What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-07-26 compared with 2023-04-26 · 102 added, 83 removed, 160 unchanged (54% of the section changed)

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This Quarterly Report on Form 10-Q (“Quarterly Report”) contains or incorporates forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Words such as expects, anticipates, intends, plans, believes, will, could, should, estimates, may, targets, strategies, projects, forecasts, guidance, likely, and usually, or variations of such words and other similar expressions identify forward-looking statements, which are based on current expectations and assumptions.

Words such as expects, anticipates, intends, plans, believes, will, could, should, estimates, may, targets, strategies, intends to, projects, forecasts, guidance, likely, and usually or variations of such words and other similar expressions identify forward-looking statements, which speak only as of the date the statement was made and are based on current expectations and assumptions.

Forward-looking statements deal with future events and are subject to risks and uncertainties that are difficult to predict, including, but not limited to:

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Securities and Exchange Commission (“SEC”).

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

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

Investors are cautioned not to place undue reliance on such forward-looking statements, and there are no assurances that the results included in such statements will be achieved.

Although subsequent events may cause our view to change, except as required by applicable law, we do not undertake and expressly disclaim any obligation to publicly update or revise these forward-looking statements whether as the result of new information, future events, or otherwise.

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

NON-GAAP MEASURES

Our non-GAAP financial measures should only be read in conjunction with our consolidated financial statements prepared in accordance with GAAP.

We believe these measures help investors understand our core operating results without the effect of often one-time charges and other items outside normal operations.

They are not a substitute for financial measures prepared under U.S.

A reconciliation of our GAAP to non-GAAP measures is located with each non-GAAP measure.

BUSINESS OVERVIEW

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

Subscription transition

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

Until we fully complete our subscription transition, which we expect will occur in 2023, our operating results may be impacted.

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.

Performance metrics

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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”)

Reconciliation of GAAP Backlog and Constant Currency Backlog

(in millions, except percentages) Q1 2023 1 Year Growth Rate

Backlog $ 1,308 11 %

Reconciliation of ACV and Constant Currency ACV

(in millions, except percentages) Q2 22 Q3 22 Q4 22 Q1 23 Q2 23 1 Year Change

ACV $ 1,026 $ 1,040 $ 1,126 $ 1,174 $ 1,164 13 %

Impact of changes in foreign exchange rates $ — $ 24 $ (1) $ (5) $ (5)

Backlog - Constant Currency $ 1,336 14 %

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

Constant Currency ACV $ 1,026 $ 1,064 $ 1,125 $ 1,169 $ 1,159 13 %

Constant currency ACV is calculated by applying the Q2 2022 foreign exchange rates to all periods shown.

(in thousands, except percentages) Six Months Ended

2023 2022 Change

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

Cash provided by (used in) operating activities $ 113,752 $ (5,069) *

Investment in property and equipment (13,933) (11,863)

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Free cash flow margin 20 % 2 %

(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.

* not meaningful

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

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• Legal fees :

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

Includes legal and related fees arising from proceedings outside 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.

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

We have excluded fees incurred due to the cancellation of in-person sales and marketing events, and incremental expenses incurred from the integration of acquisitions.

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

Remaining performance obligations (“Backlog”)

Reconciliation of Backlog and Constant Currency Backlog (Non-GAAP)

(in millions, except percentages) Q2 2023 1 Year Growth Rate

Backlog $ 1,266 12 %

Impact of changes in foreign exchange rates (8) — %

Backlog - Constant Currency $ 1,258 12 %

Constant currency Backlog is calculated by applying the Q2 2022 foreign exchange rates to all periods shown.

CRITICAL ACCOUNTING POLICIES

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RESULTS OF OPERATIONS

Subscription transition

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

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

March 31, Change

June 30, Change Six Months Ended

June 30, Change

2023 2022 2023 2022

Pega Cloud $ 115,063 39 % $ 93,506 34 % $ 21,557 23 % $ 222,942 36 % $ 183,823 28 % $ 39,119 21 %

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Subscription 238,302 80 % 213,432 78 % 24,870 12 % 510,338 82 % 520,998 80 % (10,660) (2) %

Perpetual license 403 — % 7,440 2 % (7,037) (95) %

Consulting 58,387 19 % 58,639 21 % (252) — % 111,420 18 % 119,940 19 % (8,520) (7) %

Perpetual license 1,579 1 % 2,266 1 % (687) (30) % 1,982 — % 9,706 1 % (7,724) (80) %

$ 298,268 100 % $ 274,337 100 % $ 23,931 9 % $ 623,740 100 % $ 650,644 100 % $ (26,904) (4) %

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 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.

• The increases in Pega Cloud revenue for the three and six months ended June 30, 2023, were primarily due to continued growth of the installed client base.

• The decrease in subscription license revenue in the six months ended June 30, 2023 was primarily due to several large software license contracts recognized in revenue in the six months ended June 30, 2022.

• The decreases in perpetual license revenue in the three and six months ended June 30, 2023 were primarily due to our strategy of promoting subscription-based arrangements.

• The decreases in consulting revenue in the three and six months ended June 30, 2023 were primarily due to lower realization rates.

(Dollars in thousands) Three Months Ended

March 31, Change

June 30, Change Six Months Ended

June 30, Change

2023 2022 2023 2022

Pega Cloud $ 84,761 74 % $ 62,259 67 % $ 22,502 36 % $ 162,390 73 % $ 125,677 68 % $ 36,713 29 %

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Subscription 200,896 84 % 176,226 83 % 24,670 14 % 435,349 85 % 451,140 87 % (15,791) (4) %

Perpetual license 400 99 % 7,406 100 % (7,006) (95) %

Consulting (323) (1) % 766 1 % (1,089) * (7,638) (7) % 6,556 5 % (14,194) *

Perpetual license 1,555 98 % 2,230 98 % (675) (30) % 1,955 99 % 9,636 99 % (7,681) (80) %

$ 202,128 68 % $ 179,222 65 % $ 22,906 13 % $ 429,666 69 % $ 467,332 72 % $ (37,666) (8) %

* not meaningful

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.

• The increases in Pega Cloud gross profit percent in the three and six months ended June 30, 2023 were primarily due to increased cost efficiency, particularly for hosting services, as Pega Cloud continues to grow and scale.

• The decrease in maintenance gross profit percent in the three months ended June 30, 2023 was primarily due to an increase in compensation and benefits due to an increase in headcount.

• The decrease in consulting gross profit percent in the three months ended June 30, 2023 was primarily due to lower consultant realization rates.

The decrease in consulting revenue in the six months ended June 30, 2023 was primarily due to lower consultant realization and utilization rates.

Operating expenses

(Dollars in thousands) Three Months Ended

March 31, Change

% of Revenue % of Revenue

June 30, Change Six Months Ended

June 30, Change

2023 2022 2023 2022

Selling and marketing $ 143,858 $ 157,198 $ (13,340) (8) % $ 293,655 $ 319,434 $ (25,779) (8) %

% of Revenue 48 % 57 % 47 % 49 %

Research and development $ 73,931 $ 74,341 $ (410) (1) % $ 149,307 $ 145,831 $ 3,476 2 %

% of Revenue 25 % 27 % 24 % 22 %

General and administrative $ 23,462 $ 32,723 $ (9,261) (28) % $ 46,572 $ 68,487 $ (21,915) (32) %

% of Revenue 8 % 12 % 7 % 11 %

Restructuring $ 2,167 $ — $ 2,167 100 % $ 3,628 $ — $ 3,628 100 %

• 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.

% of Revenue 1 % — % 1 % — %

• The decreases in selling and marketing during the three and six months ended June 30, 2023, were primarily due to decreases in compensation and benefits totaling $14.2 million and $26.4 million, respectively.

The decreases are due to reduced headcount associated with the optimization of our go-to-market strategy.

For additional information, see "Note 9.

Restructuring" in Part I, Item 1 of this Quarterly Report.

• The decrease in research and development for the three months ended June 30, 2023, was primarily due to a $1.2 million decrease in hosting services costs from cost-efficiency gains as the Company’s use of hosting services grows.

• The increase in research and development for the six months ended June 30, 2023, was primarily due to additional investments in our products and services.

• The decreases in general and administrative in the three and six months ended June 30, 2023 were primarily due to decreases of $7.7 million and $23.6 million, in legal fees and related expenses arising from proceedings outside the ordinary course of business.

In the six months ended June 30, 2023 the decrease was partially offset by a $4.2 million increase in compensation and benefits due to an increase in equity compensation.

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

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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.

• The increases in restructuring expenses during the three and six months ended June 30, 2023, were primarily due to a $1.6 million restructuring expense related to the optimization of our go-to-market organization in the U.S.

in the three months ended June 30, 2023 and $1.2 million primarily due to the closure of leased office space in Poland in the three months ended March 31, 2023.

Other income and expenses

(Dollars in thousands) Three Months Ended

March 31, Change

June 30, Change Six Months Ended

June 30, Change

2023 2022 2023 2022

Foreign currency transaction (loss) gain $ (3,290) $ 1,713 $ (5,003) * $ (5,965) $ 4,589 $ (10,554) *

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Interest expense (1,778) (1,944) 166 9 % (3,696) (3,890) 194 5 %

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

(Loss) income on capped call transactions (1,361) (18,945) 17,584 93 % 1,845 (49,505) 51,350 *

Other income, net 5,702 3,785 1,917 51 % 12,285 6,526 5,759 88 %

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* not meaningful

• 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

• The changes in foreign currency transaction (loss) gain in the three and six months ended June 30, 2023 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 six months ended June 30, 2023 was primarily due to increases in market interest rates.

• The decreases in interest expense in the three and six months ended June 30, 2023 were due to our repurchases of our Convertible Senior Notes.

For additional information, see "Note 8.

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

• The changes in (loss) income on capped call transactions in the three and six months ended June 30, 2023 were due to fair value adjustments for our capped call transactions.

• The increases in other income, net in the three and six months ended June 30, 2023 were due to gains from repurchases of our convertible senior notes and our venture investments portfolio.

Provision for income taxes

Six Months Ended

(Dollars in thousands) 2023 2022

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

Provision for income taxes $ 11,850 $ 178,491

Effective income tax rate (21) % (165) %

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.

The effective income tax rate in the six months ended June 30, 2023 was impacted by the valuation allowance on our deferred tax assets in the U.S.

Also, impacted by current taxes payable in the U.S.

due to projected taxable income partially offset by net operating losses and available tax credits.

LIQUIDITY AND CAPITAL RESOURCES

Three Months Ended

Six Months Ended

(in thousands) 2023 2022

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(in thousands)

March 31, 2023 December 31, 2022

June 30, 2023 December 31, 2022

$ 232,524 $ 248,389

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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.

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

Operating activities

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.

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.

The change in cash provided by (used in) operating activities in the six months ended June 30, 2023 was primarily due to growth in client collections and the impact of our cost-efficiency initiatives.

In addition, in the six months ended June 30, 2023 and 2022, we paid $3.0 million and $26.4 million in legal fees and related expenses arising from proceedings that originated outside the ordinary course of business.

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

See "Note 15.

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

For additional information, see "Note 15.

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

Investing activities

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.

The change in cash provided by (used in) investing activities in the six months ended June 30, 2023 was primarily due to our investments in

financial instruments

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 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 the six months ended June 30, 2023, we paid $89 million to repurchase $97.7 million in aggregate principal amount of convertible senior notes.

As of June 30, 2023, we had $502 million in aggregate principal amount of convertible senior notes outstanding due on March 1, 2025.

For additional information, see "Note 8.

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

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 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.

As of June 30, 2023 and December 31, 2022, we had $27.3 million in outstanding letters of credit, which reduced the Company’s available borrowing capacity under the Credit Facility and no outstanding cash borrowings under the Credit Facility.

For additional information, see "Note 8.

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

Stock repurchase program

Changes in the remaining stock repurchase authority:

(in thousands) Three Months Ended

March 31, 2023

(in thousands) Six Months Ended

June 30, 2023

December 31, 2022 $ 58,075

Authorizations (1)

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.

June 30, 2023 $ 60,000

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

Common stock repurchases

Three Months Ended

Six Months Ended

(in thousands) Shares Amount Shares Amount

Repurchases paid — $ — 242 $ 22,583

Stock repurchase program — — 279 24,508

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34 $ 1,422 475 $ 39,887

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.

In the six months ended June 30, 2023 and 2022, instead of receiving cash from the equity holders, we withheld shares with a value of $0.9 million and $8.3 million, respectively, for the exercise price of options.

These amounts are not included in the table above.

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

Three Months Ended

Six Months Ended

(in thousands) 2023 2022

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Contractual obligations

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

As of June 30, 2023, our contractual obligations were:

Payments due by period

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(1) Includes principal and interest.

(2) Represents the fixed or minimum amounts due under purchase obligations for hosting services and sales and marketing programs.

(2) Represents the fixed amount owed for purchase obligations of software licenses, hosting services, and sales and marketing programs.

(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