What changed in this filing

/stocks — the workspaceLOADING

Item 2. Management’s Discussion and Analysis

2022-07-27 compared with 2022-04-28 · 73 added, 56 removed, 160 unchanged (45% of the section changed)

18 unchanged sentences

• security breaches and security flaws;

• 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 ability to protect our intellectual property rights, costs associated with defending such rights, intellectual property rights claims and other related claims by third parties against us, including related costs, damages, and other relief that may be granted against us;

• our client retention rate;

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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.

The forward-looking statements in this Quarterly Report represent our views as of July 27, 2022.

BUSINESS OVERVIEW

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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.

Until we fully complete our subscription transition, which we expect will occur in 2024, our operating results 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 March 31, 2022, COVID-19 has not had a material impact on our results of operations or financial condition.

As of June 30, 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.

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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 21% since March 31, 2021

Annual contract value (“ACV”)

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

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

Remaining performance obligations (“Backlog”)

Reconciliation of GAAP Backlog and Constant Currency Backlog

(in millions) Q2 2022 1 Year Growth Rate

Backlog - GAAP $ 1,126 9 %

Impact of changes in foreign exchange rates 57 6 %

Backlog - Constant Currency $ 1,183 15 %

Constant currency Backlog is calculated by applying foreign exchange rates for the earliest period shown to all periods.

The above constant currency measures reflect foreign exchange rates applicable as of Q2 2021.

We believe that non-GAAP financial measures help investors understand our core operating results and prospects, consistent with how management measures and forecasts our performance without the effect of often one-time charges and other items outside our normal operations.

The supplementary non-GAAP financial measures are not meant to be superior to or a substitute for financial measures prepared under U.S.

CRITICAL ACCOUNTING POLICIES

5 unchanged sentences

Significant Accounting Policies” in Item 8.

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.

We recorded a valuation allowance of $191.9 million in income tax expense during the three months ended June 30, 2022.

See "Note 12.

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

There have been no other 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

1 unchanged sentence

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.

This transition has impacted revenue growth as revenue is recognized differently for subscription services, which includes Pega Cloud and maintenance, than license sales.

Revenue from subscription service 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

March 31, Change

June 30, Change Six Months Ended

June 30, Change

2022 2021 2022 2021

Pega Cloud $ 93,506 34 % $ 73,293 23 % $ 20,213 28 % $ 183,823 28 % $ 141,151 22 % $ 42,672 30 %

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$ 274,337 100 % $ 325,702 100 % $ (51,365) (16) % $ 650,644 100 % $ 639,201 100 % $ 11,443 2 %

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

The revenue changes in the three and six months ended June 30, 2022 generally reflect the impact of our subscription transition.

Other factors impacting our revenue include:

• 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.

• The decreases in subscription license revenue in the three and six months ended June 30, 2022 were primarily due to several large software 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, 2022 were primarily due to increases in consultant billable hours in North America.

(Dollars in thousands) Three Months Ended

March 31, Change

June 30, Change Six Months Ended

June 30, Change

2022 2021 2022 2021

Pega Cloud $ 62,259 67 % $ 49,242 67 % $ 13,017 26 % $ 125,677 68 % $ 94,543 67 % $ 31,134 33 %

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* 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.

The decreases in gross profit and gross profit percent in the three and six months ended June 30, 2022 were primarily due to decreases in subscription license revenue.

• The increase in Pega Cloud gross profit percent in the six months ended June 30, 2022 was primarily due to cost-efficiency gains as Pega Cloud grows and scales.

• The decrease in consulting gross profit percent in the three months ended June 30, 2022 was due to a decrease in consultant utilization rates.

The increase in consulting gross profit percent in the six months ended June 30, 2022 was due to an increase in consultant realization rates in North America.

Operating expenses

(Dollars in thousands) Three Months Ended

March 31, Change

% of Revenue % of Revenue

June 30, Change Six Months Ended

June 30, Change

2022 2021 2022 2021

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

Selling and marketing $ 157,198 57 % $ 156,423 48 % $ 775 — % $ 319,434 49 % $ 305,162 48 % $ 14,272 5 %

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General and administrative $ 32,723 12 % $ 19,161 6 % $ 13,562 71 % $ 68,487 11 % $ 37,431 6 % $ 31,056 83 %

• 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.

• The increase in selling and marketing in the six months ended June 30, 2022 was primarily due to an increase in employee travel and entertainment of $5.6 million and an increase in compensation and benefits of $3.8 million.

• The increases in research and development in the three and six months ended June 30, 2022 were primarily due to increases in compensation and benefits of $6.4 million and $12.1 million, attributable to increases in headcount and incentive compensation.

The increases in headcount reflects additional investments in developing our solutions.

• The increases in general and administrative in the three and six months ended June 30, 2022 were primarily due to increases of $8.2 million and $23.6 million in legal fees and related expenses arising from litigation proceedings outside the ordinary course of business.

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

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(Dollars in thousands) Three Months Ended

March 31, Change

June 30, Change Six Months Ended

June 30, Change

2022 2021 2022 2021

Foreign currency transaction gain (loss) $ 1,713 $ (403) $ 2,116 * $ 4,589 $ (5,501) $ 10,090 *

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Interest expense (1,944) (1,959) 15 1 % (3,890) (3,839) (51) (1) %

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

(Loss) income on capped call transactions (18,945) 26,309 (45,254) * (49,505) 7,192 (56,697) *

Other income, net 3,785 — 3,785 * 6,526 106 6,420 6,057 %

1 unchanged sentence

* not meaningful

• 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.

• The increases in foreign currency transaction gain (loss) in the three and six months ended June 30, 2022 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 increases in interest income in the three and six months ended June 30, 2022 were primarily due to increases in market interest rates.

• The decreases in (loss) income on capped call transactions in the three and six months ended June 30, 2022, were 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

• The increases in other income, net in the three and six months ended June 30, 2022 were due to gains on our venture investments portfolio.

Provision for (benefit from) income taxes

Three Months Ended

June 30, Six Months Ended

(Dollars in thousands) 2022 2021 2022 2021

(Benefit from) income taxes $ (7,683) $ (17,618)

Effective income tax benefit rate 95 % 73 %

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.

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.

Provision for (benefit from) income taxes $ 186,174 $ (11,916) $ 178,491 $ (29,534)

Effective income tax rate (benefit rate) 165 % (2,591) %

During the six months ended June 30, 2022, the change in our effective income tax rate (benefit rate) was primarily due to the recognition of a $191.9 million valuation allowance on our deferred tax assets.

See "Note 12.

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

LIQUIDITY AND CAPITAL RESOURCES

Three Months Ended

Six Months Ended

(in thousands) 2022 2021

4 unchanged sentences

Effect of exchange rates on cash and cash equivalents (2,907) (1,207)

Net (decrease) increase in cash and cash equivalents $ (27,194) $ 809

Net (decrease) in cash and cash equivalents $ (50,690) $ (32,021)

(in thousands)

March 31, 2022 December 31, 2021

June 30, 2022 December 31, 2021

$ 223,116 $ 274,813

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$ 296,888 $ 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 and to meet our known long-term cash requirements.

We believe that our current cash, cash flow from operations, borrowing capacity, and ability to engage in capital market transactions will be sufficient to fund our operations, stock repurchases, and quarterly cash dividends for at least the next 12 months and to meet our known long-term cash requirements.

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.

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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.

The change in cash (used in) provided by operating activities in the six months ended June 30, 2022 was primarily due to our subscription transition and increased costs as we made investments in research and development and selling and marketing activities to support future growth.

In addition, in the six months ended June 30, 2022 we incurred $28.0 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.

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Investing activities

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.

The change in cash (used in) provided by investing activities in the six months ended June 30, 2022 was primarily driven by our investments in financial instruments, an increase in office space related capital expenditures, and an acquisition in 2021.

Financing activities

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

(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.

As of June 30, 2022, we had no outstanding borrowings under the Credit Facility.

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

1 unchanged sentence

Changes in the remaining stock repurchase authority:

(in thousands) Three Months Ended

March 31, 2022

(in thousands) Six Months Ended

June 30, 2022

December 31, 2021 $ 22,583

1 unchanged sentence

Repurchases (2)

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.

June 30, 2022 $ 58,075

(1) On June 2, 2022, we announced that our Board of Directors extended the current stock repurchase program’s expiration date to June 30, 2023.

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

Common stock repurchases

Three Months Ended

Six Months Ended

(in thousands) Shares Amount Shares Amount

4 unchanged sentences

475 $ 39,887 479 $ 61,098

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.

During the six months ended June 30, 2022 and 2021, instead of receiving cash from the equity holders, we withheld shares with a value of $8.3 million and $27.8 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 without prior notice.

Three Months Ended

Six Months Ended

(in thousands) 2022 2021

1 unchanged sentence

Contractual obligations

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

As of June 30, 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