What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-10-25 compared with 2023-07-26 · 98 added, 82 removed, 180 unchanged (50% of the section changed)

26 unchanged sentences

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.

The forward-looking statements in this Quarterly Report represent our views as of October 25, 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.

We believe that these 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.

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.

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

BUSINESS OVERVIEW

12 unchanged sentences

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

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

In 2023, the Company revised its ACV methodology for maintenance and all contracts less than 12 months as its overall client renewal rate exceeds 90%.

The impact of the change was $3 million and 0.3% of Total ACV or less for all quarters in 2022.

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

This simplification, made possible by improvements to the Company’s financial systems, ensures that ACV for all contract types and lengths is consistently calculated as the total contract value divided by the duration in years.

Previously, ACV for maintenance was calculated as the maintenance revenue for the quarter then ended, multiplied by four, and ACV for contracts less than 12 months was equal to the contract’s total value.

The Company believes the simplified methodology better represents the current value of its contracts and better aligns its definition with comparable companies.

Reconciliation of ACV and Constant Currency ACV

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

(in millions, except percentages) Q3 22 Q3 23 1-Year Change

ACV $ 1,040 $ 1,169 12 %

2 unchanged sentences

Constant currency ACV is calculated by applying the Q3 2022 foreign exchange rates to all periods shown.

(in thousands, except percentages) Six Months Ended

2023 2022 Change

Cash flow (1)

Starting in the third quarter of 2023, the Company has calculated free cash flow as cash provided by (used in) operating activities less investments in property and equipment.

To ensure comparability, previously disclosed amounts have been updated.

(Dollars in thousands)

Nine Months Ended

September 30,

Cash provided by (used in) operating activities $ 137,920 14 % $ (13,446) (1) %

Investment in property and equipment (14,271) (22,285)

Free cash flow $ 123,649 13 % $ (35,731) (4) %

Additional information (3)

Legal fees $ 5,867 $ 37,944

1 unchanged sentence

Interest on convertible senior notes 4,134 4,500

Free cash flow $ 122,540 $ 11,922 928 %

Total revenue $ 623,740 $ 650,644

Free cash flow margin 20 % 2 %

* not meaningful

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

• Investment in property and equipment :

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

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

Other — 3,266

$ 31,577 $ 45,710

(1) Our non-GAAP free cash flow is defined as cash provided by (used in) operating activities less investment in property and equipment.

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

We provide information on free cash flow to enable investors to assess our ability to generate cash without incurring additional external financings.

This information is not a substitute for financial measures prepared under U.S.

(2) Operating and Free Cash Flow Margin are calculated by comparing the respective cash flow to Total Revenue.

(3) The additional information discloses items that affect our cash flows and are considered by management not to be representative of our core business operations and ongoing operational performance.

• Legal fees:

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.

• Restructuring :

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

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

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

• Interest on convertible senior notes :

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

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

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.

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.

Includes fees related to capital advisory services, canceled in-person sales and marketing events, and incremental costs incurred integrating acquisitions.

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 %

(in millions, except percentages) Q3 22 Q3 2023 1-Year Growth Rate

Backlog - GAAP $ 1,148 $ 1,265 10 %

Impact of changes in foreign exchange rates — (33)

Backlog - Constant Currency $ 1,258 12 %

Constant currency backlog $ 1,148 $ 1,232 7 %

Constant currency Backlog is calculated by applying the Q3 2022 foreign exchange rates to all periods shown.

9 unchanged sentences

(Dollars in thousands) Three Months Ended

June 30, Change Six Months Ended

June 30, Change

September 30, Change Nine Months Ended

September 30, Change

2023 2022 2023 2022

7 unchanged sentences

$ 334,643 100 % $ 270,731 100 % $ 63,912 24 % $ 958,383 100 % $ 921,375 100 % $ 37,008 4 %

• 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.

• The increases in Pega Cloud revenue for the three and nine months ended September 30, 2023 were primarily due to the growth of the hosted client base as our clients continued to expand their use of Pega Cloud.

• The increases in maintenance revenue in the three and nine months ended September 30, 2023 were primarily due to continued demand for our subscription license offerings which are generally bundled with maintenance.

• The increase in subscription license revenue in the three months ended September 30, 2023 was primarily due to increased license deliveries in the three months ended September 30, 2023.

The decrease in subscription license revenue in the nine months ended September 30, 2023 was primarily due to several large multi-year contracts recognized in revenue in the nine months ended September 30, 2022.

• The decrease in consulting revenue in the nine months ended September 30, 2023 was primarily due to lower consultant realization rates in the Americas.

• The decreases in perpetual license revenue in the three and nine months ended September 30, 2023 reflects our strategy of promoting subscription-based arrangements.

(Dollars in thousands) Three Months Ended

June 30, Change Six Months Ended

June 30, Change

September 30, Change Nine Months Ended

September 30, Change

2023 2022 2023 2022

8 unchanged sentences

* not meaningful

• 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.

• The increases in Pega Cloud gross profit percent in the three and nine months ended September 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 nine months ended September 30, 2023 was primarily due to an increase in compensation and benefits as a result of increased headcount.

• The increase in consulting gross profit percent in the three months ended September 30, 2023 was primarily due to higher consultant utilization in the Americas.

The decrease in consulting profit percent in the nine months ended September 30, 2023, was primarily due to lower consultant realization rates in the Americas.

Operating expenses

(Dollars in thousands) Three Months Ended

June 30, Change Six Months Ended

June 30, Change

September 30, Change Nine Months Ended

September 30, Change

2023 2022 2023 2022

7 unchanged sentences

% of Revenue 5 % — % 2 % — %

• 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.

• The decreases in selling and marketing during the three and nine months ended September 30, 2023 were primarily due to decreases in compensation and benefits of $18.6 million and $45.0 million, respectively.

The decreases were due to reduced headcount as we optimize 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.

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

• The changes in general and administrative in the three and nine months ended September 30, 2023 were primarily due to an increase of $2.3 million in the three months ended September 30, 2023 and a decrease of $21.4 million in the nine months ended September 30, 2023 in legal fees and related expenses arising from proceedings 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 and “Risk Factors” in Part I, Item 1A of our Annual Report for the year ended December 31, 2022.

• 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.

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 for additional information.

• The increases in restructuring expenses during the three and nine months ended September 30, 2023 were primarily due to our efforts to optimize our go-to-market organization.

For additional information, see "Note 9.

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

Other income and expenses

(Dollars in thousands) Three Months Ended

June 30, Change Six Months Ended

June 30, Change

September 30, Change Nine Months Ended

September 30, Change

2023 2022 2023 2022

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

Foreign currency transaction gain (loss) $ 1,994 $ 3,826 $ (1,832) (48) % $ (3,971) $ 8,415 $ (12,386) *

Interest income 2,532 520 2,012 387 % 5,831 1,036 4,795 463 %

Interest expense (1,533) (1,992) 459 23 % (5,229) (5,882) 653 11 %

(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 %

(Loss) on capped call transactions (2,294) (6,876) 4,582 67 % (449) (56,381) 55,932 99 %

Other income (loss), net 6,383 (29) 6,412 * 18,668 6,497 12,171 187 %

$ 7,082 $ (4,551) $ 11,633 * $ 14,850 $ (46,315) $ 61,165 *

* not meaningful

• 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.

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

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

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.

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

• The increase in other income (loss), net in the three months ended September 30, 2023 was due to a $6.4 million increase in the value of equity securities held in our venture investments portfolio.

The increase in other income (loss), net in the nine months ended September 30, 2023, was due to a $7.9 million gain from repurchases of our convertible senior notes and a $10.9 million increase in the value of equity securities held in our venture investments portfolio.

For additional information, see “Note 8.

Debt” and "Note 10.

Fair Value Measurements" in Part I, Item 1 of this Quarterly Report.

Provision for income taxes

Six Months Ended

Nine Months Ended

September 30,

(Dollars in thousands) 2023 2022

1 unchanged sentence

Effective income tax rate (26) % (100) %

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.

The effective income tax rate in the nine months ended September 30, 2023 was primarily driven by the valuation allowance on our deferred tax assets in the U.S.

and projected taxable income in the U.S., partially offset by available tax credits and losses in the U.S.

LIQUIDITY AND CAPITAL RESOURCES

Six Months Ended

Nine Months Ended

September 30,

(in thousands) 2023 2022

6 unchanged sentences

(in thousands)

June 30, 2023 December 31, 2022

September 30, 2023 December 31, 2022

$ 217,735 $ 248,389

3 unchanged sentences

$ 336,309 $ 297,221

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

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

Whether these resources are adequate to meet our liquidity needs beyond that period will depend on our future growth, operating results, and the investments needed to support our operations.

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

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

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

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

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

Operating activities

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.

The change in cash provided by (used in) operating activities in the nine months ended September 30, 2023 was primarily due to growth in client collections, the impact of our cost-efficiency initiatives, and lower legal fees and related costs arising from proceedings outside the ordinary course of business.

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

For additional information, see “Note 9.

Restructuring” and "Note 15.

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

Investing activities

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

The change in cash (used in) provided by investing activities in the nine months ended September 30, 2023 was primarily due to our investments in financial instruments and reduced investment in property and equipment as we optimize our office space.

Financing activities

1 unchanged sentence

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

In the 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.

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

As of September 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.

1 unchanged sentence

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 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.

As of September 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.

2 unchanged sentences

Changes in the remaining stock repurchase authority:

(in thousands) Six Months Ended

June 30, 2023

(in thousands) Nine Months Ended

September 30, 2023

December 31, 2022 $ 58,075

Authorizations (1)

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.

September 30, 2023 $ 60,000

Common stock repurchases

Six Months Ended

Nine Months Ended

September 30,

(in thousands) Shares Amount Shares Amount

2 unchanged sentences

39 $ 1,654 532 $ 42,083

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.

In the nine months ended September 30, 2023 and 2022, instead of receiving cash from the equity holders, we withheld shares with a value of $1.0 million and $11.5 million, respectively, for the exercise price of options.

These amounts are not included in the table above.

1 unchanged sentence

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

Six Months Ended

Nine Months Ended

September 30,

(in thousands) 2023 2022

1 unchanged sentence

Contractual obligations

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

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

Payments due by period

5 unchanged sentences

Operating lease obligations 4,775 17,976 14,870 10,853 9,808 39,299 — 97,581

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

Venture investment commitments (3)

500 500 — — — — — 1,000

Liability for uncertain tax positions (4)

3 unchanged sentences

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

(3) Represents the maximum funding under existing venture investment agreements.

Our venture investment agreements generally allow us to withhold unpaid funds at our discretion.

(4) 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