PEGASYSTEMS INC 10-Q

ITEM 1. FINANCIAL STATEMENTS PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) June 30, 2023 December 31, 2022 Assets Current assets: Cash and cash equivalents $ 186,874 $ 145,054 Marketable securities 125,939 152,167 Total cash, cash equivalents, and marketable securities 312,813 297,221 Accounts receivable 163,915 255,150 Unbilled receivables 182,257 213,719 Other current assets 78,526 80,388 Total current assets 737,511 846,478 Unbilled receivables 70,486 95,806 Goodwill 81,593 81,399 Other long-term assets 302,848 333,989 Total assets $ 1,192,438 $ 1,357,672 Liabilities and stockholders’ equity Current liabilities: Accounts payable $ 8,438 $ 18,195 Accrued expenses 53,110 50,355 Accrued compensation and related expenses 70,965 127,728 Deferred revenue 311,330 325,212 Other current liabilities 17,269 17,450 Total current liabilities 461,112 538,940 Convertible senior notes, net 498,140 593,609 Operating lease liabilities 72,886 79,152 Other long-term liabilities 14,904 15,128 Total liabilities 1,047,042 1,226,829 Commitments and contingencies (Note 15) Stockholders’ equity: Preferred stock, 1,000 shares authorized; none issued — — Common stock, 200,000 shares authorized; 83,212 and 82,436 shares issued and outstanding at June 30, 2023 and December 31, 2022, respectively 832 824 Additional paid-in capital 310,016 229,602 Accumulated deficit ( 144,091 ) ( 76,513 ) Accumulated other comprehensive (loss) ( 21,361 ) ( 23,070 ) Total stockholders’ equity 145,396 130,843 Total liabilities and stockholders’ equity $ 1,192,438 $ 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 June 30, Six Months Ended June 30, 2023 2022 2023 2022 Revenue Subscription services $ 197,105 $ 171,832 $ 384,614 $ 341,865 Subscription license 41,197 41,600 125,724 179,133 Consulting 58,387 58,639 111,420 119,940 Perpetual license 1,579 2,266 1,982 9,706 Total revenue 298,268 274,337 623,740 650,644 Cost of revenue Subscription services 36,783 36,533 73,647 68,563 Subscription license 623 673 1,342 1,295 Consulting 58,710 57,873 119,058 113,384 Perpetual license 24 36 27 70 Total cost of revenue 96,140 95,115 194,074 183,312 Gross profit 202,128 179,222 429,666 467,332 Operating expenses Selling and marketing 143,858 157,198 293,655 319,434 Research and development 73,931 74,341 149,307 145,831 General and administrative 23,462 32,723 46,572 68,487 Restructuring 2,167 — 3,628 — Total operating expenses 243,418 264,262 493,162 533,752 (Loss) from operations ( 41,290 ) ( 85,040 ) ( 63,496 ) ( 66,420 ) Foreign currency transaction (loss) gain ( 3,290 ) 1,713 ( 5,965 ) 4,589 Interest income 1,814 309 3,299 516 Interest expense ( 1,778 ) ( 1,944 ) ( 3,696 ) ( 3,890 ) (Loss) income on capped call transactions ( 1,361 ) ( 18,945 ) 1,845 ( 49,505 ) Other income, net 5,702 3,785 12,285 6,526 (Loss) before provision for income taxes ( 40,203 ) ( 100,122 ) ( 55,728 ) ( 108,184 ) Provision for income taxes 6,601 186,174 11,850 178,491 Net (loss) $ ( 46,804 ) $ ( 286,296 ) $ ( 67,578 ) $ ( 286,675 ) (Loss) per share Basic $ ( 0.56 ) $ ( 3.50 ) $ ( 0.82 ) $ ( 3.51 ) Diluted $ ( 0.56 ) $ ( 3.50 ) $ ( 0.82 ) $ ( 3.51 ) Weighted-average number of common shares outstanding Basic 83,039 81,847 82,823 81,764 Diluted 83,039 81,847 82,823 81,764 See notes to unaudited condensed consolidated financial statements. 4 PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) (in thousands) Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Net (loss) $ ( 46,804 ) $ ( 286,296 ) $ ( 67,578 ) $ ( 286,675 ) Other comprehensive income (loss), net of tax Unrealized (loss) on available-for-sale securities ( 195 ) ( 1,149 ) ( 241 ) ( 927 ) Foreign currency translation adjustments 361 ( 11,466 ) 1,950 ( 14,236 ) Total other comprehensive income (loss), net of tax $ 166 $ ( 12,615 ) 1,709 ( 15,163 ) Comprehensive (loss) $ ( 46,638 ) $ ( 298,911 ) $ ( 65,869 ) $ ( 301,838 ) 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 Repurchase of common stock ( 38 ) — ( 1,925 ) — — ( 1,925 ) Issuance of common stock for stock compensation plans 117 1 ( 3,252 ) — — ( 3,251 ) Issuance of common stock under the employee stock purchase plan 59 — 2,357 — — 2,357 Stock-based compensation — — 31,300 — — 31,300 Cash dividends declared ($ 0.03 per share) — — — ( 2,459 ) — ( 2,459 ) Other comprehensive (loss) — — — — ( 12,615 ) ( 12,615 ) Net (loss) — — — ( 286,296 ) — ( 286,296 ) June 30, 2022 81,940 $ 819 $ 170,251 $ ( 15,140 ) $ ( 22,151 ) $ 133,779 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 Issuance of common stock for stock compensation plans 225 2 1,824 — — 1,826 Issuance of common stock under the employee stock purchase plan 47 1 1,980 — — 1,981 Stock-based compensation — — 36,227 — — 36,227 Cash dividends declared ($ 0.03 per share) — — ( 2,496 ) — — ( 2,496 ) Other comprehensive income — — — — 166 166 Net (loss) — — — ( 46,804 ) — ( 46,804 ) June 30, 2023 83,212 $ 832 $ 310,016 $ ( 144,091 ) $ ( 21,361 ) $ 145,396 See notes to unaudited condensed consolidated financial statements. 6 PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Six Months Ended June 30, 2023 2022 Operating activities Net (loss) $ ( 67,578 ) $ ( 286,675 ) Adjustments to reconcile net (loss) to cash provided by (used in) operating activities Stock-based compensation 78,784 59,527 Deferred income taxes ( 136 ) 169,105 (Gain) loss on capped call transactions ( 1,845 ) 49,505 Amortization of deferred commissions 29,027 28,155 Lease expense 8,186 7,832 Amortization of intangible assets and depreciation 9,553 8,175 Foreign currency transaction loss (gain) 5,965 ( 4,589 ) Other non-cash ( 10,163 ) ( 3,479 ) Change in operating assets and liabilities, net 61,959 ( 32,625 ) Cash provided by (used in) operating activities 113,752 ( 5,069 ) Investing activities Purchases of investments ( 69,662 ) ( 38,489 ) Proceeds from maturities and called investments 88,849 34,912 Sales of investments 10,725 14,839 Payments for acquisitions, net of cash acquired — ( 922 ) Investment in property and equipment ( 13,933 ) ( 11,863 ) Cash provided by (used in) investing activities 15,979 ( 1,523 ) Financing activities Repurchases of convertible senior notes ( 88,989 ) — Proceeds from settlement of capped calls transactions 341 — Dividend payments to stockholders ( 4,962 ) ( 4,908 ) Proceeds from employee stock purchase plan 4,124 4,803 Proceeds from stock option exercises 3,920 — Common stock repurchases ( 1,422 ) ( 41,086 ) Cash (used in) financing activities ( 86,988 ) ( 41,191 ) Effect of exchange rate changes on cash, cash equivalents, and restricted cash 1,010 ( 2,907 ) Net increase (decrease) in cash, cash equivalents, and restricted cash 43,753 ( 50,690 ) Cash, cash equivalents, and restricted cash, beginning of period 145,054 159,965 Cash, cash equivalents, and restricted cash, end of period $ 188,807 $ 109,275 Cash and cash equivalents $ 186,874 $ 109,275 Restricted cash included in other long-term assets 1,933 — Total cash, cash equivalents, and restricted cash $ 188,807 $ 109,275 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 2023. NOTE 2. MARKETABLE SECURITIES June 30, 2023 December 31, 2022 (in thousands) Amortized Cost Unrealized Gains Unrealized Losses Fair Value Amortized Cost Unrealized Gains Unrealized Losses Fair Value Government debt $ 16,372 $ — $ ( 17 ) $ 16,355 $ 2,960 $ — $ ( 52 ) $ 2,908 Corporate debt 110,483 — ( 899 ) 109,584 151,906 — ( 2,647 ) 149,259 $ 126,855 $ — $ ( 916 ) $ 125,939 $ 154,866 $ — $ ( 2,699 ) $ 152,167 As of June 30, 2023, marketable securities’ maturities ranged from July 2023 to January 2026, with a weighted average remaining maturity of 0.4 years. NOTE 3. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE Receivables (in thousands) June 30, 2023 December 31, 2022 Accounts receivable $ 163,915 $ 255,150 Unbilled receivables 182,257 213,719 Long-term unbilled receivables 70,486 95,806 $ 416,658 $ 564,675 Unbilled receivables Unbilled receivables are client-committed amounts for which revenue recognition precedes billing. Billing is solely subject to the passage of time. Unbilled receivables by expected billing date: (Dollars in thousands) June 30, 2023 1 year or less $ 182,257 72 % 1-2 years 58,025 23 % 2-5 years 12,461 5 % $ 252,743 100 % Unbilled receivables by contract effective date: (Dollars in thousands) June 30, 2023 2023 $ 62,243 25 % 2022 88,337 35 % 2021 67,852 27 % 2020 23,157 9 % 2019 and prior 11,154 4 % $ 252,743 100 % 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) June 30, 2023 December 31, 2022 Contract assets (1) $ 13,850 $ 17,546 Long-term contract assets (2) 11,126 16,470 $ 24,976 $ 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) June 30, 2023 December 31, 2022 Deferred revenue $ 311,330 $ 325,212 Long-term deferred revenue (1) 3,020 3,552 $ 314,350 $ 328,764 (1) Included in other long-term liabilities. Deferred revenue decreased in the six months ended June 30, 2023 primarily due to $ 230.3 million of revenue recognized during the period included in deferred revenue as of December 31, 2022 exceeded new billings in advance of revenue recognition. NOTE 4. DEFERRED COMMISSIONS (in thousands) June 30, 2023 December 31, 2022 Deferred commissions (1) $ 114,406 $ 130,195 (1) Included in other long-term assets. Three Months Ended June 30, Six Months Ended June 30, (in thousands) 2023 2022 2023 2022 Amortization of deferred commissions (1) $ 14,750 $ 10,934 $ 29,027 $ 28,155 (1) Included in selling and marketing. NOTE 5. GOODWILL AND OTHER INTANGIBLES Goodwill Six Months Ended June 30, (in thousands) 2023 2022 January 1, $ 81,399 $ 81,923 Currency translation adjustments 194 ( 206 ) June 30, $ 81,593 $ 81,717 Intangibles Intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives. June 30, 2023 (in thousands) Useful Lives Cost Accumulated Amortization Net Book Value (1) Client-related 4 - 10 years $ 63,111 $ ( 59,344 ) $ 3,767 Technology 2 - 10 years 68,137 ( 62,972 ) 5,165 Other 1 - 5 years 5,361 ( 5,361 ) — $ 136,609 $ ( 127,677 ) $ 8,932 (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) June 30, 2023 Remainder of 2023 $ 1,932 2024 3,180 2025 2,619 2026 874 2027 327 $ 8,932 Amortization of intangible assets: Three Months Ended June 30, Six Months Ended June 30, (in thousands) 2023 2022 2023 2022 Cost of revenue $ 621 $ 683 $ 1,327 $ 1,312 Selling and marketing 342 342 685 685 $ 963 $ 1,025 $ 2,012 $ 1,997 NOTE 6. OTHER ASSETS AND LIABILITIES Other current assets (in thousands) June 30, 2023 December 31, 2022 Income tax receivables $ 21,383 $ 25,354 Contract assets 13,850 17,546 Other 43,293 37,488 $ 78,526 $ 80,388 Other long-term assets (in thousands) June 30, 2023 December 31, 2022 Deferred commissions $ 114,406 $ 130,195 Right of use assets 69,839 76,114 Property and equipment 52,698 55,056 Venture investments 13,382 13,069 Contract assets 11,126 16,470 Intangible assets 8,932 10,888 Capped call transactions 4,086 2,582 Deferred income taxes 4,836 4,795 Restricted cash 1,933 — Other 21,610 24,820 $ 302,848 $ 333,989 Other current liabilities (in thousands) June 30, 2023 December 31, 2022 Operating lease liabilities $ 14,773 $ 14,976 Dividends payable 2,496 2,474 $ 17,269 $ 17,450 10 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Other long-term liabilities (in thousands) June 30, 2023 December 31, 2022 Deferred revenue $ 3,020 $ 3,552 Income taxes payable 3,989 3,207 Other 7,895 8,369 $ 14,904 $ 15,128 NOTE 7. LEASES Expense Three Months Ended June 30, Six Months Ended June 30, (in thousands) 2023 2022 2023 2022 Fixed lease costs $ 4,495 $ 4,965 $ 10,261 $ 10,059 Short-term lease costs 696 787 1,477 1,594 Variable lease costs 2,186 727 4,160 1,491 $ 7,377 $ 6,479 $ 15,898 $ 13,144 Right of use assets and lease liabilities (in thousands) June 30, 2023 December 31, 2022 Right of use assets (1) $ 69,839 $ 76,114 Operating lease liabilities (2) $ 14,773 $ 14,976 Long-term operating lease liabilities $ 72,886 $ 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: June 30, 2023 December 31, 2022 Weighted-average remaining lease term 7.1 years 7.5 years Weighted-average discount rate (1) 4.0 % 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) June 30, 2023 Remainder of 2023 $ 8,596 2024 18,024 2025 14,869 2026 10,940 2027 9,882 2028 9,312 Thereafter 30,149 Total lease payments 101,772 Less: imputed interest (1) ( 14,113 ) $ 87,659 (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 Six Months Ended June 30, (in thousands) 2023 2022 Cash paid for operating leases, net of tenant improvement allowances $ 10,540 $ 7,296 Right of use assets recognized for new leases and amendments (non-cash) $ 1,465 $ 2,223 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 September 1, 2020. In the three and six months ended June 30, 2023, the Company recognized gains of $ 5.1 million and $ 7.9 million, respectively, in other income, net from repurchases of Notes representing $ 64.7 million and $ 97.7 million, respectively, 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 June 30, 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) June 30, 2023 December 31, 2022 Principal $ 502,270 $ 600,000 Unamortized issuance costs ( 4,130 ) ( 6,391 ) Convertible senior notes, net $ 498,140 $ 593,609 Interest expense related to the Notes: Three Months Ended June 30, Six Months Ended June 30, (in thousands) 2023 2022 2023 2022 Contractual interest expense ( 0.75 % coupon) $ 997 $ 1,125 $ 2,122 $ 2,250 Amortization of issuance costs 647 720 1,375 1,439 $ 1,644 $ 1,845 $ 3,497 $ 3,689 12 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) The average interest rate on the Notes in the six months ended June 30, 2023 and 2022 was 1.2 %. Future payments: June 30, 2023 (in thousands) Principal Interest Total Remainder of 2023 $ — $ 1,998 $ 1,998 2024 — 3,767 3,767 2025 502,270 1,884 504,154 $ 502,270 $ 7,649 $ 509,919 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 and six months ended June 30, 2023, Capped Call Transactions covering approximately 0.5 million and 0.7 million shares, respectively, were settled for proceeds of $ 0.1 million and $ 0.3 million, respectively. As of June 30, 2023, Capped Call Transactions representing approximately 3.7 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: Six Months Ended June 30, (in thousands) 2023 2022 January 1, $ 2,582 $ 59,964 Settlements ( 341 ) — Fair value adjustment 1,845 ( 49,505 ) June 30, $ 4,086 $ 10,459 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: • Through December 31, 2023, the parent company must maintain at least $ 200 million in cash, investments, and availability under the Credit Facility and the Company must 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 June 30, 2023 and December 31, 2022, the Company 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. 13 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 9. RESTRUCTURING The Company has undertaken the following restructuring activities as it optimizes its go-to-market strategy and reassesses its office space needs: Three months ended Expense Employee severance and related benefits and closure of a US office December 31, 2022 $ 21,743 Office space reduction March 31, 2023 $ 1,241 Employee severance and related benefits June 30, 2023 $ 1,581 Accrued employee severance and related benefits: Change for all restructuring actions: Six Months Ended June 30, (in thousands) 2023 January 1, $ 18,573 Costs incurred 2,387 Cash disbursements ( 17,521 ) Currency translation adjustments 185 June 30, $ 3,624 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 with 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: June 30, 2023 December 31, 2022 (in thousands) Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total Cash equivalents $ 16,733 $ — $ — $ 16,733 $ 2,526 $ — $ — $ 2,526 Marketable securities $ — $ 125,939 $ — $ 125,939 $ — $ 152,167 $ — $ 152,167 Capped Call Transactions (1) $ — $ 4,086 $ — $ 4,086 $ — $ 2,582 $ — $ 2,582 Venture investments (1) (2) $ — $ — $ 13,382 $ 13,382 $ — $ — $ 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: Six Months Ended June 30, (in thousands) 2023 2022 January 1, $ 13,069 $ 7,648 New investments 400 400 Sales of investments ( 2,773 ) ( 165 ) Changes in foreign exchange rates 119 ( 290 ) Changes in fair value: included in other income, net 4,475 5,978 included in other comprehensive (loss) ( 1,908 ) 2,502 June 30, $ 13,382 $ 16,073 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 $ 460.8 million as of June 30, 2023 and $ 521.1 million as of December 31, 2022. In the six months ended June 30, 2023 the Company repurchased Notes representing $ 97.7 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 June 30, Six Months Ended June 30, (Dollars in thousands) 2023 2022 2023 2022 U.S. $ 150,385 50 % $ 147,725 54 % $ 334,904 54 % $ 364,997 55 % Other Americas 19,505 7 % 16,261 6 % 34,516 6 % 62,012 10 % United Kingdom (“U.K.”) 28,892 10 % 28,831 11 % 71,129 11 % 59,763 9 % Europe (excluding U.K.), Middle East, and Africa 54,353 18 % 45,238 16 % 105,671 17 % 94,374 15 % Asia-Pacific 45,133 15 % 36,282 13 % 77,520 12 % 69,498 11 % $ 298,268 100 % $ 274,337 100 % $ 623,740 100 % $ 650,644 100 % Revenue streams Three Months Ended June 30, Six Months Ended June 30, (in thousands) 2023 2022 2023 2022 Perpetual license $ 1,579 $ 2,266 $ 1,982 $ 9,706 Subscription license 41,197 41,600 125,724 179,133 Revenue recognized at a point in time 42,776 43,866 127,706 188,839 Maintenance 82,042 78,326 161,672 158,042 Pega Cloud 115,063 93,506 222,942 183,823 Consulting 58,387 58,639 111,420 119,940 Revenue recognized over time 255,492 230,471 496,034 461,805 Total revenue $ 298,268 $ 274,337 $ 623,740 $ 650,644 15 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Three Months Ended June 30, Six Months Ended June 30, (in thousands) 2023 2022 2023 2022 Pega Cloud $ 115,063 $ 93,506 $ 222,942 $ 183,823 Maintenance 82,042 78,326 161,672 158,042 Subscription services 197,105 171,832 384,614 341,865 Subscription license 41,197 41,600 125,724 179,133 Subscription 238,302 213,432 510,338 520,998 Consulting 58,387 58,639 111,420 119,940 Perpetual license 1,579 2,266 1,982 9,706 $ 298,268 $ 274,337 $ 623,740 $ 650,644 Remaining performance obligations ("Backlog") Expected future revenue from existing non-cancellable contracts: As of June 30, 2023: (Dollars in thousands) Subscription services Subscription license Perpetual license Consulting Total Maintenance Pega Cloud 1 year or less $ 214,579 $ 397,183 $ 35,616 $ 4,979 $ 37,355 $ 689,712 55 % 1-2 years 58,551 238,691 3,026 2,252 6,772 309,292 24 % 2-3 years 25,103 124,616 6,764 — 1,523 158,006 12 % Greater than 3 years 7,592 101,494 — — — 109,086 9 % $ 305,825 $ 861,984 $ 45,406 $ 7,231 $ 45,650 $ 1,266,096 100 % As of June 30, 2022: (Dollars in thousands) Subscription services Subscription license Perpetual license Consulting Total Maintenance Pega Cloud 1 year or less $ 204,974 $ 320,102 $ 46,810 $ 6,681 $ 32,159 $ 610,726 54 % 1-2 years 57,862 200,135 10,711 4,505 7,919 281,132 25 % 2-3 years 28,403 96,861 2,126 2,252 2,574 132,216 12 % Greater than 3 years 18,447 81,069 1,680 — 424 101,620 9 % $ 309,686 $ 698,167 $ 61,327 $ 13,438 $ 43,076 $ 1,125,694 100 % NOTE 12. STOCK-BASED COMPENSATION Expense Three Months Ended June 30, Six Months Ended June 30, (in thousands) 2023 2022 2023 2022 Cost of revenue $ 7,174 $ 6,579 $ 16,087 $ 12,957 Selling and marketing 15,349 12,633 33,009 23,591 Research and development 7,851 7,355 16,911 14,701 General and administrative 5,853 4,733 12,777 8,278 $ 36,227 $ 31,300 $ 78,784 $ 59,527 Income tax benefit $ ( 581 ) $ ( 543 ) $ ( 1,253 ) $ ( 905 ) As of June 30, 2023, the Company had $ 171.0 million of unrecognized stock-based compensation expense, net of estimated forfeitures, which is expected to be recognized over a weighted-average period of 1.9 years. 16 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Grants Six Months Ended June 30, 2023 (in thousands) Shares Total Fair Value Restricted stock units 1,489 $ 69,704 Non-qualified stock options 870 $ 18,289 Performance stock options (1) 906 $ 18,265 (1) Performance stock options allow the holder to purchase a specified number of common stock shares at an exercise price equal to or greater than the shares' fair market value at the grant date. The options usually vest over two years and expire ten years from the grant date, subject to specific performance conditions. NOTE 13. INCOME TAXES Effective income tax rate Three Months Ended June 30, Six Months Ended June 30, (Dollars in thousands) 2023 2022 2023 2022 Provision for income taxes $ 6,601 $ 186,174 $ 11,850 $ 178,491 Effective income tax rate ( 21 ) % ( 165 ) % The Company’s effective income tax rate in the six months ended June 30, 2023 was impacted by the valuation allowance on the Company’s deferred tax assets in the U.S. and U.K. 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. The Company recognizes deferred tax assets to the extent that it believes that these assets are more likely than not to be realized. A deferred tax valuation allowance requires significant judgment and uncertainties, including assumptions about future taxable income. Quarterly, the Company reassesses the need for a valuation allowance on its net deferred tax assets by weighting all available and objectively verifiable negative and positive evidence, including projected future reversals of existing taxable temporary differences, committed contractual backlog (“Backlog”), projected future taxable income, including the impact of enacted legislation, tax-planning strategies, and recent operating results. The Company intends to maintain a valuation allowance on the Company’s U.S. and U.K. net deferred tax assets until sufficient evidence exists 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 June 30, Six Months Ended June 30, (in thousands, except per share amounts) 2023 2022 2023 2022 Net (loss) $ ( 46,804 ) $ ( 286,296 ) $ ( 67,578 ) $ ( 286,675 ) Weighted-average common shares outstanding 83,039 81,847 82,823 81,764 (Loss) per share, basic $ ( 0.56 ) $ ( 3.50 ) $ ( 0.82 ) $ ( 3.51 ) Net (loss) $ ( 46,804 ) $ ( 286,296 ) $ ( 67,578 ) $ ( 286,675 ) Weighted-average common shares outstanding, assuming dilution (1) (2) (3) 83,039 81,847 82,823 81,764 (Loss) per share, diluted $ ( 0.56 ) $ ( 3.50 ) $ ( 0.82 ) $ ( 3.51 ) Outstanding anti-dilutive stock options and RSUs (4) 1,354 3,569 1,351 3,873 (1) All dilutive securities are excluded in periods of loss 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 3.7 million shares as of June 30, 2023. (3) The Company’s Capped Call Transactions represent the equivalent of approximately 3.7 million shares of the Company’s common stock (representing the number of shares for which the Notes are initially convertible) as of June 30, 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. 17 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 15. COMMITMENTS AND CONTINGENCIES Commitments See "Note 7. Leases" for additional information. Legal proceedings In addition to the matters below, the Company is or may become involved in a variety of claims, demands, suits, investigations, and proceedings that arise from time to time relating to matters incidental to the ordinary course of the Company’s business, including actions concerning contracts, intellectual property, employment, benefits, and securities matters. Regardless of the outcome, legal disputes can have a material effect on the Company because of defense and settlement costs, diversion of management resources, and other factors. In addition, as the Company is a party to ongoing litigation, it is at least reasonably possible that 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 June 30, 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 in the Court of Appeals of Virginia is completed. The Court of Appeals of Virginia has not yet set a date for oral arguments in the appeal. 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 Company’s motion to dismiss took place on May 17, 2023. After hearing argument from both sides, the Court denied the Company’s motion from the bench and stated that a written opinion would follow. On June 30, 2023, the Company filed its Answer to the complaint. On July 24, 2023, the Court issued its written opinion denying the motion to dismiss as to the Company and Defendant Trefler but granting the motion without prejudice as to Mr. Stillwell. The Company believes it has strong defenses to the claims brought against the defendants 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 it has strong defenses to the claims asserted, its intent to defend against these claims, and there being no specified quantum of damages sought in the complaint. 18 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) In re Pegasystems Inc., Derivative Litigation 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 April 28, 2023, a lawsuit was filed in the United States District Court for the District of Massachusetts by Dag Sagfors, derivatively on behalf of nominal defendant Pegasystems Inc. asserting breach of fiduciary duty and related claims relating to the Virginia Appian litigation against the same defendants as the Larkin lawsuit. On May 17, 2023, the Larkin and Sagfors cases were consolidated and a joint motion to stay the consolidated case is pending before the Court. The Company also has received confidential demand letters raising substantially the same allegations set forth in the foregoing derivative complaints. On April 12, 2023, the Company’s board of directors (other than Mr. Trefler, who recused himself), formed a committee consisting solely of independent directors, to review, analyze, and investigate the matters raised in the demands and to determine in good faith what actions (if any) are reasonably believed to be appropriate under similar circumstances and reasonably believed to be in the best interests of the Company in response to the demand letters. The Company is unable to reasonably estimate possible damages or a range of possible damages in this matter given the stage of the lawsuit 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