PEGASYSTEMS INC 10-Q

ITEM 1. FINANCIAL STATEMENTS PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) September 30, 2023 December 31, 2022 Assets Current assets: Cash and cash equivalents $ 169,023 $ 145,054 Marketable securities 167,286 152,167 Total cash, cash equivalents, and marketable securities 336,309 297,221 Accounts receivable, net 168,795 255,150 Unbilled receivables, net 199,948 213,719 Other current assets 71,438 80,388 Total current assets 776,490 846,478 Unbilled receivables, net 73,795 95,806 Goodwill 81,437 81,399 Other long-term assets 290,807 333,989 Total assets $ 1,222,529 $ 1,357,672 Liabilities and stockholders’ equity Current liabilities: Accounts payable $ 20,541 $ 18,195 Accrued expenses 43,624 50,355 Accrued compensation and related expenses 93,511 127,728 Deferred revenue 297,067 325,212 Other current liabilities 18,038 17,450 Total current liabilities 472,781 538,940 Convertible senior notes, net 498,753 593,609 Operating lease liabilities 68,874 79,152 Other long-term liabilities 14,485 15,128 Total liabilities 1,054,893 1,226,829 Commitments and contingencies (Note 15) Stockholders’ equity: Preferred stock, 1,000 shares authorized; none issued — — Common stock, 200,000 shares authorized; 83,523 and 82,436 shares issued and outstanding at September 30, 2023 and December 31, 2022, respectively 835 824 Additional paid-in capital 343,259 229,602 Accumulated deficit ( 151,370 ) ( 76,513 ) Accumulated other comprehensive (loss) ( 25,088 ) ( 23,070 ) Total stockholders’ equity 167,636 130,843 Total liabilities and stockholders’ equity $ 1,222,529 $ 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 September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Revenue Subscription services $ 201,578 $ 174,885 $ 586,192 $ 516,750 Subscription license 74,342 31,112 200,066 210,245 Consulting 55,976 55,511 167,396 175,451 Perpetual license 2,747 9,223 4,729 18,929 Total revenue 334,643 270,731 958,383 921,375 Cost of revenue Subscription services 35,906 34,541 109,553 103,104 Subscription license 629 628 1,971 1,923 Consulting 57,204 57,778 176,262 171,162 Perpetual license 24 103 51 173 Total cost of revenue 93,763 93,050 287,837 276,362 Gross profit 240,880 177,681 670,546 645,013 Operating expenses Selling and marketing 131,598 153,517 425,253 472,951 Research and development 74,955 75,342 224,262 221,173 General and administrative 27,321 26,043 73,893 94,530 Restructuring 17,822 — 21,450 — Total operating expenses 251,696 254,902 744,858 788,654 (Loss) from operations ( 10,816 ) ( 77,221 ) ( 74,312 ) ( 143,641 ) Foreign currency transaction gain (loss) 1,994 3,826 ( 3,971 ) 8,415 Interest income 2,532 520 5,831 1,036 Interest expense ( 1,533 ) ( 1,992 ) ( 5,229 ) ( 5,882 ) (Loss) on capped call transactions ( 2,294 ) ( 6,876 ) ( 449 ) ( 56,381 ) Other income (loss), net 6,383 ( 29 ) 18,668 6,497 (Loss) before provision for income taxes ( 3,734 ) ( 81,772 ) ( 59,462 ) ( 189,956 ) Provision for income taxes 3,545 11,748 15,395 190,239 Net (loss) $ ( 7,279 ) $ ( 93,520 ) $ ( 74,857 ) $ ( 380,195 ) (Loss) per share Basic $ ( 0.09 ) $ ( 1.14 ) $ ( 0.90 ) $ ( 4.65 ) Diluted $ ( 0.09 ) $ ( 1.14 ) $ ( 0.90 ) $ ( 4.65 ) Weighted-average number of common shares outstanding Basic 83,336 81,996 82,996 81,842 Diluted 83,336 81,996 82,996 81,842 See notes to unaudited condensed consolidated financial statements. 4 PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) (in thousands) Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Net (loss) $ ( 7,279 ) $ ( 93,520 ) $ ( 74,857 ) $ ( 380,195 ) Other comprehensive (loss), net of tax Unrealized (loss) on available-for-sale securities ( 40 ) ( 73 ) ( 281 ) ( 1,000 ) Foreign currency translation adjustments ( 3,687 ) ( 6,700 ) ( 1,737 ) ( 20,936 ) Total other comprehensive (loss), net of tax ( 3,727 ) ( 6,773 ) ( 2,018 ) ( 21,936 ) Comprehensive (loss) $ ( 11,006 ) $ ( 100,293 ) $ ( 76,875 ) $ ( 402,131 ) 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 Issuance of common stock for stock compensation plans 138 2 ( 2,198 ) — — ( 2,196 ) Issuance of common stock under the employee stock purchase plan 86 1 2,362 — — 2,363 Stock-based compensation — — 33,774 — — 33,774 Cash dividends declared ($ 0.03 per share) — — — ( 2,466 ) — ( 2,466 ) Other comprehensive (loss) — — — — ( 6,773 ) ( 6,773 ) Net (loss) — — — ( 93,520 ) — ( 93,520 ) September 30, 2022 82,164 $ 822 $ 204,189 $ ( 111,126 ) $ ( 28,924 ) $ 64,961 6 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, 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 Issuance of common stock for stock compensation plans 257 3 2,447 — — 2,450 Issuance of common stock under the employee stock purchase plan 54 — 2,003 — — 2,003 Stock-based compensation — — 31,299 — — 31,299 Cash dividends declared ($ 0.03 per share) — — ( 2,506 ) — — ( 2,506 ) Other comprehensive (loss) — — — — ( 3,727 ) ( 3,727 ) Net (loss) — — — ( 7,279 ) — ( 7,279 ) September 30, 2023 83,523 $ 835 $ 343,259 $ ( 151,370 ) $ ( 25,088 ) $ 167,636 See notes to unaudited condensed consolidated financial statements. 7 PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Nine Months Ended September 30, 2023 2022 Operating activities Net (loss) $ ( 74,857 ) $ ( 380,195 ) Adjustments to reconcile net (loss) to cash provided by (used in) operating activities Stock-based compensation 110,083 93,301 Deferred income taxes ( 188 ) 169,489 Loss on capped call transactions 449 56,381 Amortization of deferred commissions 43,974 39,752 Lease expense 12,018 11,500 Amortization of intangible assets and depreciation 14,181 12,381 Foreign currency transaction loss (gain) 3,971 ( 8,415 ) Other non-cash ( 16,487 ) ( 1,705 ) Change in operating assets and liabilities, net 44,776 ( 5,935 ) Cash provided by (used in) operating activities 137,920 ( 13,446 ) Investing activities Purchases of investments ( 190,466 ) ( 39,056 ) Proceeds from maturities and called investments 169,836 53,952 Sales of investments 10,725 18,415 Payments for acquisitions, net of cash acquired — ( 922 ) Investment in property and equipment ( 14,271 ) ( 22,285 ) Cash (used in) provided by investing activities ( 24,176 ) 10,104 Financing activities Repurchases of convertible senior notes ( 88,989 ) — Dividend payments to stockholders ( 7,458 ) ( 7,368 ) Proceeds from employee stock purchase plan 6,127 7,166 Proceeds from stock option exercises 6,602 — Common stock repurchases ( 1,654 ) ( 43,282 ) Other 341 — Cash (used in) financing activities ( 85,031 ) ( 43,484 ) Effect of exchange rate changes on cash, cash equivalents, and restricted cash ( 1,621 ) ( 5,513 ) Net increase (decrease) in cash, cash equivalents, and restricted cash 27,092 ( 52,339 ) Cash, cash equivalents, and restricted cash, beginning of period 145,054 159,965 Cash, cash equivalents, and restricted cash, end of period $ 172,146 $ 107,626 Cash and cash equivalents $ 169,023 $ 107,626 Restricted cash included in other long-term assets 3,123 — Total cash, cash equivalents, and restricted cash $ 172,146 $ 107,626 See notes to unaudited condensed consolidated financial statements. 8 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 September 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 $ 17,931 $ — $ ( 18 ) $ 17,913 $ 2,960 $ — $ ( 52 ) $ 2,908 Corporate debt 149,927 — ( 554 ) 149,373 151,906 — ( 2,647 ) 149,259 $ 167,858 $ — $ ( 572 ) $ 167,286 $ 154,866 $ — $ ( 2,699 ) $ 152,167 As of September 30, 2023, marketable securities’ maturities ranged from October 2023 to January 2026, with a weighted average remaining maturity of 0.5 years. NOTE 3. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE Receivables (in thousands) September 30, 2023 December 31, 2022 Accounts receivable, net $ 168,795 $ 255,150 Unbilled receivables, net 199,948 213,719 Long-term unbilled receivables, net 73,795 95,806 $ 442,538 $ 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 collection date: (Dollars in thousands) September 30, 2023 1 year or less $ 199,948 73 % 1-2 years 58,604 21 % 2-5 years 15,191 6 % $ 273,743 100 % Unbilled receivables by contract effective date: (Dollars in thousands) September 30, 2023 2023 $ 90,227 33 % 2022 92,065 34 % 2021 62,729 23 % 2020 19,820 7 % 2019 and prior 8,902 3 % $ 273,743 100 % 9 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) September 30, 2023 December 31, 2022 Contract assets (1) $ 13,263 $ 17,546 Long-term contract assets (2) 10,732 16,470 $ 23,995 $ 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) September 30, 2023 December 31, 2022 Deferred revenue $ 297,067 $ 325,212 Long-term deferred revenue (1) 2,605 3,552 $ 299,672 $ 328,764 (1) Included in other long-term liabilities. Deferred revenue decreased in the nine months ended September 30, 2023, primarily due to $ 292.3 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) September 30, 2023 December 31, 2022 Deferred commissions (1) $ 107,399 $ 130,195 (1) Included in other long-term assets. Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2023 2022 2023 2022 Amortization of deferred commissions (1) $ 14,947 $ 11,597 $ 43,974 $ 39,752 (1) Included in selling and marketing. NOTE 5. GOODWILL AND OTHER INTANGIBLES Goodwill Nine Months Ended September 30, (in thousands) 2023 2022 January 1, $ 81,399 $ 81,923 Currency translation adjustments 38 ( 722 ) September 30, $ 81,437 $ 81,201 Intangibles Intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives. September 30, 2023 (in thousands) Useful Lives Cost Accumulated Amortization Net Book Value (1) Client-related 4 - 10 years $ 63,086 $ ( 59,661 ) $ 3,425 Technology 2 - 10 years 68,103 ( 63,579 ) 4,524 Other 1 - 5 years 5,361 ( 5,361 ) — $ 136,550 $ ( 128,601 ) $ 7,949 (1) Included in other long-term assets. 10 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) September 30, 2023 Remainder of 2023 $ 964 2024 3,169 2025 2,615 2026 874 2027 327 $ 7,949 Amortization of intangible assets: Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2023 2022 2023 2022 Cost of revenue $ 622 $ 705 $ 1,949 $ 2,017 Selling and marketing 343 343 1,028 1,028 $ 965 $ 1,048 $ 2,977 $ 3,045 NOTE 6. OTHER ASSETS AND LIABILITIES Other current assets (in thousands) September 30, 2023 December 31, 2022 Income tax receivables $ 19,663 $ 25,354 Contract assets 13,263 17,546 Other 38,512 37,488 $ 71,438 $ 80,388 Other long-term assets (in thousands) September 30, 2023 December 31, 2022 Deferred commissions $ 107,399 $ 130,195 Right of use assets 65,871 76,114 Property and equipment 49,481 55,056 Venture investments 19,348 13,069 Contract assets 10,732 16,470 Intangible assets 7,949 10,888 Capped call transactions 1,792 2,582 Deferred income taxes 5,046 4,795 Restricted cash 3,123 — Other 20,066 24,820 $ 290,807 $ 333,989 Other current liabilities (in thousands) September 30, 2023 December 31, 2022 Operating lease liabilities $ 15,532 $ 14,976 Dividends payable 2,506 2,474 $ 18,038 $ 17,450 11 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Other long-term liabilities (in thousands) September 30, 2023 December 31, 2022 Deferred revenue $ 2,605 $ 3,552 Income taxes payable 2,017 3,207 Other 9,863 8,369 $ 14,485 $ 15,128 NOTE 7. LEASES Expense Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2023 2022 2023 2022 Fixed lease costs $ 4,718 $ 4,688 $ 14,979 $ 14,747 Short-term lease costs 660 916 2,137 2,510 Variable lease costs 2,254 905 6,414 2,395 $ 7,632 $ 6,509 $ 23,530 $ 19,652 Right of use assets and lease liabilities (in thousands) September 30, 2023 December 31, 2022 Right of use assets (1) $ 65,871 $ 76,114 Operating lease liabilities (2) $ 15,532 $ 14,976 Long-term operating lease liabilities $ 68,874 $ 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: September 30, 2023 December 31, 2022 Weighted-average remaining lease term 7.0 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) September 30, 2023 Remainder of 2023 $ 4,775 2024 17,976 2025 14,870 2026 10,853 2027 9,808 2028 9,245 Thereafter 30,054 Total lease payments 97,581 Less: imputed interest (1) ( 13,175 ) $ 84,406 (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 Nine Months Ended September 30, (in thousands) 2023 2022 Cash paid for operating leases, net of tenant improvement allowances $ 14,378 $ 11,628 Right of use assets recognized for new leases and amendments (non-cash) $ 1,782 $ 6,618 12 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 nine months ended September 30, 2023, the Company recognized a gain of $ 7.9 million in other income (loss), net from repurchases of Notes representing $ 97.7 million in aggregate principal amount. Conversion rights The conversion rate is 7.4045 shares of common stock per $1,000 principal amount of the Notes, representing an initial conversion price of $ 135.05 per share of common stock. The conversion rate will be adjusted upon certain events, including spin-offs, tender offers, exchange offers, and certain stockholder distributions. 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. 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 September 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) September 30, 2023 December 31, 2022 Principal $ 502,270 $ 600,000 Unamortized issuance costs ( 3,517 ) ( 6,391 ) Convertible senior notes, net $ 498,753 $ 593,609 Interest expense related to the Notes: Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2023 2022 2023 2022 Contractual interest expense ( 0.75 % coupon) $ 827 $ 1,125 $ 2,949 $ 3,375 Amortization of issuance costs 613 724 1,988 2,163 $ 1,440 $ 1,849 $ 4,937 $ 5,538 13 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) The average interest rate on the Notes in the nine months ended September 30, 2023 and 2022 was 1.2 %. Future payments: September 30, 2023 (in thousands) Principal Interest Total 2024 $ — $ 3,767 $ 3,767 2025 502,270 1,884 504,154 $ 502,270 $ 5,651 $ 507,921 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 nine months ended September 30, 2023, Capped Call Transactions covering approximately 0.7 million shares were settled for proceeds of $ 0.3 million. As of September 30, 2023, Capped Call Transactions covering 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 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: Nine Months Ended September 30, (in thousands) 2023 2022 January 1, $ 2,582 $ 59,964 Settlements ( 341 ) — Fair value adjustment ( 449 ) ( 56,381 ) September 30, $ 1,792 $ 3,583 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 September 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. 14 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 Employee severance and related benefits and closure of a foreign office September 30, 2023 $ 17,236 Accrued employee severance and related benefits: Change for all restructuring actions: Nine Months Ended September 30, (in thousands) 2023 January 1, $ 18,573 Costs incurred 19,921 Cash disbursements ( 21,576 ) Currency translation adjustments ( 203 ) September 30, $ 16,715 Note: Accrued employee severance and related benefits is included in accrued compensation and related expenses. 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: September 30, 2023 December 31, 2022 (in thousands) Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total Cash equivalents $ 22,686 $ — $ — $ 22,686 $ 2,526 $ — $ — $ 2,526 Marketable securities $ — $ 167,286 $ — $ 167,286 $ — $ 152,167 $ — $ 152,167 Capped Call Transactions (1) $ — $ 1,792 $ — $ 1,792 $ — $ 2,582 $ — $ 2,582 Venture investments (1) (2) $ — $ — $ 19,348 $ 19,348 $ — $ — $ 13,069 $ 13,069 (1) Included in other long-term assets. (2) Investments in privately-held companies. 15 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Changes in venture investments: Nine Months Ended September 30, (in thousands) 2023 2022 January 1, $ 13,069 $ 7,648 New investments 400 400 Sales of investments ( 2,773 ) ( 3,954 ) Changes in foreign exchange rates 27 ( 675 ) Changes in fair value: included in other income (loss), net 10,886 5,989 included in other comprehensive (loss) ( 2,261 ) 2,502 September 30, $ 19,348 $ 11,910 The carrying value of certain financial instruments, including receivables and accounts payable, approximates fair value due to their short maturities. Fair value of the Notes The fair value of the Notes outstanding (including the embedded conversion feature) was $ 460.3 million as of September 30, 2023 and $ 521.1 million as of December 31, 2022. In the nine months ended September 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 September 30, Nine Months Ended September 30, (Dollars in thousands) 2023 2022 2023 2022 U.S. $ 154,741 47 % $ 148,200 55 % $ 489,645 51 % $ 513,197 56 % Other Americas 23,497 7 % 18,546 7 % 58,013 6 % 80,558 9 % United Kingdom (“U.K.”) 41,622 12 % 24,074 9 % 112,751 12 % 83,837 9 % Europe (excluding U.K.), Middle East, and Africa 67,880 20 % 46,212 17 % 173,551 18 % 140,586 15 % Asia-Pacific 46,903 14 % 33,699 12 % 124,423 13 % 103,197 11 % $ 334,643 100 % $ 270,731 100 % $ 958,383 100 % $ 921,375 100 % Revenue streams Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2023 2022 2023 2022 Perpetual license $ 2,747 $ 9,223 $ 4,729 $ 18,929 Subscription license 74,342 31,112 200,066 210,245 Revenue recognized at a point in time 77,089 40,335 204,795 229,174 Maintenance 83,538 77,526 245,210 235,568 Pega Cloud 118,040 97,359 340,982 281,182 Consulting 55,976 55,511 167,396 175,451 Revenue recognized over time 257,554 230,396 753,588 692,201 Total revenue $ 334,643 $ 270,731 $ 958,383 $ 921,375 16 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2023 2022 2023 2022 Pega Cloud $ 118,040 $ 97,359 $ 340,982 $ 281,182 Maintenance 83,538 77,526 245,210 235,568 Subscription services 201,578 174,885 586,192 516,750 Subscription license 74,342 31,112 200,066 210,245 Subscription 275,920 205,997 786,258 726,995 Consulting 55,976 55,511 167,396 175,451 Perpetual license 2,747 9,223 4,729 18,929 $ 334,643 $ 270,731 $ 958,383 $ 921,375 Remaining performance obligations ("Backlog") Expected future revenue from existing non-cancellable contracts: As of September 30, 2023: (Dollars in thousands) Subscription services Subscription license Perpetual license Consulting Total Maintenance Pega Cloud 1 year or less $ 202,610 $ 391,324 $ 48,427 $ 4,567 $ 39,335 $ 686,263 54 % 1-2 years 58,610 239,787 4,356 2,696 3,662 309,111 24 % 2-3 years 28,585 121,778 8,518 — 1,100 159,981 13 % Greater than 3 years 17,478 89,870 2,664 — — 110,012 9 % $ 307,283 $ 842,759 $ 63,965 $ 7,263 $ 44,097 $ 1,265,367 100 % As of September 30, 2022: (Dollars in thousands) Subscription services Subscription license Perpetual license Consulting Total Maintenance Pega Cloud 1 year or less $ 191,045 $ 328,111 $ 69,753 $ 814 $ 27,968 $ 617,691 53 % 1-2 years 55,141 213,304 4,113 4,505 6,699 283,762 25 % 2-3 years 24,496 115,416 1,420 2,252 1,648 145,232 13 % Greater than 3 years 16,198 82,807 1,734 — 508 101,247 9 % $ 286,880 $ 739,638 $ 77,020 $ 7,571 $ 36,823 $ 1,147,932 100 % NOTE 12. STOCK-BASED COMPENSATION Expense Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2023 2022 2023 2022 Cost of revenue $ 6,410 $ 6,797 $ 22,497 $ 19,754 Selling and marketing 10,401 12,933 43,410 36,524 Research and development 7,375 7,724 24,286 22,425 General and administrative 7,113 6,320 19,890 14,598 $ 31,299 $ 33,774 $ 110,083 $ 93,301 Income tax benefit $ ( 316 ) $ ( 600 ) $ ( 1,569 ) $ ( 1,505 ) As of September 30, 2023, the Company had $ 137.5 million of unrecognized stock-based compensation expense, net of estimated forfeitures, which is expected to be recognized over a weighted-average period of 1.8 years. 17 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) Grants Nine Months Ended September 30, 2023 (in thousands) Shares Total Fair Value Restricted stock units 1,514 $ 70,962 Non-qualified stock options 911 $ 19,142 Performance stock options (1) 906 $ 18,265 Common stock 13 $ 600 (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 September 30, Nine Months Ended September 30, (Dollars in thousands) 2023 2022 2023 2022 Provision for income taxes $ 3,545 $ 11,748 $ 15,395 $ 190,239 Effective income tax rate ( 26 ) % ( 100 ) % The Company’s effective income tax rate in the nine months ended September 30, 2023 was primarily driven by the valuation allowance on the Company’s deferred tax assets in the U.S. and U.K. and projected taxable income in the U.S., partially offset by available tax credits and losses in the U.S. 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 September 30, Nine Months Ended September 30, (in thousands, except per share amounts) 2023 2022 2023 2022 Net (loss) $ ( 7,279 ) $ ( 93,520 ) $ ( 74,857 ) $ ( 380,195 ) Weighted-average common shares outstanding 83,336 81,996 82,996 81,842 (Loss) per share, basic $ ( 0.09 ) $ ( 1.14 ) $ ( 0.90 ) $ ( 4.65 ) Net (loss) $ ( 7,279 ) $ ( 93,520 ) $ ( 74,857 ) $ ( 380,195 ) Weighted-average common shares outstanding, assuming dilution (1) (2) (3) 83,336 81,996 82,996 81,842 (Loss) per share, diluted $ ( 0.09 ) $ ( 1.14 ) $ ( 0.90 ) $ ( 4.65 ) Outstanding anti-dilutive stock options and RSUs (4) 2,255 3,019 1,652 3,589 (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 September 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 convertible) as of September 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. 18 PEGASYSTEMS INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued) (4) Outstanding stock options and RSUs that were anti-dilutive under the treasury stock method in the period were excluded from the computation of diluted (loss) per share. These awards may be dilutive in the future. NOTE 15. COMMITMENTS AND CONTINGENCIES Commitments See "Note 7. Leases" for additional information. 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 September 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 set November 15, 2023 as the 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. 19 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. 20