PEGASYSTEMS INC 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS 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. 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: • our future financial performance and business plans; • the adequacy of our liquidity and capital resources; • the successful execution of investments in artificial intelligence; • the continued payment of our quarterly dividends; • the timing of revenue recognition; • variation in demand for our products and services, including among clients in the public sector; • reliance on key personnel; • reliance on third-party service providers, including hosting providers; • compliance with our debt obligations and covenants; • foreign currency exchange rates; • potential legal and financial liabilities, as well as damage to our reputation, due to cyber-attacks; • security breaches and security flaws; • our ability to protect our intellectual property rights, costs associated with defending such rights, intellectual property rights claims, and other related claims by third parties against us, including related costs, damages, and other relief that may be granted against us; • our ongoing litigation with Appian Corp.; • our client retention rate; and • management of our growth. These risks and others that may cause actual results to differ materially from those expressed in such forward-looking statements are described further in Part I of our Annual Report on Form 10-K for the year ended December 31, 2024, Part II of this Quarterly Report on Form 10-Q, and other filings we make with the U.S. Securities and Exchange Commission (“SEC”). Investors are cautioned not to place undue reliance on such forward-looking statements, and there are no assurances that the results included in such statements will be achieved. Although subsequent events may cause our view to change, except as required by applicable law, we do not undertake and expressly disclaim any obligation to publicly update or revise these forward-looking statements, whether as the result of new information, future events, or otherwise. The forward-looking statements in this Quarterly Report represent our views as of April 22, 2025. 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, 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. Management uses these measures to assess the performance of the company's operations and establish operational goals and incentives. They are not a substitute for financial measures prepared under U.S. GAAP. A reconciliation of GAAP and non-GAAP measures is located with each non-GAAP measure. BUSINESS OVERVIEW We develop, market, license, host, and support enterprise software that helps organizations optimize decisions and processes in real-time so they can deliver outcomes that transform their business. Our powerful platform for enterprise AI decisioning and workflow automation enables the world’s leading brands and government agencies to hyper-personalize customer experiences, automate customer service, and streamline operations, mission-critical business processes, and workflows. With Pega, our clients can leverage our AI technology and scalable architecture to accelerate their digital transformation. In addition, our sales and client success teams, world-class partners, and clients are able to leverage Pega GenAI Blueprint TM (“Blueprint”) to rapidly prototype and accelerate the development and deployment of applications quickly and collaboratively. 23 Our target clients are Global 2000 organizations and government agencies that require solutions to distinguish themselves in the markets they serve. 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 by industry. Performance metrics We use performance metrics to analyze and assess our overall performance, make operating decisions, and forecast and plan for future periods, including: Annual contract value (“ACV”) ACV represents the annualized value of our active contracts as of the measurement date. The contract's total value is divided by its duration in years to calculate ACV. ACV is a performance measure that we believe provides useful information to our management and investors. (Dollars in thousands) March 31, 2024 March 31, 2025 Change Constant Currency Change Pega Cloud $ 570,356 $ 701,311 $ 130,955 23 % 23 % Maintenance 313,550 298,422 (15,128) (5) % (5) % Subscription services 883,906 999,733 115,827 13 % 13 % Subscription license 389,431 445,677 56,246 14 % 14 % $ 1,273,337 $ 1,445,410 $ 172,073 13 % 13 % Reconciliation of ACV and constant currency ACV (in millions, except percentages) March 31, 2024 March 31, 2025 1-Year Change ACV $ 1,273 $ 1,445 13 % Impact of changes in foreign exchange rates — (0.7) Constant currency ACV $ 1,273 $ 1,445 13 % Note: Constant currency ACV is calculated by applying the March 31, 2024 foreign exchange rates to current period shown. 24 Cash Flow (1) (Dollars in thousands) Three Months Ended March 31, Change 2024 2025 Cash provided by operating activities $ 180,146 $ 204,228 13 % Investment in property and equipment (604) (1,880) Free cash flow (1) $ 179,542 $ 202,348 13 % Supplemental information (2) Legal fees $ 2,739 $ 2,413 Restructuring 3,347 1,184 Interest on convertible senior notes 1,884 1,754 Income taxes 8,163 4,102 $ 16,133 $ 9,453 (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. GAAP. (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. ◦ Legal fees: Legal and related fees arising from proceedings outside the ordinary course of business. ◦ Restructuring: Restructuring fluctuates in amount and frequency and is significantly affected by the timing and size of our restructuring activities. ◦ Interest on convertible senior notes : In February 2020, we issued convertible senior notes (the “Notes”), due March 1, 2025, in a private placement. The Notes accrued interest at an annual rate of 0.75%, paid semi-annually in arrears on March 1 and September 1. The outstanding Notes were repaid in their entirety at maturity. ◦ Income taxes : Direct income taxes paid net of refunds received. 25 ff Remaining performance obligations (“Backlog”) Reconciliation of Backlog and Constant Currency Backlog (Non-GAAP) (in millions, except percentages) March 31, 2024 March 31, 2025 1-Year Growth Rate Backlog - GAAP $ 1,425 $ 1,728 21 % Impact of changes in foreign exchange rates — (5) Constant currency backlog $ 1,425 $ 1,723 21 % Note: Constant currency Backlog is calculated by applying the March 31, 2024 foreign exchange rates to current period shown. CRITICAL ACCOUNTING POLICIES Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our unaudited condensed consolidated financial statements, which have been prepared following accounting principles generally accepted in the United States of America (“U.S.”) and the rules and regulations of the SEC for interim financial reporting. Preparing these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, knowledge of current conditions, and expectations of what could occur in the future based on the available information. For more information about our critical accounting policies, we encourage you to read the discussion in the following locations in our Annual Report on Form 10-K for the year ended December 31, 2024: • “Critical Accounting Estimates and Significant Judgments” in Item 7; and • “Note 2. Significant Accounting Policies” in Item 8. No significant changes have been made to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2024. 26 RESULTS OF OPERATIONS Revenue (Dollars in thousands) Three Months Ended March 31, Change 2025 2024 Pega Cloud $ 151,123 32 % $ 130,902 40 % $ 20,221 15 % Maintenance 76,368 16 % 81,001 24 % (4,633) (6) % Subscription services 227,491 48 % 211,903 64 % 15,588 7 % Subscription license 186,555 39 % 63,338 19 % 123,217 195 % Subscription 414,046 87 % 275,241 83 % 138,805 50 % Consulting 60,421 13 % 54,047 17 % 6,374 12 % Perpetual license 1,166 — % 859 — % 307 36 % $ 475,633 100 % $ 330,147 100 % $ 145,486 44 % • The increase in Pega Cloud revenue in the three months ended March 31, 2025 was primarily due to expanded adoption of Pega Cloud by our existing clients. • The decrease in maintenance revenue in the three months ended March 31, 2025 was primarily due to our clients’ shift to Pega Cloud-based offerings, which do not generally result in maintenance revenue. • The increase in subscription license revenue in the three months ended March 31, 2025 was primarily due to several large multi-year contracts recognized in revenue in the three months ended March 31, 2025. • The increase in consulting revenue in the three months ended March 31, 2025 was primarily due to increases in consultant billable hours. Gross profit (Dollars in thousands) Three Months Ended March 31, Change 2025 2024 Pega Cloud $ 118,654 79 % $ 101,305 77 % $ 17,349 17 % Maintenance 70,709 93 % 74,774 92 % (4,065) (5) % Subscription services 189,363 83 % 176,079 83 % 13,284 8 % Subscription license 186,169 100 % 62,695 99 % 123,474 197 % Subscription 375,532 91 % 238,774 87 % 136,758 57 % Consulting (3,513) (6) % (4,135) (8) % 622 15 % Perpetual license 1,164 100 % 850 99 % 314 37 % $ 373,183 78 % $ 235,489 71 % $ 137,694 58 % • The increase in Pega Cloud gross profit percent in the three months ended March 31, 2025 was primarily due to increased cost efficiency, primarily 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, 2025 was primarily due to increases in consultant utilization rates. Operating expenses (Dollars in thousands) Three Months Ended March 31, Change 2025 2024 Selling and marketing $ 138,069 $ 127,695 $ 10,374 8 % % of Revenue 29 % 39 % Research and development $ 74,286 $ 72,113 $ 2,173 3 % % of Revenue 16 % 22 % General and administrative $ 33,828 $ 23,527 $ 10,301 44 % % of Revenue 7 % 7 % Litigation settlement, net of recoveries $ — $ 32,403 $ (32,403) * % of Revenue — % 10 % Restructuring $ 11 $ 163 $ (152) (93) % % of Revenue — % — % * Not meaningful • The increase in selling and marketing in the three months ended March 31, 2025 was primarily due to an increase in compensation and benefits of $6.7 million attributable to increases in commissions and equity compensation. 27 • The increase in research and development in the three months ended March 31, 2025 was primarily due to an increase in computer hardware and software costs of $1 million and an increase in compensation and benefits of $0.5 million. • The increase in general and administrative in the three months ended March 31, 2025 was primarily due to an increase in compensation and benefits of $4.2 million attributable to an increase in equity compensation and an increase of $4.6 million in legal fees and related expenses arising from legal proceedings outside the ordinary course of business. We expect to continue to incur additional costs for these proceedings. For additional information, see "Note 17. Commitments and Contingencies" in Part I, Item 1 of this Quarterly Report. • The decrease in litigation settlement, net of recoveries in the three months ended March 31, 2025 was primarily due to the cost to settle litigation arising from proceedings outside the ordinary course of business in the three months ended March 31, 2024. See “Note 20. Commitments and Contingencies” in Item 8 of our Annual Report filed on Form-10K for the year ended December 31, 2024 and prior filings for further information. Other income and expenses (Dollars in thousands) Three Months Ended March 31, Change 2025 2024 Foreign currency transaction (loss) $ (5,325) $ (3,262) $ (2,063) (63) % Interest income 5,335 5,281 54 1 % Interest expense (1,027) (1,752) 725 41 % (Loss) income on capped call transactions (223) 3,299 (3,522) * Other income, net 561 1,684 (1,123) (67) % $ (679) $ 5,250 $ (5,929) * * Not meaningful • The increase in foreign currency transaction (loss) in the three months ended March 31, 2025 was primarily due to fluctuations in foreign currency exchange rates associated with foreign currency-denominated cash, receivables, and intercompany balances held by our subsidiary in the United Kingdom. • The decrease in interest expense in the three months ended March 31, 2025 was primarily due to the repayment of the Notes at maturity on March 3, 2025. • The change in (loss) income on capped call transactions was due to the termination of the capped call transactions in the three months ended March 31, 2025. • The decrease in other income, net was primarily due to lower recorded valuation gains from our venture investments portfolio. For additional information, see "Note 12. Fair Value Measurements" in Part I, Item 1 of this Quarterly Report. Provision for (benefit from) income taxes Three Months Ended March 31, (Dollars in thousands) 2025 2024 Provision for (benefit from) income taxes $ 40,888 $ (3,038) Effective income tax rate 32 % 20 % Our effective income tax rate for the three months ended March 31, 2025, is impacted by the valuation allowance on our deferred tax assets in the U.S. and U.K. as well as the jurisdictional mix and timing of the actual compared to projected earnings. The Organization for Economic Cooperation and Development (“OECD”) has introduced new global minimum tax regulations, known as Pillar Two, that was supported by over 130 countries worldwide. Parts of the minimum tax rules were applicable in 2024, with the remaining provisions becoming fully effective for 2025. We do not expect this legislation to have a material impact on our consolidated financial statements. We will continue to monitor and evaluate new legislation and guidance, which could change our current assessment. 28 LIQUIDITY AND CAPITAL RESOURCES Three Months Ended March 31, (in thousands) 2025 2024 Cash provided by (used in): Operating activities $ 204,228 $ 180,146 Investing activities 261,895 (132,399) Financing activities (575,986) 17,899 Effect of exchange rate changes on cash, cash equivalents, and restricted cash 3,570 (2,803) Net (decrease) increase in cash, cash equivalents, and restricted cash $ (106,293) $ 62,843 (in thousands) March 31, 2025 December 31, 2024 Held in U.S. entities $ 118,576 $ 474,509 Held in foreign entities 253,160 265,464 Total cash, cash equivalents, and marketable securities 371,736 739,973 Restricted cash included in other current assets 49 98 Restricted cash included in other long-term assets 4,058 4,328 Total cash, cash equivalents, marketable securities, and restricted cash $ 375,843 $ 744,399 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, 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 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 operating activities in the three months ended March 31, 2025 was primarily due to increase in client collections. Investing activities The change in cash provided by (used in) investing activities in the three months ended March 31, 2025 was primarily due to scheduled maturities of our investments in financial instruments in anticipation of the repayment of the maturing Notes. Financing activities Debt financing In February 2020, we issued $600 million in aggregate principal amount of Notes, which matured on March 1, 2025. As of December 31, 2024, we had $468 million in aggregate principal amount of Notes outstanding, which were repaid in their entirety at maturity. For additional information, see "Note 10. Debt" in Part I, Item 1 of this Quarterly Report. In November 2019, and as since amended, we entered into a five-year $100 million senior secured revolving credit agreement (the “Credit Facility”) with PNC Bank, National Association. Effective as of February 4, 2025, the Credit Facility was amended to extend the expiration date to February 4, 2027. As of March 31, 2025 and December 31, 2024, we had $27.3 million in outstanding letters of credit under the Credit Facility, reducing available borrowing capacity, but we had no outstanding cash borrowings. For additional information, see "Note 10. Debt" in Part I, Item 1 of this Quarterly Report. Stock repurchase program Changes in the remaining stock repurchase authority: (in thousands) Three Months Ended March 31, 2025 December 31, 2024 $ 240,443 Repurchases (1) (118,704) March 31, 2025 (2) $ 121,739 (1) All purchases under this program have been made on the open market. 29 (2) On April 22, 2025, the Company’s Board of Directors further extended the expiration date of the share repurchase program from December 31, 2025 to June 30, 2026 and increased the authorized repurchase by $500 million. Common stock repurchases Three Months Ended March 31, 2025 2024 (in thousands) Shares Amount Shares Amount Repurchases paid 1,416 $ 115,704 — — Repurchases unpaid at period end 44 3,000 — — Stock repurchase program 1,460 118,704 — — Tax withholdings for net settlement of equity awards 29 2,304 32 2,005 1,489 $ 121,008 32 $ 2,005 During the three months ended March 31, 2025 and 2024, instead of receiving cash from the equity holders, we withheld shares with a value of $1.5 million and $2.8 million, respectively, for the exercise price of options. These amounts are not included in the table above. Dividends We intend to pay a quarterly cash dividend of $0.03 per share. However, the Board of Directors may terminate or modify the dividend program without prior notice. Three Months Ended March 31, (in thousands) 2025 2024 Dividend payments to stockholders $ 2,583 $ 2,515 Contractual obligations As of March 31, 2025, our contractual obligations were: Payments due by period (in thousands) Remainder of 2025 2026 2027 2028 2029 2030 and after Other Total Purchase obligations (1) $ 96,642 $ 154,275 $ 171,132 $ 34,242 $ 493 $ 510 $ — $ 457,294 Operating lease obligations 13,689 15,589 14,104 13,479 10,813 23,666 — 91,340 Venture investment commitments (2) 500 500 — — — — — 1,000 Liability for uncertain tax positions (3) — — — — — — 20,785 20,785 $ 110,831 $ 170,364 $ 185,236 $ 47,721 $ 11,306 $ 24,176 $ 20,785 $ 570,419 (1) Represents the fixed amount owed for purchase obligations including software licenses, hosting services, and sales and marketing programs. (2) Represents the maximum funding under existing venture investment agreements. Our venture investment agreements generally allow us to withhold unpaid funds at our discretion. (3) We cannot reasonably estimate the timing of this cash outflow due to uncertainties in the timing of the effective settlement of tax positions.