What changed in this filing

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Item 2. Management’s Discussion and Analysis

2024-04-24 compared with 2023-10-25 · 77 added, 105 removed, 173 unchanged (51% of the section changed)

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

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

These statements represent our views only as of the date the statement was made and are based on current expectations and assumptions.

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

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• the timing of revenue recognition;

• management of our transition to a more subscription-based business model;

• variation in demand for our products and services, including among clients in the public sector;

• reliance on key personnel;

• global economic and political conditions and uncertainty, including impacts from public health emergencies and the war in Ukraine;

• reliance on third-party service providers, including hosting providers;

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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 October 25, 2023.

The forward-looking statements in this Quarterly Report represent our views as of April 24, 2024.

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 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.

We believe that these measures help investors understand our core operating results and prospects, which is 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.

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Our powerful, low-code platform for workflow automation and artificial intelligence-powered decisioning enables the world’s leading brands and government agencies to hyper-personalize customer experiences, streamline customer service, and automate mission-critical business processes and workflows.

With Pega, our clients can leverage our intelligent technology and scalable architecture to accelerate their digital transformation.

With Pega, our clients can leverage our artificial intelligence (“AI”) technology and scalable architecture to accelerate their digital transformation.

In addition, our client success teams, world-class partners, and clients leverage our Pega Express™ methodology to design and deploy mission-critical applications quickly and collaboratively.

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Our solutions achieve and facilitate differentiation by increasing business agility, driving growth, improving productivity, attracting and retaining customers, and reducing risk.

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

Along with our partners, we deliver solutions tailored to our clients’ specific industry.

Performance metrics

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

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) Q3 22 Q3 23 1-Year Change

(in millions, except percentages) March 31, 2023 March 31, 2024 1-Year Change

ACV $ 1,174 $ 1,273 9 %

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Constant currency ACV

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

$ 1,174 $ 1,277 9 %

Constant currency ACV is calculated by applying the March 31, 2023 foreign exchange rates to all periods shown.

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) %

Three Months Ended

Cash provided by operating activities $ 180,146 $ 68,107

Investment in property and equipment (604) (11,487)

Free cash flow (1)

Additional information (3)

Legal fees $ 5,867 $ 37,944

$ 179,542 $ 56,620

Supplemental information (2)

Restructuring $ 3,347 $ 14,458

Legal fees 2,739 1,515

Interest on convertible senior notes 1,884 2,250

Other — 3,266

$ 16,133 $ 21,048

(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.

(1) Our non-GAAP free cash flow is defined as cash provided by operating activities less 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 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.

(2) The supplemental 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.

▪ Restructuring :

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

▪ Legal fees:

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

▪ Interest on convertible senior notes :

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

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.

The Notes accrue interest at an annual rate of 0.75%, payable semi-annually in arrears on March 1 and September 1.

▪ Income taxes :

Direct income taxes paid net of refunds received.

Remaining performance obligations (“Backlog”)

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

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

(in millions, except percentages) March 31, 2023 March 31, 2024 1-Year Growth Rate

Backlog - GAAP $ 1,308 $ 1,425 9 %

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(Dollars in thousands) Three Months Ended

September 30, Change Nine Months Ended

September 30, Change

2023 2022 2023 2022

March 31, Change

Pega Cloud $ 130,902 40 % $ 107,879 33 % $ 23,023 21 %

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$ 330,147 100 % $ 325,472 100 % $ 4,675 1 %

• 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.

• The increase in Pega Cloud revenue for the three months ended March 31, 2024 was primarily due to the growth of the hosted client base as our clients continued to expand their use of Pega Cloud.

• The increase in maintenance revenue in the three months ended March 31, 2024 was primarily due to continued demand for our subscription license offerings, which are generally bundled with maintenance.

• The decrease in subscription license revenue in the three months ended March 31, 2024 was primarily due to a large multi-year contract recognized in revenue in the three months ended March 31, 2023.

• The increase in consulting revenue in the three months ended March 31, 2024 was primarily due to an increase in consultant realization rates in the Americas.

(Dollars in thousands) Three Months Ended

September 30, Change Nine Months Ended

September 30, Change

2023 2022 2023 2022

March 31, Change

Pega Cloud $ 101,305 77 % $ 77,629 72 % $ 23,676 30 %

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* not meaningful

• 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.

• The increase in Pega Cloud gross profit percent in the three months ended March 31, 2024 was primarily due to increased cost efficiency, particularly for hosting services and employee compensation and benefits, as Pega Cloud continues to grow and scale.

• The increase in consulting gross profit percent in the three months ended March 31, 2024 was primarily due to an increase in consultant realization rates in the Americas.

Operating expenses

(Dollars in thousands) Three Months Ended

September 30, Change Nine Months Ended

September 30, Change

2023 2022 2023 2022

March 31, Change

Selling and marketing $ 127,695 $ 149,797 $ (22,102) (15) %

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% of Revenue 7 % 7 %

Litigation settlement, net of recoveries $ 32,403 $ — $ 32,403 100 %

% of Revenue 10 % — %

Restructuring $ 163 $ 1,461 $ (1,298) (89) %

% of Revenue — % — %

• 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.

• The decrease in selling and marketing during the three months ended March 31, 2024 was primarily due to a decrease in compensation and benefits of $17.5 million from reduced headcount as we optimized our go-to-market strategy.

For additional information, see "Note 9.

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

• 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.

• The decrease in research and development for the three months ended March 31, 2024 was primarily due to a decrease in compensation and benefits of $1.5 million due to reduced headcount and a decrease in cloud hosting expenses of $1.2 million.

• The increase in litigation settlement, net of recoveries in the three months ended March 31, 2024 was primarily due to the estimated cost to settle ongoing litigation arising from proceedings outside the ordinary course of business.

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, 2023 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.

• The decrease in restructuring expenses during the three months ended March 31, 2024 was primarily due to efforts to optimize our go-to-market organization in the three months ended March 31, 2023.

For additional information, see "Note 9.

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(Dollars in thousands) Three Months Ended

September 30, Change Nine Months Ended

September 30, Change

2023 2022 2023 2022

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

March 31, Change

Foreign currency transaction (loss) $ (3,262) $ (2,675) $ (587) (22) %

Interest income 5,281 1,485 3,796 256 %

Interest expense (1,752) (1,918) 166 9 %

(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 %

Gain on capped call transactions 3,299 3,206 93 3 %

Other income, net 1,684 6,583 (4,899) (74) %

$ 5,250 $ 6,681 $ (1,431) (21) %

* not meaningful

• 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) 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.

• The change in foreign currency transaction (loss) in the three months ended March 31, 2024 was primarily due to fluctuations in foreign currency exchange rates associated with foreign currency-denominated cash and receivables held by our subsidiary in the United Kingdom.

• The increase in interest income in the three months ended March 31, 2024 was primarily due to higher investment balances and market interest rates.

• The decrease in other income, net in the three months ended March 31, 2024 was due to a gain of $3.8 million on our venture investments and a gain of $2.8 million from repurchases of our convertible senior notes in the three months ended March 31, 2023.

For additional information, see “Note 8.

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

Provision for income taxes

Nine Months Ended

September 30,

(Benefit from) provision for income taxes

Three Months Ended

(Dollars in thousands) 2024 2023

Provision for income taxes $ 15,395 $ 190,239

(Benefit from) provision for income taxes $ (3,038) $ 5,249

Effective income tax rate 20 % (34) %

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.

The effective income tax rate in the three months ended March 31, 2024 was primarily driven by the valuation allowance on our deferred tax assets in the U.S.

and U.K., and forecasted taxable income, offset by an income tax benefit for discrete items in the three months ended March 31, 2024.

The Organization for Economic Cooperation and Development (“OECD”) has introduced new global minimum tax regulations, known as Pillar Two, that began to come into effect on January 1, 2024.

We are monitoring this development and evaluating its potential impact on our tax rate and eligibility to qualify for the safe harbor provisions.

For 2024, we currently anticipate meeting the transitional safe harbors in most jurisdictions, with any remaining top-up tax being immaterial.

LIQUIDITY AND CAPITAL RESOURCES

Nine Months Ended

September 30,

Three Months Ended

(in thousands) 2024 2023

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Effect of exchange rate changes on cash, cash equivalents, and restricted cash (2,803) 782

Net increase (decrease) in cash, cash equivalents, and restricted cash $ 27,092 $ (52,339)

Net increase in cash, cash equivalents, and restricted cash $ 62,843 $ 25,104

(in thousands)

September 30, 2023 December 31, 2022

$ 217,735 $ 248,389

Held by foreign entities

118,574 48,832

March 31, 2024 December 31, 2023

entities $ 491,808 $ 263,453

Held in foreign entities 127,141 159,885

Total cash, cash equivalents, and marketable securities 618,949 423,338

Restricted cash included in other current assets 775 —

Restricted cash included in other long-term assets 2,990 2,925

Total cash, cash equivalents, marketable securities, and restricted cash

$ 622,714 $ 426,263

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.

We believe that our current cash, marketable securities, cash flow provided by operations, borrowing capacity, and ability to engage in capital market transactions will be sufficient to fund our operations, convertible senior notes due on March 1, 2025, 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.

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Operating activities

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.

The change in cash provided by operating activities in the three months ended March 31, 2024 was primarily due to growth in client collections and the impact of our cost-efficiency initiatives.

For additional information, see “Note 9.

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Investing activities

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.

The change in cash (used in) investing activities in the three months ended March 31, 2024 was primarily due to our investments in financial instruments and reduced investment in property and equipment as we optimize our office space.

Financing activities

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

In the 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.

As of March 31, 2024, we had $502.3 million in aggregate principal amount of convertible senior notes outstanding due on March 1, 2025.

For additional information, see "Note 8.

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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 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.

On April 23, 2024, the Credit Facility was amended to extend the expiration date to February 4, 2025.

As of March 31, 2024 and December 31, 2023, we had $27.3 million in outstanding letters of credit, reducing available borrowing capacity under the Credit Facility, but no outstanding cash borrowings.

For additional information, see "Note 8.

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Changes in the remaining stock repurchase authority:

(in thousands) Nine Months Ended

September 30, 2023

(in thousands) Three Months Ended

March 31, 2024

December 31, 2023 $ 60,000

Authorizations (1)

September 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 was increased to $60 million.

March 31, 2024 $ 60,000

(1) On April 23, 2024, our Board of Directors extended the expiration date of our current share repurchase program from June 30, 2024 to June 30, 2025.

Common stock repurchases

Nine Months Ended

September 30,

Three Months Ended

(in thousands) Shares Amount Shares Amount

Stock repurchase program — — 279 24,508

Tax withholdings for net settlement of equity awards 32 $ 2,005 27 $ 1,107

39 $ 1,654 532 $ 42,083

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.

In the three months ended March 31, 2024 and 2023, instead of receiving cash from the equity holders, we withheld shares with a value of $2.8 million and $0.6 million, respectively, for the exercise price of options.

These amounts are not included in the table above.

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

Nine Months Ended

September 30,

Three Months Ended

(in thousands) 2024 2023

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Contractual obligations

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

As of March 31, 2024, our contractual obligations were:

Payments due by period

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Operating lease obligations

12,700 16,024 11,246 10,066 9,334 30,147 — 89,517

Venture investment commitments (3)

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(1) Includes principal and interest.

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

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

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

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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