PEGASYSTEMS INC 10-Q

ITEM 1. FINANCIAL STATEMENTS PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) March 31, 2023 December 31, 2022 Assets Current assets: Cash and cash equivalents $ 168,318 $ 145,054 Marketable securities 155,564 152,167 Total cash, cash equivalents, and marketable securities 323,882 297,221 Accounts receivable 201,585 255,150 Unbilled receivables 196,279 213,719 Other current assets 73,982 80,388 Total current assets 795,728 846,478 Unbilled receivables 79,704 95,806 Goodwill 81,434 81,399 Other long-term assets 324,975 333,989 Total assets $ 1,281,841 $ 1,357,672 Liabilities and stockholders’ equity Current liabilities: Accounts payable $ 12,565 $ 18,195 Accrued expenses 45,432 50,355 Accrued compensation and related expenses 56,574 127,728 Deferred revenue 342,591 325,212 Other current liabilities 17,802 17,450 Total current liabilities 474,964 538,940 Convertible senior notes, net 561,655 593,609 Operating lease liabilities 76,082 79,152 Other long-term liabilities 14,644 15,128 Total liabilities 1,127,345 1,226,829 Commitments and contingencies (Note 15) Stockholders’ equity: Preferred stock, 1,000 shares authorized; none issued — — Common stock, 200,000 shares authorized; 82,940 and 82,436 shares issued and outstanding at March 31, 2023 and December 31, 2022, respectively 829 824 Additional paid-in capital 272,481 229,602 Accumulated deficit ( 97,287 ) ( 76,513 ) Accumulated other comprehensive (loss) ( 21,527 ) ( 23,070 ) Total stockholders’ equity 154,496 130,843 Total liabilities and stockholders’ equity $ 1,281,841 $ 1,357,672 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, 2023 2022 Revenue Subscription services $ 187,509 $ 170,033 Subscription license 84,527 137,533 Consulting 53,033 61,301 Perpetual license 403 7,440 Total revenue 325,472 376,307 Cost of revenue Subscription services 36,864 32,030 Subscription license 719 622 Consulting 60,348 55,511 Perpetual license 3 34 Total cost of revenue 97,934 88,197 Gross profit 227,538 288,110 Operating expenses Selling and marketing 149,797 162,236 Research and development 75,376 71,490 General and administrative 23,110 35,764 Restructuring 1,461 — Total operating expenses 249,744 269,490 (Loss) income from operations ( 22,206 ) 18,620 Foreign currency transaction (loss) gain ( 2,675 ) 2,876 Interest income 1,485 207 Interest expense ( 1,918 ) ( 1,946 ) Gain (loss) on capped call transactions 3,206 ( 30,560 ) Other income, net 6,583 2,741 (Loss) before provision for (benefit from) income taxes ( 15,525 ) ( 8,062 ) Provision for (benefit from) income taxes 5,249 ( 7,683 ) Net (loss) $ ( 20,774 ) $ ( 379 ) (Loss) per share Basic $ ( 0.25 ) $ — Diluted $ ( 0.25 ) $ — Weighted-average number of common shares outstanding Basic 82,604 81,680 Diluted 82,604 81,680 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, 2023 2022 Net (loss) $ ( 20,774 ) $ ( 379 ) Other comprehensive income (loss), net of tax Unrealized (loss) gain on available-for-sale securities ( 46 ) 222 Foreign currency translation adjustments 1,589 ( 2,770 ) Total other comprehensive income (loss), net of tax 1,543 ( 2,548 ) Comprehensive (loss) $ ( 19,231 ) $ ( 2,927 ) 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 Deficit) Accumulated Other Comprehensive (Loss) Total Stockholders’ Equity Number of Shares Amount 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 December 31, 2022 82,436 $ 824 $ 229,602 $ ( 76,513 ) $ ( 23,070 ) $ 130,843 Issuance of common stock for stock compensation plans 452 4 668 — — 672 Issuance of common stock under the employee stock purchase plan 52 1 2,142 — — 2,143 Stock-based compensation — — 42,557 — — 42,557 Cash dividends declared ($ 0.03 per share) — — ( 2,488 ) — — ( 2,488 ) Other comprehensive income — — — — 1,543 1,543 Net (loss) — — — ( 20,774 ) — ( 20,774 ) March 31, 2023 82,940 $ 829 $ 272,481 $ ( 97,287 ) $ ( 21,527 ) $ 154,496 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, 2023 2022 Operating activities Net (loss) $ ( 20,774 ) $ ( 379 ) Adjustments to reconcile net (loss) to cash provided by operating activities Stock-based compensation 42,557 28,227 Deferred income taxes ( 126 ) ( 9,295 ) (Gain) loss on capped call transactions ( 3,206 ) 30,560 Amortization of deferred commissions 14,277 17,221 Lease expense 4,594 3,919 Amortization of intangible assets and depreciation 4,724 4,171 Foreign currency transaction loss (gain) 2,675 ( 2,876 ) Other non-cash ( 5,729 ) ( 1,100 ) Change in operating assets and liabilities, net 29,115 ( 55,332 ) Cash provided by operating activities 68,107 15,116 Investing activities Purchases of investments ( 39,401 ) ( 33,690 ) Proceeds from maturities and called investments 36,475 20,915 Sales of investments — 13,350 Investment in property and equipment ( 11,487 ) ( 6,657 ) Cash (used in) investing activities ( 14,413 ) ( 6,082 ) Financing activities Repurchases of convertible senior notes ( 29,901 ) — Proceeds from settlement of capped calls transactions 188 — Dividend payments to stockholders ( 2,474 ) ( 2,454 ) Proceeds from employee stock purchase plan 2,143 2,446 Proceeds from stock option exercises 1,779 — Common stock repurchases ( 1,107 ) ( 35,910 ) Cash (used in) financing activities ( 29,372 ) ( 35,918 ) 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 ) Cash, cash equivalents, and restricted cash, beginning of period 145,054 159,965 Cash, cash equivalents, and restricted cash, end of period $ 170,158 $ 132,771 Cash and cash equivalents $ 168,318 $ 132,771 Restricted cash included in other long-term assets 1,840 — Total cash, cash equivalents and restricted cash $ 170,158 $ 132,771 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, 2022. 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 2023. NOTE 2. MARKETABLE SECURITIES March 31, 2023 December 31, 2022 (in thousands) Amortized Cost Unrealized Gains Unrealized Losses Fair Value Amortized Cost Unrealized Gains Unrealized Losses Fair Value Government debt $ 2,970 $ — $ ( 33 ) $ 2,937 $ 2,960 $ — $ ( 52 ) $ 2,908 Corporate debt 154,299 8 ( 1,680 ) 152,627 151,906 — ( 2,647 ) 149,259 $ 157,269 $ 8 $ ( 1,713 ) $ 155,564 $ 154,866 $ — $ ( 2,699 ) $ 152,167 As of March 31, 2023, marketable securities’ maturities ranged from April 2023 to January 2026, with a weighted-average remaining maturity of 0.5 years. NOTE 3. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE Receivables (in thousands) March 31, 2023 December 31, 2022 Accounts receivable $ 201,585 $ 255,150 Unbilled receivables 196,279 213,719 Long-term unbilled receivables 79,704 95,806 $ 477,568 $ 564,675 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, 2023 1 year or less $ 196,279 71 % 1-2 years 64,812 24 % 2-5 years 14,892 5 % $ 275,983 100 % Unbilled receivables by contract effective date: (Dollars in thousands) March 31, 2023 2023 $ 51,895 19 % 2022 96,349 34 % 2021 87,278 32 % 2020 27,755 10 % 2019 and prior 12,706 5 % $ 275,983 100 % 8 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) 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, 2023 December 31, 2022 Contract assets (1) $ 14,463 $ 17,546 Long-term contract assets (2) 11,323 16,470 $ 25,786 $ 34,016 (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, 2023 December 31, 2022 Deferred revenue $ 342,591 $ 325,212 Long-term deferred revenue (1) 3,323 3,552 $ 345,914 $ 328,764 (1) Included in other long-term liabilities. The increase in deferred revenue in the three months ended March 31, 2023 was primarily due to new billings in advance of revenue recognition exceeding the $ 139.7 million of revenue recognized during the period that was included in deferred revenue as of December 31, 2022. NOTE 4. DEFERRED COMMISSIONS (in thousands) March 31, 2023 December 31, 2022 Deferred commissions (1) $ 124,069 $ 130,195 (1) Included in other long-term assets. Three Months Ended March 31, (in thousands) 2023 2022 Amortization of deferred commissions (1) $ 14,277 $ 17,221 (1) Included in selling and marketing expense . NOTE 5. GOODWILL AND OTHER INTANGIBLES Goodwill Three Months Ended March 31, (in thousands) 2023 2022 January 1, $ 81,399 $ 81,923 Currency translation adjustments 35 108 March 31, $ 81,434 $ 82,031 Intangibles Intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives. March 31, 2023 (in thousands) Useful Lives Cost Accumulated Amortization Net Book Value (1) Client-related 4 - 10 years $ 63,094 $ ( 58,983 ) $ 4,111 Technology 2 - 10 years 68,085 ( 62,335 ) 5,750 Other 1 - 5 years 5,361 ( 5,361 ) — $ 136,540 $ ( 126,679 ) $ 9,861 (1) Included in other long-term assets. 9 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) December 31, 2022 (in thousands) Useful Lives Cost Accumulated Amortization Net Book Value (1) Client-related 4 - 10 years $ 63,076 $ ( 58,623 ) $ 4,453 Technology 2 - 10 years 68,056 ( 61,621 ) 6,435 Other 1 - 5 years 5,361 ( 5,361 ) — $ 136,493 $ ( 125,605 ) $ 10,888 (1) Included in other long-term assets. Future estimated intangibles assets amortization: (in thousands) March 31, 2023 Remainder of 2023 $ 2,884 2024 3,163 2025 2,613 2026 874 2027 327 $ 9,861 Amortization of intangible assets: Three Months Ended March 31, (in thousands) 2023 2022 Cost of revenue $ 706 $ 629 Selling and marketing 343 343 $ 1,049 $ 972 NOTE 6. OTHER ASSETS AND LIABILITIES Other current assets (in thousands) March 31, 2023 December 31, 2022 Income tax receivables $ 22,344 $ 25,354 Contract assets 14,463 17,546 Other 37,175 37,488 $ 73,982 $ 80,388 Other long-term assets (in thousands) March 31, 2023 December 31, 2022 Deferred commissions $ 124,069 $ 130,195 Right of use assets 72,549 76,114 Property and equipment 55,775 55,056 Venture investments 16,265 13,069 Contract assets 11,323 16,470 Intangible assets 9,861 10,888 Capped call transactions 5,600 2,582 Deferred income taxes 4,827 4,795 Restricted cash 1,840 — Other 22,866 24,820 $ 324,975 $ 333,989 Other current liabilities (in thousands) March 31, 2023 December 31, 2022 Operating lease liabilities $ 15,314 $ 14,976 Dividends payable 2,488 2,474 $ 17,802 $ 17,450 10 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Other long-term liabilities (in thousands) March 31, 2023 December 31, 2022 Deferred revenue $ 3,323 $ 3,552 Income taxes payable 3,578 3,207 Other 7,743 8,369 $ 14,644 $ 15,128 NOTE 7. LEASES Expense Three Months Ended March 31, (in thousands) 2023 2022 Fixed lease costs $ 5,766 $ 5,093 Short-term lease costs 781 806 Variable lease costs 1,975 764 $ 8,522 $ 6,663 Right of use assets and lease liabilities (in thousands) March 31, 2023 December 31, 2022 Right of use assets (1) $ 72,549 $ 76,114 Operating lease liabilities (2) $ 15,314 $ 14,976 Long-term operating lease liabilities $ 76,082 $ 79,152 (1) 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, 2023 December 31, 2022 Weighted-average remaining lease term 7.3 years 7.5 years Weighted-average discount rate (1) 4.1 % 4.1 % (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, 2023 Remainder of 2023 $ 14,003 2024 17,642 2025 14,562 2026 10,917 2027 9,863 2028 9,290 Thereafter 30,090 Total lease payments 106,367 Less: imputed interest (1) ( 14,971 ) $ 91,396 (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) 2023 2022 Cash paid for operating leases, net of tenant improvement allowances $ 5,038 $ 3,650 Right of use assets recognized for new leases and amendments (non-cash) $ 721 $ 3,854 11 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) 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. In the three months ended March 31, 2023, the Company recorded a gain of $ 2.8 million in other income, net from the repurchase of Notes representing $ 33 million in aggregate principal amount. 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: • 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, 2023, the Notes were not eligible for conversion. Repurchase rights On or after March 1, 2023 and on or before the 40 th 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, 2023 December 31, 2022 Principal $ 567,000 $ 600,000 Unamortized issuance costs ( 5,345 ) ( 6,391 ) Convertible senior notes, net $ 561,655 $ 593,609 Interest expense related to the Notes: Three Months Ended March 31, (in thousands) 2023 2022 Contractual interest expense ( 0.75 % coupon) $ 1,125 $ 1,125 Amortization of issuance costs 728 719 $ 1,853 $ 1,844 12 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) The average interest rate on the Notes in the three months ended March 31, 2023 and 2022 was 1.2 %. Future payments of principal and contractual interest: March 31, 2023 (in thousands) Principal Interest Total Remainder of 2023 $ — $ 1,772 $ 1,772 2024 — 4,253 4,253 2025 567,000 2,126 569,126 $ 567,000 $ 8,151 $ 575,151 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 covered approximately 4.4 million shares (representing the number of shares for which the Notes were initially convertible) of the Company’s common stock. In the three months ended March 31, 2023, Capped Call Transactions covering approximately 0.2 million shares were settled for proceeds of $ 0.2 million. As of March 31, 2023, Capped Call Transactions representing approximately 4.2 million shares were outstanding. 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) 2023 2022 January 1, $ 2,582 $ 59,964 Settlements ( 188 ) — Fair value adjustment 3,206 ( 30,560 ) March 31, $ 5,600 $ 29,404 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 and the agreement of the financial institutions lending the additional amount, the aggregate commitment may be increased 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, 2023, Pegasystems Inc. must maintain at least $ 200 million in cash, investments, and availability under the Revolving Credit Loan. • Beginning with the fiscal quarter ended March 31, 2023 and ending with the fiscal year ended December 31, 2023, maintain Year to Date (in thousands) March 31, 2023 June 30, 2023 September 30, 2023 December 31, 2023 Minimum Consolidated EBITDA (as defined in the Credit Facility) $ 38,862 $ 59,894 $ 95,597 $ 214,590 • Beginning with the fiscal quarter ended March 31, 2024, 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, 2023 and December 31, 2022, the Company had no outstanding cash borrowings under the Credit Facility. As of March 31, 2023, the Company had $ 27.3 million in outstanding letters of credit, which reduce the Company’s available borrowing capacity under the Credit Facility. 13 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 9. RESTRUCTURING Go-to-market plan and Salem office During the fourth quarter of 2022, management committed to a restructuring plan aligned with the Company’s target organization go-to-market strategy. The plan resulted in a restructuring expense of $ 21.7 million, primarily associated with severance and benefits for impacted employees and expenses incurred as a result of the closure of the Company’s Salem, New Hampshire office. Accrued employee severance and related benefits: (in thousands) 2023 January 1, $ 18,573 Costs incurred 220 Cash disbursements ( 14,458 ) Currency translation adjustments 181 March 31, $ 4,516 2023 office space closure In the three months ended March 31, 2023, the Company recognized an impairment of $ 1.2 million on its operating lease right of use assets primarily due to the closure of leased office space in Poland. NOTE 10. 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. 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 uses 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 the underlying equity security’s historical and implied volatility levels. 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, 2023 December 31, 2022 (in thousands) Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total Cash equivalents $ 41,088 $ — $ — $ 41,088 $ 2,526 $ — $ — $ 2,526 Marketable securities $ — $ 155,564 $ — $ 155,564 $ — $ 152,167 $ — $ 152,167 Capped Call Transactions (1) $ — $ 5,600 $ — $ 5,600 $ — $ 2,582 $ — $ 2,582 Venture investments (1) (2) $ — $ — $ 16,265 $ 16,265 $ — $ — $ 13,069 $ 13,069 (1) Included in other long-term assets. (2) Investments in privately-held companies. 14 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Changes in venture investments: Three Months Ended March 31, (in thousands) 2023 2022 January 1, $ 13,069 $ 7,648 New investments 400 — Changes in foreign exchange rates 58 ( 61 ) Changes in fair value: included in other income, net 3,802 2,741 included in other comprehensive (loss) ( 1,064 ) 2,502 March 31, $ 16,265 $ 12,830 The carrying value of certain other financial instruments, including receivables and accounts payable, approximates fair value due to these items’ short maturities. Fair value of the Notes The fair value of the Notes outstanding (including the embedded conversion feature) was $ 507.8 million as of March 31, 2023 and $ 521.1 million as of December 31, 2022. In the three months ended March 31, 2023 the Company repurchased Notes representing $ 33 million in aggregate principal amount. 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 11. REVENUE Geographic revenue Three Months Ended March 31, (Dollars in thousands) 2023 2022 U.S. $ 184,519 56 % $ 217,272 58 % Other Americas 15,011 5 % 45,751 12 % United Kingdom (“U.K.”) 42,237 13 % 30,932 8 % Europe (excluding U.K.), Middle East, and Africa 51,318 16 % 49,136 13 % Asia-Pacific 32,387 10 % 33,216 9 % $ 325,472 100 % $ 376,307 100 % Revenue streams Three Months Ended March 31, (in thousands) 2023 2022 Perpetual license $ 403 $ 7,440 Subscription license 84,527 137,533 Revenue recognized at a point in time 84,930 144,973 Maintenance 79,630 79,716 Pega Cloud 107,879 90,317 Consulting 53,033 61,301 Revenue recognized over time 240,542 231,334 Total revenue $ 325,472 $ 376,307 15 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Three Months Ended March 31, (in thousands) 2023 2022 Pega Cloud $ 107,879 $ 90,317 Maintenance 79,630 79,716 Subscription services 187,509 170,033 Subscription license 84,527 137,533 Subscription 272,036 307,566 Perpetual license 403 7,440 Consulting 53,033 61,301 $ 325,472 $ 376,307 Remaining performance obligations ("Backlog") Expected future revenue from existing non-cancellable contracts: As of March 31, 2023: (Dollars in thousands) Subscription services Subscription license Perpetual license Consulting Total Maintenance Pega Cloud 1 year or less $ 235,315 $ 389,632 $ 35,346 $ 5,262 $ 41,203 $ 706,758 54 % 1-2 years 66,272 239,228 3,215 2,252 6,653 317,620 24 % 2-3 years 29,295 131,085 6,777 — 2,292 169,449 13 % Greater than 3 years 7,479 106,778 — — — 114,257 9 % $ 338,361 $ 866,723 $ 45,338 $ 7,514 $ 50,148 $ 1,308,084 100 % 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 % NOTE 12. STOCK-BASED COMPENSATION Expense Three Months Ended March 31, (in thousands) 2023 2022 Cost of revenue $ 8,912 $ 6,378 Selling and marketing 17,661 10,958 Research and development 9,060 7,346 General and administrative 6,924 3,545 $ 42,557 $ 28,227 Income tax benefit $ ( 672 ) $ ( 5,311 ) As of March 31, 2023, the Company had $ 178.6 million of unrecognized stock-based compensation expense, net of estimated forfeitures, which is expected to be recognized over a weighted-average period of 2 years. Grants Three Months Ended March 31, 2023 (in thousands) Shares Total Fair Value Restricted stock units 1,460 $ 68,352 Non-qualified stock options 43 $ 615 16 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 13. INCOME TAXES Effective income tax rate Three Months Ended March 31, (Dollars in thousands) 2023 2022 Provision for (benefit from) income taxes $ 5,249 $ ( 7,683 ) 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 the Company’s U.S. and U.K. 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. The Company recognizes deferred tax assets to the extent that it believes that these assets are more likely than not to be realized. Future realization of deferred tax assets ultimately depends on sufficient taxable income within the available carryback or carryforward periods. The Company’s deferred tax valuation allowance requires significant judgment and uncertainties, including assumptions about future taxable income based on historical and projected information. On a quarterly basis, the Company reassesses the need for a valuation allowance on its existing net deferred tax assets by tax-paying jurisdiction, weighing positive and negative evidence to assess its recoverability. In making such a determination, the Company considers all available and objectively verifiable negative and positive evidence, including future reversals of existing taxable temporary differences, committed contractual backlog (“Backlog”), projected future taxable income inclusive of the impact of enacted legislation, tax-planning strategies, and results of recent operations. The weight given to the potential effect of negative and positive evidence is commensurate with the extent to which it can be objectively verified. The Company intends to continue maintaining a full valuation allowance on the Company’s U.S and U.K. deferred tax assets until there is sufficient evidence to support the realization of these deferred tax assets. NOTE 14. (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) 2023 2022 Net (loss) $ ( 20,774 ) $ ( 379 ) Weighted-average common shares outstanding 82,604 81,680 (Loss) per share, basic $ ( 0.25 ) $ — Net (loss) $ ( 20,774 ) $ ( 379 ) Weighted-average common shares outstanding, assuming dilution (1) (2) (3) 82,604 81,680 (Loss) per share, diluted $ ( 0.25 ) $ — Outstanding anti-dilutive stock options and RSUs (4) 1,348 4,178 (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 approximately 4.2 million shares as of March 31, 2023. (3) The Company’s Capped Call Transactions represent the equivalent of approximately 4.2 million shares of the Company’s common stock (representing the number of shares for which the Notes are initially convertible) as of March 31, 2023. 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 15. COMMITMENTS AND CONTINGENCIES Commitments See "Note 7. Leases" for additional information. 17 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) 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 the Company’s estimates will change in the near term, and the effect may be material. The Company had no accrued losses for litigation as of March 31, 2023 and December 31, 2022. Appian Corp. v. Pegasystems Inc. & Youyong Zou As previously reported, the Company is a defendant in litigation brought by Appian in the Circuit Court of Fairfax County, Virginia (the “Court”) titled Appian Corp. v. Pegasystems Inc. & Youyong Zou, No. 2020-07216 (Fairfax Cty. Ct.). On May 9, 2022, the jury rendered its verdict finding that the Company had misappropriated one or more of Appian’s trade secrets, that the Company had violated the Virginia Computer Crimes Act, and that the trade secret misappropriation was willful and malicious. The jury awarded damages of $ 2,036,860,045 for trade secret misappropriation and $ 1.00 for violating the Virginia Computer Crimes Act. On September 15, 2022, the circuit court of Fairfax County entered judgment of $ 2,060,479,287 , consisting of the damages previously awarded by the jury plus attorneys’ fees and costs, and stating that the judgment is subject to post-judgment interest at a rate of 6.0 % per annum, from the date of the jury verdict (May 9, 2022) as to the amount of the jury verdict and from September 15, 2022 as to the amount of the award of attorneys’ fees and costs. On September 15, 2022, the Company filed a notice of appeal from the judgment. On September 29, 2022, the circuit court of Fairfax County approved a $ 25,000,000 letter of credit obtained by the Company to secure the judgment and entered an order suspending the judgment during the pendency of the Company’s appeal. Appellate briefing is currently in process. Although it is not possible to predict timing, this appeals process could potentially take years to complete. The Company continues to believe that it did not misappropriate any alleged trade secrets and that its sales of the Company’s products at issue were not caused by, or the result of, any alleged misappropriation of trade secrets. The Company is unable to reasonably estimate possible damages because of, among other things, uncertainty as to the outcome of appellate proceedings and/or any potential new trial resulting from the appellate proceedings. City of Fort Lauderdale Police and Firefighters’ Retirement System, Individually and on Behalf of All Others Similarly Situated v. Pegasystems Inc., Alan Trefler, and Kenneth Stillwell On May 19, 2022, a lawsuit was filed against the Company, the Company’s chief executive officer and the Company’s chief operating and financial officer in the United States District Court for the Eastern District of Virginia Alexandria Division, captioned City of Fort Lauderdale Police and Firefighters’ Retirement System, Individually and on Behalf of All Others Similarly Situated v. Pegasystems Inc., Alan Trefler, and Kenneth Stillwell (Case 1:22-cv-00578-LMB-IDD). The complaint generally alleges, among other things, that the defendants violated Section 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Rule 10b-5 promulgated thereunder and that the individual defendants violated Section 20(a) of the Exchange Act, in each case by allegedly making materially false and/or misleading statements, as well as allegedly failing to disclose material adverse facts about the Company’s business, operations, and prospects, which caused the Company’s securities to trade at artificially inflated prices. The complaint seeks unspecified damages on behalf of a class of purchasers of the Company’s securities between May 29, 2020 and May 9, 2022. The litigation has since been transferred to the United States District Court for the District of Massachusetts (Case 1:22-cv-11220-WGY), and lead plaintiff class representatives—Central Pennsylvania Teamsters Pension Fund - Defined Benefit Plan, Central Pennsylvania Teamsters Pension Fund - Retirement Income Plan 1987, and Construction Industry Laborers Pension Fund—have been appointed. On October 18, 2022, a consolidated amended complaint was filed that does not add any new parties or legal claims, is based upon the same general factual allegations as the original complaint, and now seeks unspecified damages on behalf of a class of purchasers of the Company’s securities between June 16, 2020 and May 9, 2022. The Company moved to dismiss the consolidated amended complaint on December 19, 2022. The hearing on the motion to dismiss is scheduled for May 17, 2023. The Company believes the claims brought against the defendants are without merit and intends to defend against these claims vigorously. The Company is unable to reasonably estimate possible damages or a range of possible damages in this matter given the stage of the lawsuit, the Company’s belief that the claims are without merit, and there being no specified quantum of damages sought in the complaint. 18 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Mary Larkin, derivatively on behalf of nominal defendant Pegasystems Inc. v. Peter Gyenes, Richard Jones, Christopher Lafond, Dianne Ledingham, Sharon Rowlands, Alan Trefler, Larry Weber, and Kenneth Stillwell, defendants, and Pegasystems Inc., nominal defendant On November 21, 2022, a lawsuit was filed against the members of the Company’s board of directors, the Company’s chief operating and financial officer and the Company in the United States District Court for the District of Massachusetts, captioned Mary Larkin, derivatively on behalf of nominal defendant Pegasystems Inc. v. Peter Gyenes, Richard Jones, Christopher Lafond, Dianne Ledingham, Sharon Rowlands, Alan Trefler, Larry Weber, and Kenneth Stillwell, defendants, and Pegasystems Inc., nominal defendant (Case 1:22-cv-11985). The complaint generally alleges the defendants sold shares of the Company while in possession of material nonpublic information relating to (i) the litigation brought by Appian in the Circuit Court of Fairfax County, Virginia, described above, and (ii) alleged misconduct by Company employees alleged in that litigation. On January 10, 2023, the Court entered an order staying the matter until after a final judgment dismissing the City of Fort Lauderdale matter referenced above, the denial of a motion to dismiss in the City of Fort Lauderdale action, or if any related derivative complaint is filed and not stayed for the same or longer duration. The Company believes the claims brought against the defendants are without merit and intends to defend against these claims vigorously. The Company is unable to reasonably estimate possible damages or a range of possible damages in this matter given the stage of the lawsuit, the Company’s belief that the claims are without merit, and there being no specified quantum of damages sought in the complaint. SEC Inquiry Beginning in March 2023, the U.S. Securities and Exchange Commission (“SEC”) has requested certain information relating to, among other things, the accounting treatment of the Company’s above-described litigation with Appian Corporation. The Company is fully cooperating with the SEC’s requests. 19