 years 7.7 years Weighted-average discount rate (1) 4.3 % 4.4 % (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, 2022 Remainder of 2022 $ 3,887 2023 20,317 2024 17,141 2025 14,352 2026 10,664 2027 and thereafter 48,381 Total lease payments 114,742 Less: imputed interest (1) ( 19,188 ) $ 95,554 (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) 2022 2021 Cash paid for leases $ 3,650 $ 6,716 Right of use assets recognized for new leases and amendments (non-cash) $ 3,854 $ 714 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 due 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: 12 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) • During any calendar quarter beginning 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, 2022, the Notes were not eligible for conversion. 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. Carrying value of the Notes: (in thousands) March 31, 2022 December 31, 2021 Principal $ 600,000 $ 600,000 Unamortized issuance costs ( 8,560 ) ( 9,278 ) Convertible senior notes, net $ 591,440 $ 590,722 Interest expense related to the Notes: Three Months Ended March 31, (in thousands) 2022 2021 Contractual interest expense ( 0.75 % coupon) $ 1,125 $ 1,125 Amortization of issuance costs 719 673 $ 1,844 $ 1,798 13 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) The effective interest rate for the Notes: Three Months Ended March 31, 2022 2021 Weighted-average effective interest rate 1.2 % 1.2 % Future payments of principal and contractual interest: March 31, 2022 (in thousands) Principal Interest Total Remainder of 2022 $ — $ 2,250 $ 2,250 2023 — 4,500 4,500 2024 — 4,500 4,500 2025 600,000 2,250 602,250 $ 600,000 $ 13,500 $ 613,500 Capped call transactions In February 2020, the Company entered into privately negotiated capped call transactions (the “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 expected to reduce common stock dilution and/or offset any potential cash payments the Company must 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 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 following 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 each reporting period, resulting in a non-operating gain or loss. Change in capped call transactions: Three Months Ended March 31, (in thousands) 2022 2021 January 1, $ 59,964 $ 83,597 Fair value adjustment ( 30,560 ) ( 19,117 ) March 31, $ 29,404 $ 64,480 Credit facility In November 2019, and as since amended, the Company entered into a five-year $ 100 million senior secured revolving credit agreement (the “Credit Facility”) with PNC Bank, National Association. The Company may use borrowings for general corporate purposes and to finance working capital needs. 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 required to comply with financial covenants, including: • Beginning with the fiscal quarter ended March 31, 2022 and ending with the fiscal quarter ended December 31, 2022, Pegasystems Inc. must maintain at least $ 200 million in cash, investments, and availability under the Revolving Credit Loan. • Beginning with the quarter ended March 31, 2023, a maximum net consolidated leverage ratio of 3.5 to 1.0 (with a step-up for certain acquisitions) and a minimum consolidated interest coverage ratio of 3.5 to 1.0. As of March 31, 2022 and December 31, 2021, 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. 14 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) 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 model 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 multiple 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, 2022 December 31, 2021 (in thousands) Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total Cash equivalents $ 19,626 $ — $ — $ 19,626 $ 3,216 $ — $ — $ 3,216 Marketable securities $ — $ 199,401 $ — $ 199,401 $ — $ 202,814 $ — $ 202,814 Capped Call Transactions (1) $ — $ 29,404 $ — $ 29,404 $ — $ 59,964 $ — $ 59,964 Venture investments (1) (2) $ — $ — $ 12,830 $ 12,830 $ — $ — $ 7,648 $ 7,648 (1) Included in other long-term assets. (2) Investments in privately-held companies. Changes in venture investments: Three Months Ended March 31, (in thousands) 2022 2021 January 1, $ 7,648 $ 8,345 New investments — 500 Sales of investments — ( 400 ) Changes in foreign exchange rates ( 61 ) ( 9 ) Changes in fair value: included in other income 2,741 100 included in other comprehensive income 2,502 1,220 March 31, $ 12,830 $ 9,756 The carrying value of certain other financial instruments, including receivables and accounts payable, approximates fair value due to these items’ short maturity. Fair value of the Notes The Notes’ fair value (including the conversion feature embedded in the Notes) was $ 573.0 million as of March 31, 2022 and $ 642.0 million as of December 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. NOTE 10. REVENUE Geographic revenue Three Months Ended March 31, (Dollars in thousands) 2022 2021 U.S. $ 217,272 58 % $ 194,568 62 % Other Americas 45,751 12 % 11,901 4 % United Kingdom (“U.K.”) 30,932 8 % 28,212 9 % Europe (excluding U.K.), Middle East, and Africa 49,136 13 % 51,659 16 % Asia-Pacific 33,216 9 % 27,159 9 % $ 376,307 100 % $ 313,499 100 % 15 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Revenue streams Three Months Ended March 31, (in thousands) 2022 2021 Perpetual license $ 7,440 $ 5,452 Subscription license 137,533 111,509 Revenue recognized at a point in time 144,973 116,961 Maintenance 79,716 75,561 Pega Cloud 90,317 67,858 Consulting 61,301 53,119 Revenue recognized over time 231,334 196,538 Total revenue $ 376,307 $ 313,499 Three Months Ended March 31, (in thousands) 2022 2021 Pega Cloud $ 90,317 $ 67,858 Maintenance 79,716 75,561 Subscription services 170,033 143,419 Subscription license 137,533 111,509 Subscription 307,566 254,928 Perpetual license 7,440 5,452 Consulting 61,301 53,119 $ 376,307 $ 313,499 Remaining performance obligations ("Backlog") Expected future revenue from existing non-cancellable contracts: As of March 31, 2022: (Dollars in thousands) Subscription services Subscription license Perpetual license Consulting Total Maintenance Pega Cloud 1 year or less $ 228,984 $ 329,857 $ 47,428 $ 7,281 $ 40,661 $ 654,211 55 % 1- 2 years 63,870 208,875 16,111 4,505 10,955 304,316 26 % 2- 3 years 33,617 106,156 2,422 2,252 3,876 148,323 13 % Greater than 3 years 22,611 44,596 1,758 — 522 69,487 6 % $ 349,082 $ 689,484 $ 67,719 $ 14,038 $ 56,014 $ 1,176,337 100 % As of March 31, 2021: (Dollars in thousands) Subscription services Subscription license Perpetual license Consulting Total Maintenance Pega Cloud 1 year or less $ 220,100 $ 252,104 $ 41,025 $ 9,649 $ 21,068 $ 543,946 55 % 1- 2 years 52,366 187,456 9,874 629 914 251,239 26 % 2- 3 years 33,337 91,861 7,055 — 1,756 134,009 14 % Greater than 3 years 16,834 32,895 377 — 510 50,616 5 % $ 322,637 $ 564,316 $ 58,331 $ 10,278 $ 24,248 $ 979,810 100 % 16 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 11. STOCK-BASED COMPENSATION Expense Three Months Ended March 31, (in thousands) 2022 2021 Cost of revenue $ 6,378 $ 5,925 Selling and marketing 10,958 13,720 Research and development 7,346 6,770 General and administrative 3,545 3,685 $ 28,227 $ 30,100 Income tax benefit $ ( 5,311 ) $ ( 5,991 ) As of March 31, 2022, the Company had $ 200.8 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, 2022 (in thousands) Shares Total Fair Value Restricted stock units 1,096 $ 94,538 Non-qualified stock options 2,212 $ 60,514 NOTE 12. INCOME TAXES Effective income tax rate Three Months Ended March 31, (Dollars in thousands) 2022 2021 (Benefit from) income taxes $ ( 7,683 ) $ ( 17,618 ) Effective income tax benefit rate 95 % 73 % The change in the 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. The impact of stock-based compensation on a given period depends on our profitability, the attributes of the stock compensation awards the Company grants, and award holders' exercise behavior. 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) 2022 2021 Net (loss) $ ( 379 ) $ ( 6,617 ) Weighted-average common shares outstanding 81,680 81,004 (Loss) per share, basic $ 0.00 $ ( 0.08 ) Net (loss) $ ( 379 ) $ ( 6,617 ) Weighted-average common shares outstanding, assuming dilution (1) (2) (3) 81,680 81,004 (Loss) per share, diluted $ 0.00 $ ( 0.08 ) Outstanding anti-dilutive stock options and RSUs (4) 4,178 6,465 (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 approximately 4.4 million shares. 17 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) (3) The Company’s Capped Call Transactions represent the equivalent of 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 expected to reduce common stock dilution and/or offset any potential cash payments the Company must 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 from weighted-average common shares outstanding, assuming dilution, 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. NOTE 14. COMMITMENTS AND CONTINGENCIES Commitments See "Note 7. Leases" for additional information. Legal Proceedings In addition to the matters below, the Company is, or may become, involved in a variety of claims, demands, suits, investigations, and proceedings that arise from time to time relating to matters incidental to the ordinary course of the Company’s business, including actions concerning contracts, intellectual property, employment, benefits, and securities matters. Regardless of the outcome, legal disputes can have a material effect on the Company because of defense and settlement costs, diversion of management resources, and other factors. In addition, as the Company is a party to ongoing litigation, it is at least reasonably possible that our estimates will change in the near term and the effect may be material. As of March 31, 2022 and December 31, 2021, the Company has no accrued losses for litigation. Pegasystems Inc. v. Appian Corp. & Business Process Management Inc. On July 3, 2019, the Company filed suit in Massachusetts federal court against Appian Corp. (“Appian”) and Business Process Management, Inc. (“BPM”) relating to a BPM “Market Report” that Appian had used to promote itself against the Company. Pegasystems Inc. v. Appian Corp. & Business Process Management Inc., No. 1:19-cv-11461 (D. Mass). On April 15, 2022, each of the parties filed motions for summary judgment with the court. The Company continues to believe the counterclaims brought by Appian against the Company are without merit, and the Company intends to vigorously pursue its claims against Appian and defend against the counterclaims brought against the Company in this matter. The Company is unable to reasonably estimate possible damages or a range of possible damages in this matter given the Company’s belief that the damages claimed by Appian fail to satisfy the required legal standard, the status of the proceeding, and due to the uncertainty as to how a jury may rule if this ultimately proceeds to trial. Appian Corp. v. Pegasystems Inc. & Youyong Zou As previously reported, the Company is a defendant in litigation brought by Appian that is currently being tried in Virginia (the “Court”) titled Appian Corp. v. Pegasystems Inc. & Youyong Zou, No. 2020-07216 (Fairfax Cty. Ct.). The jury trial began on March 21, 2022. On April 13, 2022, Appian withdrew its claim against the Company for tortious interference with business expectancy. On that same day, in the course of making determinations on various motions, the Court stated that if the jury finds that the Company misappropriated information that constituted Appian trade secrets and finds that the Company incorporated those trade secrets into the Company’s products or the Company’s marketing materials, the burden will then shift to the Company to prove that the sales Appian seeks as damages were not the result of the alleged misappropriation and use of the alleged trade secrets. This legal standard has not previously been adopted by the Virginia courts. The Company continues to believe that its sales of the products at issue were not caused by, or the result of, the alleged misappropriation of trade secrets, and is submitting evidence to the jury to that effect. The Company is unable to reasonably estimate possible damages because, among other things, of the uncertainty as to how a jury may decide and the parties’ existing grounds for appeal based on rulings to date in the proceeding. 18