What changed in this filing

/stocks — the workspaceLOADING

Item 2. Management’s Discussion and Analysis

2023-04-26 compared with 2022-10-26 · 101 added, 97 removed, 142 unchanged (58% of the section changed)

11 unchanged sentences

• 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;

• global economic and political conditions and uncertainty, including impacts from public health emergencies and the war in Ukraine;

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

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• 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 ongoing litigation with Appian Corp.;

• 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 October 26, 2022.

The forward-looking statements in this Quarterly Report represent our views as of April 26, 2023.

BUSINESS OVERVIEW

We develop, market, license, host, and support enterprise software that helps organizations build agility into their business so they can adapt to change.

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.

Our powerful low-code platform for workflow automation and artificial intelligence-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.

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

Our target clients are Global 2000 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.

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

Subscription transition

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Until we fully complete our subscription transition, which we expect will occur in 2023, 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.

Operating performance, revenue mix, 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, 2022 for additional information.

Coronavirus (“COVID-19”)

As of September 30, 2022, COVID-19 has not had a material impact on our results of operations or financial condition.

See “ Actual or threatened public health emergencies could harm our business ” 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 and the impact on our people, partners, clients, and vendors in neighboring countries and globally, all of which are uncertain and unpredictable.

Performance metrics

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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 subscription license and Pega Cloud contracts.

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

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

The contract's total value is divided by its duration in years to calculate ACV.

ACV is a performance measure that we believe provides useful information to our management and investors.

In 2023, we changed our ACV calculation methodology for maintenance and all contracts less than 12 months to align with other contract types.

Previously disclosed ACV amounts have been updated to allow for comparability.

Constant currency ACV is calculated by applying the Q1 2022 foreign exchange rates to all periods shown.

Remaining performance obligations (“Backlog”)

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Backlog - Constant Currency $ 1,336 14 %

Constant currency measures are 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 Q3 2021.

Constant currency Backlog is calculated by applying the Q1 2022 foreign exchange rates to all periods shown.

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.

Free cash flow (1)

(in thousands, except percentages) Three Months Ended

2023 2022 Change

Cash provided by operating activities $ 68,107 $ 15,116 351 %

Investment in property and equipment (11,487) (6,657)

Legal fees 1,515 6,887

Restructuring 14,458 —

Interest on convertible senior notes 2,250 2,250

Free cash flow $ 74,843 $ 17,596 325 %

Total revenue $ 325,472 $ 376,307

Free cash flow margin 23 % 5 %

(1) 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.

Our non-GAAP free cash flow measures reflect the following adjustments:

• Investment in property and equipment :

Investment in property and equipment fluctuates in amount and frequency and is significantly affected by the timing and size of investments in our facilities.

We believe excluding these amounts provides a useful comparison of our operational performance in different periods.

• Legal fees :

Includes legal and related fees arising from proceedings outside of the ordinary course of business.

We believe excluding these amounts from our non-GAAP financial measures is useful to investors as the disputes giving rise to them are not representative of our core business operations and ongoing operational performance.

• Restructuring :

We have excluded restructuring from our non-GAAP financial measures.

Restructuring fluctuates in amount and frequency and is significantly affected by the timing and size of our restructuring activities.

We believe excluding the impact from our non-GAAP financial measures is useful to investors as these amounts are not representative of our core business operations and ongoing operational performance.

• Interest on convertible senior notes :

In February 2020, we issued convertible senior notes, due March 1, 2025, in a private placement.

We believe excluding the interest payments provides a useful comparison of our operational performance in different periods.

CRITICAL ACCOUNTING POLICIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our unaudited condensed consolidated financial statements, which have been prepared following accounting principles generally accepted in the United States and the rules and regulations of the SEC for interim financial reporting.

The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosure of contingent assets and liabilities.

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our unaudited condensed consolidated financial statements, which have been prepared following accounting principles generally accepted in the United States of America (“U.S.”) and the rules and regulations of the SEC for interim financial reporting.

Preparing these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosure of contingent assets and liabilities.

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.

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Significant Accounting Policies” in Item 8.

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, 2022.

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

This transition has impacted the optics of revenue growth as revenue from subscription service arrangements, which includes Pega Cloud and maintenance, 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 from subscription service arrangements, which includes Pega Cloud and maintenance, 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

2022 2021 2022 2021

March 31, Change

Pega Cloud $ 107,879 33 % $ 90,317 24 % $ 17,562 19 %

6 unchanged sentences

$ 325,472 100 % $ 376,307 100 % $ (50,835) (14) %

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

The revenue changes in the three months ended March 31, 2023 generally reflect the impact of our subscription transition.

Other factors impacting our revenue include:

• The United States Dollar has strengthened against foreign currencies in the markets we operate, which reduced total revenue growth in the three and nine months ended September 30, 2022 by approximately 5 percent.

• The decreases in subscription license revenue in the three and nine months ended September 30, 2022 were primarily due to several large software license contracts recognized in revenue in the three and nine months ended September 30, 2021.

• The decreases in maintenance revenue in the three and nine months ended September 30, 2022 were primarily due to changes in foreign currency exchange rates and the continuing shift to Pega Cloud.

• The increase in consulting revenue in the nine months ended September 30, 2022 was primarily due to an increase in consultant billable hours in North America.

• The decrease in subscription license revenue in the three months ended March 31, 2023 was primarily due to several large software license contracts recognized in revenue in the three months ended March 31, 2022.

• The decrease in consulting revenue in the three months ended March 31, 2023 was primarily due to a decrease in billable hours and realization rates.

(Dollars in thousands) Three Months Ended

September 30, Change Nine Months Ended

September 30, Change

2022 2021 2022 2021

March 31, Change

Pega Cloud $ 77,629 72 % $ 63,418 70 % $ 14,211 22 %

7 unchanged sentences

* not meaningful

The gross profit percent changes in the three and nine months ended September 30, 2022 were primarily due to a shift in the revenue mix.

• The increases in Pega Cloud gross profit percent in the three and nine months ended September 30, 2022 were primarily due to cost-efficiency gains as Pega Cloud grows and scales.

• The decrease in Maintenance gross profit percent in the three months ended September 30, 2022 was primarily due to a decrease in maintenance revenue.

• The decreases in consulting gross profit percent in the three and nine months ended September 30, 2022 were due to increases in consultant availability.

The gross profit percent changes in the three months ended March 31, 2023 were primarily due to a shift in the revenue mix.

• The increase in Pega Cloud gross profit percent in the three months ended March 31, 2023 was primarily due to cost-efficiency gains as Pega Cloud continues to grow and scale.

• The decrease in maintenance gross profit percent in the three months ended March 31, 2023 was primarily due to an increase in compensation and benefits due to increased headcount.

• The decrease in consulting gross profit percent in the three months ended March 31, 2023 was due to a decrease in realization rates and consultant utilization.

Operating expenses

(Dollars in thousands) Three Months Ended

September 30, Change Nine Months Ended

September 30, Change

2022 2021 2022 2021

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

March 31, Change

% of Revenue % of Revenue

Selling and marketing $ 149,797 46 % $ 162,236 43 % $ (12,439) (8) %

1 unchanged sentence

General and administrative $ 23,110 7 % $ 35,764 10 % $ (12,654) (35) %

• The increase in selling and marketing in the nine months ended September 30, 2022 was primarily due to an increase in employee travel and entertainment and marketing events of $10.7 million.

• The increases in research and development in the three and nine months ended September 30, 2022 were primarily due to increases in compensation and benefits of $7.5 million and $19.6 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 nine months ended September 30, 2022 were primarily due to increases in compensation and benefits of $2.9 million and $5.7 million, facilities expenses of $1.1 million and $2.8 million, and legal fees and related expenses arising from litigation proceedings outside the ordinary course of business of $0.4 million and $24.0 million.

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

Restructuring $ 1,461 — $ — — $ 1,461 100 %

• The decrease in selling and marketing in the three months ended March 31, 2023 was primarily due to a decrease in compensation and benefits of $12.2 million.

• The increase in research and development in the three months ended March 31, 2023 was primarily due to an increase in compensation and benefits of $2.5 million, attributable to increases in headcount and incentive compensation.

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

• The decrease in general and administrative in the three months ended March 31, 2023 was primarily due to a decrease in legal fees and related expenses arising from litigation proceedings outside the ordinary course of business of $15.9 million.

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

See "Note 15.

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

Commitments and Contingencies" in Part I, Item 1 of this Quarterly Report and “Risk Factors” in Part I, Item 1A of our Annual Report for the year ended December 31, 2022.

• The increase in restructuring in the three months ended March 31, 2023 was primarily due to an impairment of $1.2 million on our operating lease right of use assets primarily due to the closure of leased office space in Poland.

Other income and expenses

(Dollars in thousands) Three Months Ended

September 30, Change Nine Months Ended

September 30, Change

2022 2021 2022 2021

Foreign currency transaction gain (loss) $ 3,826 $ 518 $ 3,308 639 % $ 8,415 $ (4,983) $ 13,398 *

March 31, Change

Foreign currency transaction (loss) gain $ (2,675) $ 2,876 $ (5,551) *

Interest income 1,485 207 1,278 617 %

Interest expense (1,918) (1,946) 28 1 %

(Loss) on capped call transactions (6,876) (14,735) 7,859 53 % (56,381) (7,543) (48,838) (647) %

Other (loss) income, net (29) 2 (31) * 6,497 108 6,389 5,916 %

Gain (loss) on capped call transactions 3,206 (30,560) 33,766 *

Other income, net 6,583 2,741 3,842 140 %

$ 6,681 $ (26,682) $ 33,363 *

* not meaningful

• The increases in foreign currency transaction gain (loss) in the three and nine months ended September 30, 2022 were primarily due to the impact of fluctuations in foreign currency exchange rates associated with foreign currency-denominated cash and receivables held by our subsidiary in the United Kingdom.

• The increases in interest income in the three and nine months ended September 30, 2022 were primarily due to increases in market interest rates.

• The changes in (loss) on capped call transactions in the three and nine months ended September 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 (loss) income, net in the nine months ended September 30, 2022 was due to gains on our venture investments portfolio.

• The decrease in foreign currency transaction (loss) gain in the three months ended March 31, 2023 was primarily due to the impact of fluctuations in foreign currency exchange rates associated with foreign currency-denominated cash and receivables held by our subsidiary in the United Kingdom.

• The increase in interest income in the three months ended March 31, 2023 was primarily due to an increase in market interest rates.

• The change in gain (loss) on capped call transactions in the three months ended March 31, 2023 was due to fair value adjustments for our capped call transactions.

• The increase in other income, net in the three months ended March 31, 2023 was due to a gain from the repurchase of convertible senior notes and from our venture investments portfolio.

Provision for (benefit from) income taxes

Three Months Ended

September 30, Nine Months Ended

September 30,

(Dollars in thousands) 2023 2022

Provision for (benefit from) income taxes $ 5,249 $ (7,683)

Effective income tax rate (benefit rate) 100 % (68) %

During the nine months ended September 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 recognized at June 30, 2022, on our U.S.

and U.K deferred tax assets.

As a result of recording the valuation allowance, we are no longer recording any income tax benefit on our U.S and U.K losses.

The $11.7 million provision for (benefit from) income taxes for the three months ended September 30, 2022 primarily represents non-U.K.

foreign income taxes.

Effective income tax rate (34) % 95 %

The effective income tax rate in the three months ended March 31, 2023 was impacted by the valuation allowance on our U.S.

deferred tax assets and current taxes payable in the U.S.

as a result of projecting taxable income that cannot be fully offset by net operating losses and available tax credits.

LIQUIDITY AND CAPITAL RESOURCES

Nine Months Ended

September 30,

Three Months Ended

(in thousands) 2023 2022

3 unchanged sentences

Financing activities (29,372) (35,918)

Effect of exchange rates on cash and cash equivalents (5,513) (1,466)

Net (decrease) in cash and cash equivalents $ (52,339) $ (55,488)

Effect of exchange rate changes on cash, cash equivalents, and restricted cash 782 (310)

Net increase (decrease) in cash, cash equivalents, and restricted cash $ 25,104 $ (27,194)

(in thousands)

September 30, 2022 December 31, 2021

March 31, 2023 December 31, 2022

$ 229,214 $ 248,389

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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.

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.

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

If it becomes necessary or desirable to repatriate foreign funds, we may be required to pay federal, state, and local income and foreign withholding taxes upon repatriation.

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.

1 unchanged sentence

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 subscription licenses and services 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.

The change in cash (used in) operating activities in the nine months ended September 30, 2022 was primarily due to our subscription transition and increased costs as we made investments in research and development to support development of our offerings partially offset by strong client collections.

In addition, in the nine months ended September 30, 2022 and 2021, we incurred $32.4 million and $8.4 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.

This transition has impacted and is expected to continue impacting our billings and cash collections.

Subscription licenses and services are typically billed and collected over the contract term, while perpetual license arrangements are generally 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, 2023 was primarily due to our subscription transition and improved client collections.

In addition, in the three months ended March 31, 2023 and 2022, we paid $1.5 million and $6.9 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 costs for these proceedings.

See "Note 15.

1 unchanged sentence

Investing activities

The change in cash provided by investing activities in the nine months ended September 30, 2022 was primarily driven by our investments in financial instruments and an increase in office space related capital expenditures.

The change in cash (used in) investing activities in the three months ended March 31, 2023 was primarily driven by an increase in office space-related capital expenditures.

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 the three months ended March 31, 2023, we paid $29.9 million to repurchase $33 million in aggregate principal amount of convertible senior notes.

As of March 31, 2023, we had $567 million in aggregate principal amount of convertible senior notes outstanding.

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

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

As of September 30, 2022, we had no outstanding cash borrowings under the Credit Facility but had $27.3 million in outstanding letters of credit which reduce the available borrowing capacity.

As of March 31, 2023, we had no outstanding cash borrowings under the Credit Facility but had $27.3 million in outstanding letters of credit which reduces our available borrowing capacity.

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) Nine Months Ended

September 30, 2022

(in thousands) Three Months Ended

March 31, 2023

December 31, 2022 $ 58,075

Authorizations (1)

Repurchases (2)

September 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.

March 31, 2023 $ 58,075

(1) On April 25, 2023, our Board of Directors extended the expiration date of our current share repurchase program to June 30, 2024, and the amount of stock we are authorized to repurchase has been increased to $60 million.

Common stock repurchases

Nine Months Ended

September 30,

Three Months Ended

(in thousands) Shares Amount Shares Amount

Repurchases paid — $ — 242 $ 22,583

Repurchases unpaid at period end — — 3 400

Stock repurchase program — — 242 22,583

1 unchanged sentence

27 $ 1,107 383 $ 34,711

During the nine months ended September 30, 2022 and 2021, instead of receiving cash from the equity holders, we withheld shares with a value of $11.5 million and $47.1 million, respectively, for the exercise price of options.

In the three months ended March 31, 2023 and 2022, instead of receiving cash from the equity holders, we withheld shares with a value of $0.6 million and $6.1 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.

Nine Months Ended

September 30,

Three Months Ended

(in thousands) 2023 2022

1 unchanged sentence

Contractual obligations

As of September 30, 2022, our contractual obligations were:

As of March 31, 2023, our contractual obligations were:

Payments due by period

(in thousands) Remainder of 2022 2023 2024 2025 2026 2027 and thereafter Other Total

(in thousands) Remainder of 2023 2024 2025 2026 2027 2028 and after Other Total

Convertible senior notes (1)

3 unchanged sentences

Operating lease obligations 14,003 17,642 14,562 10,917 9,863 39,380 — 106,367

Investment commitments 1,000 — — — — — — 1,000

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) 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.

(3) We cannot 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