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PEGASYSTEMS INC - Quarter Report: 2018 September (Form 10-Q)

Form 10-Q
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

            For the quarterly period ended September 30, 2018

OR

 

Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 1-11859

 

 

PEGASYSTEMS INC.

(Exact name of registrant as specified in its charter)

 

 

 

Massachusetts   04-2787865
(State or other jurisdiction of incorporation or organization)   (IRS Employer Identification No.)
One Rogers Street, Cambridge, MA   02142-1209
(Address of principal executive offices)   (Zip Code)

(617) 374-9600

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ☒        No  ☐

Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files).     Yes  ☒        No  ☐

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☒    Accelerated filer ☐    Non-accelerated filer ☐    Smaller reporting company ☐    Emerging growth company ☐

If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ☐      No  ☒

There were 78,700,651 shares of the Registrant’s common stock, $0.01 par value per share, outstanding on November 1, 2018.

 

 


Table of Contents

PEGASYSTEMS INC.

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

 

             Page          
PART I - FINANCIAL INFORMATION  

Item 1. Unaudited Condensed Consolidated Financial Statements

  

 Unaudited Condensed Consolidated Balance Sheets as of September  30, 2018 and December 31, 2017

     3  

  Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2018 and 2017

     4  

  Unaudited Condensed Consolidated Statements of Comprehensive (Loss) Income for the three and nine months ended September 30, 2018 and 2017

     5  

  Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017

     6  

 Notes to Unaudited Condensed Consolidated Financial Statements

     7  

Item  2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     19  

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     26  

Item 4. Controls and Procedures

     27  
PART II - OTHER INFORMATION  

Item 1A. Risk Factors

     28  

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     28  

Item 6. Exhibits

     28  

Signature

     29  

 

2


Table of Contents

PART I - FINANCIAL INFORMATION

ITEM 1.

        UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS(1)

(in thousands)

 

           September 30,      
2018
       December 31,  
2017
 

Assets

     

Current assets:

     

  Cash and cash equivalents

   $ 106,195        $ 162,279    

  Marketable securities

     99,782          61,469    
  

 

 

    

 

 

 

   Total cash, cash equivalents, and marketable securities

     205,977          223,748    

  Accounts receivable

     150,733          222,735    

  Unbilled receivables

     155,964          158,898    

  Other current assets

     73,464          41,135    
  

 

 

    

 

 

 

     Total current assets

     586,138          646,516    

Long-term unbilled receivables

     168,929          160,708    

Goodwill

     72,897          72,952    

Other long-term assets

     134,679          131,391    
  

 

 

    

 

 

 

   Total assets

   $ 962,643        $ 1,011,567    
  

 

 

    

 

 

 

Liabilities and stockholders’ equity

     

Current liabilities:

     

  Accounts payable

   $ 12,926        $ 17,370    

  Accrued expenses

     39,829          45,508    

  Accrued compensation and related expenses

     71,318          66,040    

  Deferred revenue

     158,178          166,297    
  

 

 

    

 

 

 

 Total current liabilities

     282,251          295,215    

Deferred income tax liabilities

     36,166          38,463    

Other long-term liabilities

     23,371          23,652    
  

 

 

    

 

 

 

       Total liabilities

     341,788          357,330    

Stockholders’ equity:

     

  Preferred stock, 1,000 shares authorized; no shares issued and outstanding

     —          —    

  Common stock, 200,000 shares authorized; 78,816 and 78,081 shares issued and outstanding at

  September 30, 2018 and December 31, 2017, respectively

     788          781    

  Additional paid-in capital

     135,132          152,097    

  Retained earnings

     496,815          508,051    

  Accumulated other comprehensive loss

     (11,880)         (6,692)   
  

 

 

    

 

 

 

   Total stockholders’ equity

     620,855          654,237    
  

 

 

    

 

 

 

   Total liabilities and stockholders’ equity

   $ 962,643        $ 1,011,567    
  

 

 

    

 

 

 

 

  (1) 

On January 1, 2018, the Company adopted the ASC 606 revenue recognition standard and has adjusted prior periods to conform. See Note 2. “New Accounting Pronouncements” for additional information.

See notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(1)

(in thousands, except per share amounts)

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2018      2017      2018      2017  

Revenue

           

 Software license

   $ 52,342       $ 53,234       $ 184,899       $ 231,392   

 Maintenance

     66,017         61,812         196,448         179,949   

 Services

     84,904         75,911         253,877         222,521   
  

 

 

    

 

 

    

 

 

    

 

 

 

  Total revenue

     203,263         190,957         635,224         633,862   
  

 

 

    

 

 

    

 

 

    

 

 

 

Cost of revenue

           

 Software license

     1,255         1,276         3,772         3,826   

 Maintenance

     6,079         6,716         18,035         20,945   

 Services

     67,089         61,739         202,047         180,925   
  

 

 

    

 

 

    

 

 

    

 

 

 

  Total cost of revenue

     74,423         69,731         223,854         205,696   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross profit

     128,840         121,226         411,370         428,166   
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating expenses

           

 Selling and marketing

     87,490         69,363         269,845         214,244   

 Research and development

     46,504         41,031         135,261         121,089   

 General and administrative

     12,104         13,133         38,749         38,174   
  

 

 

    

 

 

    

 

 

    

 

 

 

  Total operating expenses

     146,098         123,527         443,855         373,507   
  

 

 

    

 

 

    

 

 

    

 

 

 

(Loss) income from operations

     (17,258)        (2,301)        (32,485)        54,659   

Foreign currency transaction gain (loss)

     399         (5,052)        558         (6,549)  

Interest income, net

     683         140         2,076         547   

Other income, net

     —         —         363         287   
  

 

 

    

 

 

    

 

 

    

 

 

 

(Loss) income before benefit from income taxes

     (16,176)        (7,213)        (29,488)        48,944   

Benefit from income taxes

     (8,589)        (8,501)        (23,692)        (9,009)  
  

 

 

    

 

 

    

 

 

    

 

 

 

        Net (loss) income

   $             (7,587)      $             1,288       $             (5,796)      $             57,953   
  

 

 

    

 

 

    

 

 

    

 

 

 

(Loss) earnings per share

           

 Basic

   $ (0.10)      $ 0.01       $ (0.07)      $ 0.75   

 Diluted

   $ (0.10)      $ 0.01       $ (0.07)      $ 0.70   

Weighted-average number of common shares outstanding

           

 Basic

     78,700         77,691         78,525         77,258   

 Diluted

     78,700         83,323         78,525         82,717   

Cash dividends declared per share

   $ 0.03       $ 0.03       $ 0.09       $ 0.09   

 

  (1) 

On January 1, 2018, the Company adopted the ASC 606 revenue recognition standard and has adjusted prior periods to conform. See Note 2. “New Accounting Pronouncements” for additional information.

See notes to unaudited condensed consolidated financial statements.

 

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PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME(1)

(in thousands)

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2018      2017      2018      2017  

Net (loss) income

   $ (7,587)      $ 1,288       $ (5,796)      $ 57,953   

Other comprehensive (loss) income, net of tax

           

 Unrealized (loss) gain on available-for-sale marketable securities, net of tax

     (162)        22         (277)        148   

 Foreign currency translation adjustments

     (1,934)        2,576         (4,911)        8,848   
  

 

 

    

 

 

    

 

 

    

 

 

 

  Total other comprehensive (loss) income, net of tax

     (2,096)        2,598         (5,188)        8,996   
  

 

 

    

 

 

    

 

 

    

 

 

 

Comprehensive (loss) income

   $         (9,683)      $         3,886       $         (10,984)      $         66,949   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

  (1) 

On January 1, 2018, the Company adopted the ASC 606 revenue recognition standard and has adjusted prior periods to conform. See Note 2. “New Accounting Pronouncements” for additional information.

See notes to unaudited condensed consolidated financial statements.

 

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PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(1)

(in thousands)

 

     Nine Months Ended
September 30,
 
     2018      2017  

Operating activities:

     

 Net (loss) income

   $ (5,796)       $ 57,953    

 Adjustment to reconcile net (loss) income to cash provided by operating activities:

     

  Change in operating assets and liabilities, net

     8,698          (15,455)   

  Stock-based compensation expense

     47,573          39,929    

  Amortization of intangible assets and depreciation

     18,692          18,703    

  Other non-cash

     (2,079)         12,796    
  

 

 

    

 

 

 

     Cash provided by operating activities

     67,088          113,926    

Investing activities:

     

 Purchases of investments

     (68,177)         (25,687)   

 Proceeds from maturities and called investments

     26,456          23,124    

 Other

     (7,874)         (9,403)   
  

 

 

    

 

 

 

     Cash used in investing activities

     (49,595)         (11,966)   

Financing activities:

     

 Dividend payments to shareholders

     (7,067)         (6,941)   

 Common stock repurchases

     (64,597)         (37,099)   
  

 

 

    

 

 

 

     Cash used in financing activities

     (71,664)         (44,040)   

Effect of exchange rates on cash and cash equivalents

     (1,913)         2,054    
  

 

 

    

 

 

 

Net (decrease) increase in cash and cash equivalents

     (56,084)         59,974    

Cash and cash equivalents, beginning of period

     162,279          70,594    
  

 

 

    

 

 

 

Cash and cash equivalents, end of period

   $             106,195        $             130,568    
  

 

 

    

 

 

 

 

  (1) 

On January 1, 2018, the Company adopted the ASC 606 revenue recognition standard and has adjusted prior periods to conform. See Note 2. “New Accounting Pronouncements” for additional information.

See notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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 of the information and footnotes 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, 2017.

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.

The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year 2018.

On January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” using the full retrospective method which required that each prior reporting period presented be adjusted to reflect the application of this ASU. See Note 2. “New Accounting Pronouncements” for additional information.

2. NEW ACCOUNTING PRONOUNCEMENTS

Financial instruments

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-13, “Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which requires measurement and recognition of expected credit losses for financial assets measured at amortized cost, including accounts receivable, upon initial recognition of that financial asset using a forward-looking expected loss model, rather than an incurred loss model. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses when the fair value is below the amortized cost of the asset, removing the concept of “other-than-temporary” impairments. The effective date for the Company will be January 1, 2020, with early adoption permitted. The Company is currently evaluating the effect this ASU will have on its consolidated financial statements and related disclosures.

Leases

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842),” which requires lessees to record most leases on their balance sheets, recognizing a lease liability for the obligation to make lease payments and a right-of-use asset for the right to use the underlying asset for the lease term. The effective date for the Company will be January 1, 2019, with early adoption permitted. The Company expects that most of its operating lease commitments will be subject to this ASU and recognized as operating lease liabilities and right-of-use assets upon adoption with a material impact to the Company’s balance sheet but an immaterial impact to its results of operations and cash flows. The Company expects to elect the optional transition method to apply the new lease standard prospectively at the adoption date, as opposed to recasting prior reporting periods. As a result, the Company expects to recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption.

ASC 606 and ASC 340-40

On January 1, 2018, the Company adopted the ASC 606 revenue recognition standard and has adjusted prior periods to conform.

The most significant adoption impacts were as follows:

 

   

Perpetual licenses with extended payment terms and term licenses - Revenue from perpetual licenses with extended payment terms and term licenses is now recognized when control is transferred to the client, which is defined as the point in time when the client can use and benefit from the license. Previously, the Company recognized revenue over the term of the agreements as payments became due or earlier if prepaid. Any unrecognized license revenue from these arrangements is recognized in the period that control transfers or as a cumulative adjustment to retained earnings as of December 31, 2015. Unbilled receivables in the Company’s unaudited condensed consolidated balance sheets increased significantly upon adoption due to the revenue from term licenses being recognized prior to amounts being due, or prepaid, by clients and perpetual licenses with extended payment terms.

 

   

Allocation of future credits and significant discounts - Perpetual or term licenses delivered are a separate performance obligation which now requires the Company to allocate any future credits and discounts to the performance obligations in the arrangement based upon their relative stand-alone selling prices.

 

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Table of Contents

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

   

Deferred contract costs - Sales incentive programs and other incremental costs to obtain a contract were previously expensed when incurred. ASC 340-40 requires these costs be recognized as an asset when incurred and expensed over the period of expected benefit, which is on average five years. This change primarily impacts the Company’s contracts related to multi-year cloud offerings, maintenance on term and perpetual licenses, and long-term term and perpetual licenses with client usage rights that increase over time.

 

   

Taxes - The corresponding effect on tax balances of the above impacts has also been recognized.

For additional information on the Company’s accounting policies as a result of the adoption of ASC 606 and ASC 340-40 see Note 4. “Receivables, Contract Assets, and Deferred Revenue”, Note 5. “Deferred Contract Costs”, and Note 9. “Revenue”.

The impact of the adoption of ASC 606 and ASC 340-40 on the Company’s unaudited condensed consolidated balance sheet and unaudited condensed consolidated statement of operations is:

 

     December 31, 2017  
(in thousands)        Previously reported                    Adjustments                          As adjusted            

Assets

        

Accounts receivable, unbilled receivables, and contract assets

   $ 248,331       $ 134,216       $ 382,547   

Long-term unbilled receivables

     —         160,708         160,708   

Deferred income taxes

     57,127         (42,887)        14,240   

Deferred contract costs

     —         37,924         37,924   

Other assets(1)

     416,148         —         416,148   
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 721,606       $ 289,961       $ 1,011,567   
  

 

 

    

 

 

    

 

 

 

Liabilities and stockholders’ equity

        

Deferred revenue

   $ 195,073       $ (28,776)      $ 166,297   

Long-term deferred revenue

     6,591         (2,885)        3,706   

Deferred income tax liabilities

     —         38,463         38,463   

Other liabilities(2)

     148,864         —         148,864   
  

 

 

    

 

 

    

 

 

 

Total liabilities

     350,528         6,802         357,330   

Foreign currency translation adjustments

     (3,494)        (2,966)        (6,460)  

Retained earnings

     221,926         286,125         508,051   

Other equity(3)

     152,646         —         152,646   
  

 

 

    

 

 

    

 

 

 

Total stockholders’ equity

     371,078         283,159         654,237   
  

 

 

    

 

 

    

 

 

 

Total liabilities and stockholders’ equity

   $         721,606       $         289,961       $         1,011,567   
  

 

 

    

 

 

    

 

 

 

 

  (1) 

Includes cash, cash equivalents, marketable securities, income taxes receivable, other current assets, property and equipment, intangible assets, goodwill, and other long-term assets (as reflected in the consolidated balance sheets in the Annual Report on Form 10-K for the year ended December 31, 2017).

  (2) 

Includes accounts payable, accrued expenses, accrued compensation and related expenses, income taxes payable, and other long-term liabilities (as reflected in the consolidated balance sheets in the Annual Report on Form 10-K for the year ended December 31, 2017).

  (3)

Includes common stock, additional paid-in capital, and net unrealized loss on available-for-sale marketable securities (as reflected in the consolidated balance sheets in the Annual Report on Form 10-K for the year ended December 31, 2017).

 

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Table of Contents

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

     September 30, 2017  
     Three Months Ended      Nine Months Ended  
(in thousands, except per share amounts)      Previously  
Reported
       Adjustments          As Adjusted          Previously  
Reported
       Adjustments          As Adjusted    

Revenue:

                 

 Software license

   $ 41,793       $ 11,441       $ 53,234       $ 195,220       $ 36,172       $ 231,392   

 Maintenance

     62,204         (392)        61,812         180,759         (810)        179,949   

 Services

     75,818         93         75,911         225,063         (2,542)        222,521   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

  Total revenue

     179,815         11,142         190,957         601,042         32,820         633,862   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Cost of revenue:

                 

 Software license

     1,276         —          1,276         3,826         —          3,826   

 Maintenance

     6,716         —          6,716         20,945         —          20,945   

 Services

     61,739         —          61,739         180,925         —          180,925   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

  Total cost of revenue

     69,731         —          69,731         205,696         —          205,696   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross profit

     110,084         11,142         121,226         395,346         32,820         428,166   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Operating expenses:

                 

 Selling and marketing

     70,209         (846)        69,363         217,384         (3,140)        214,244   

 Research and development

     41,031         —          41,031         121,089         —          121,089   

 General and administrative

     13,133         —          13,133         38,174         —          38,174   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 Total operating expenses

     124,373         (846)        123,527         376,647         (3,140)        373,507   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

(Loss) income from operations

     (14,289)        11,988         (2,301)        18,699         35,960         54,659   

Foreign currency transaction loss

     (552)        (4,500)        (5,052)        (793)        (5,756)        (6,549)  

Interest income, net

     144         (4)        140         470         77         547   

Other income, net

     —          —          —          287         —          287   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

(Loss) income before benefit from income taxes

     (14,697)        7,484         (7,213)        18,663         30,281         48,944   

Benefit from income taxes

     (12,885)        4,384         (8,501)        (17,952)        8,943         (9,009)  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

  Net (loss) income

   $ (1,812)      $ 3,100       $ 1,288       $ 36,615       $ 21,338       $ 57,953   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

(Loss) earnings per share:

                 

 Basic

   $ (0.03)         $ 0.01       $ 0.47          $ 0.75   
  

 

 

       

 

 

    

 

 

       

 

 

 

 Diluted

   $ (0.03)         $ 0.01       $ 0.44          $ 0.70   
  

 

 

       

 

 

    

 

 

       

 

 

 

Weighted-average number of common shares outstanding:

                 

 Basic

     77,691            77,691         77,258            77,258   

 Diluted

     77,691            83,323         82,717            82,717   

Adoption of ASC 606 and ASC 340-40 did not change the Company’s total cash provided by or used in operating, financing, or investing activities in the Company’s unaudited condensed consolidated statements of cash flows for the nine months ended September 30, 2017.

3. MARKETABLE SECURITIES

 

     September 30, 2018  
(in thousands)        Amortized Cost              Unrealized Gains              Unrealized Losses                  Fair Value          

Municipal bonds

   $ 46,633       $ —       $ (267)      $ 46,366   

Corporate bonds

     53,738                (323)        53,416   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 100,371       $      $ (590)      $ 99,782   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2017  
(in thousands)        Amortized Cost              Unrealized Gains              Unrealized Losses                  Fair Value          

Municipal bonds

   $ 32,996       $ —       $ (148)      $ 32,848   

Corporate bonds

     28,757                (137)        28,621   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 61,753       $      $ (285)      $ 61,469   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of September 30, 2018, the Company did not hold any investments with unrealized losses that are considered to be other-than-temporary.

 

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

As of September 30, 2018, remaining maturities of marketable securities ranged from October 2018 to August 2021, with a weighted-average remaining maturity of approximately 1.5 years.

4. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE

Receivables

 

(in thousands)            September 30,        
2018
             December 31,        
2017
 

Accounts receivable

   $ 150,733       $ 222,735   

Unbilled receivables

     155,964         158,898   

Long-term unbilled receivables

     168,929         160,708   
  

 

 

    

 

 

 
   $                         475,626       $                         542,341   
  

 

 

    

 

 

 

Unbilled receivables are the amounts due from clients where the only condition to the right of payment is the passage of time. As of September 30, 2018 and December 31, 2017, the allowance for doubtful accounts was not material.

Unbilled receivables are expected to be billed in the future as follows:

 

(Dollars in thousands)            September 30,        
2018
 

1 Year or Less

   $         155,964                     48%   

1-2 Years

     89,177         27%   

2-5 Years

     79,752         25%   
  

 

 

    

 

 

 
   $ 324,893         100%   
  

 

 

    

 

 

 

Contract assets and deferred revenue

 

(in thousands)            September 30,        
2018
             December 31,        
2017
 

Contract assets(1)

   $ 2,888       $ 914   

Long-term contract assets(2)

     1,581         —   
  

 

 

    

 

 

 
   $ 4,469       $ 914   
  

 

 

    

 

 

 

Deferred revenue

   $ 158,178       $ 166,297   

Long-term deferred revenue(3)

     5,840         3,706   
  

 

 

    

 

 

 
   $ 164,018       $ 170,003   
  

 

 

    

 

 

 

  (1) Included in other current assets.

  (2) Included in other long-term assets.

  (3) Included in other long-term liabilities.

Contract assets are amounts under client contracts where revenue recognized exceeds the amount billed to the client and the right to payment is subject to conditions other than the passage of time, such as the completion of a related performance obligation. Deferred revenue consists of billings and payments received in advance of revenue recognition. Contract assets and deferred revenue are netted at the contract level for each reporting period.

The change in deferred revenue in the nine months ended September 30, 2018 was primarily due to $225.1 million of revenue recognized, excluding the impact of netting contract assets and deferred revenue at the contract level, during the period that was included in deferred revenue at December 31, 2017, partially offset by new billings in advance of revenue recognition.

Major clients

No client represented 10% or more of the Company’s total receivables as of September 30, 2018 or December 31, 2017.

5. DEFERRED CONTRACT COSTS

The Company recognizes an asset for the incremental costs of obtaining a contract with a client if the Company expects the benefit of those costs to be longer than one year. Deferred costs are amortized on a straight-line basis over the benefit period, which is on average five years.

 

(in thousands)        September 30,    
2018
         December 31,    
2017
 

Deferred contract costs(1)

   $                         50,799        $                         37,924    

  (1) Included in other long-term assets.

 

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

Amortization of deferred contract costs was as follows:

 

                 Three Months Ended        
September 30,
             Nine Months Ended        
September 30,
 
(in thousands)          2018                  2017                  2018                  2017        

Amortization of deferred contract costs(1)

   $             4,208       $             3,034       $             11,806       $             8,529   

  (1) Included in selling and marketing expenses.

6. GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill

The change in the carrying amount of goodwill was as follows:

 

(in thousands)               Nine Months Ended             
September 30,
 
  2018  

Balance as of January 1,

  $ 72,952   

Currency translation adjustments

    (55)  
 

 

 

 

Balance as of September 30,

  $ 72,897   
 

 

 

 

Intangibles

Intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives as follows:

 

          September 30, 2018  
(in thousands)           Useful Lives             Cost     Accumulated
Amortization
    Net Book Value(1)  

Client-related intangibles

    4-10 years      $                 63,136      $                 (49,633)      $                 13,503   

Technology

    3-10 years        58,942        (49,067)        9,875   

Other

    1-5 years        5,361        (5,361)        —   
   

 

 

   

 

 

   

 

 

 
    $               127,439      $               (104,061)      $                 23,378   
   

 

 

   

 

 

   

 

 

 

  (1) Included in other long-term assets.

 

          December 31, 2017  
(in thousands)           Useful Lives             Cost     Accumulated
Amortization
    Net Book Value(1)  

Client-related intangibles

    4-10 years      $                 63,164      $                 (44,835)      $                 18,329   

Technology

    3-10 years        58,942        (45,372)        13,570   

Other

    1-5 years        5,361        (5,361)        —   
   

 

 

   

 

 

   

 

 

 
    $               127,467      $                 (95,568)      $                 31,899   
   

 

 

   

 

 

   

 

 

 

  (1) Included in other long-term assets.

Amortization of intangible assets was as follows:

 

                 Three Months Ended             
September 30,
                 Nine Months Ended             
September 30,
 
(in thousands)    2018      2017      2018      2017  

Cost of revenue

   $                 1,232       $                 1,232       $                 3,695       $                 3,871   

Selling and marketing

     1,603         1,873         4,813         5,608   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,835       $ 3,105       $ 8,508       $ 9,479   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

7. ACCRUED EXPENSES

 

(in thousands)    September 30,
2018
     December 31,
2017
 

Outside professional services

   $ 11,638       $ 14,468   

Income and other taxes

     3,971         7,420   

Marketing and sales program expenses

     4,623         6,444   

Dividends payable

     2,365         2,344   

Employee-related expenses

     5,212         4,065   

Other

     12,020         10,767   
  

 

 

    

 

 

 
   $                     39,829       $                     45,508   
  

 

 

    

 

 

 

8. FAIR VALUE MEASUREMENTS

Assets and liabilities measured at fair value on a recurring basis

The Company records its cash equivalents, marketable securities, and investments in privately-held companies 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 on which there is 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 to minimize the use of unobservable inputs when determining fair value.

The Company’s cash equivalents are composed of money market funds and time deposits, which are classified within Level 1 and Level 2, respectively, in the fair value hierarchy. The Company’s marketable securities, which are classified within Level 2 of the fair value hierarchy are valued based on a market approach using quoted prices, when available, or matrix pricing compiled by third party pricing vendors, using observable market inputs such as interest rates, yield curves, and credit risk. The Company’s investments in privately-held companies are classified within Level 3 of the fair value hierarchy and are valued using model-based techniques, including option pricing models and discounted cash flow models.

If applicable, the Company will recognize transfers into and out of levels within the fair value hierarchy at the end of the reporting period in which the actual event or change in circumstance occurs. There were no transfers between levels during the nine months ended September 30, 2018.

The Company’s assets and liabilities measured at fair value on a recurring basis were as follows:

 

     September 30, 2018  
(in thousands)            Level 1                      Level 2                      Level 3                      Total          

Cash equivalents

   $                     10,212        $                     15,212        $                     —        $                     25,424    

Marketable securities:

           

Municipal bonds

   $ —        $ 46,366        $ —        $ 46,366    

Corporate bonds

     —          53,416          —          53,416    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total marketable securities

   $ —        $ 99,782        $ —        $ 99,782    

Investments in privately-held companies(1)

   $ —        $ —        $ 2,890        $ 2,890    

  (1) Included in other long-term assets.

 

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

     December 31, 2017  
(in thousands)            Level 1                      Level 2                      Level 3                      Total          

Cash equivalents

   $             2,720        $             40,051        $             —        $             42,771    

Marketable securities:

                  

Municipal bonds

   $ —        $ 32,848        $ —        $ 32,848    

Corporate bonds

     —          28,621          —          28,621    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total marketable securities

   $ —        $ 61,469        $ —        $ 61,469    

Investments in privately-held companies(1)

   $ —        $ —        $ 1,030        $ 1,030    

  (1) Included in other long-term assets.

For certain other financial instruments, including accounts receivable and accounts payable, the carrying value approximates fair value due to the relatively short maturity of these items.

Assets measured at fair value on a nonrecurring basis

Assets recorded at fair value on a nonrecurring basis, including property and equipment and intangible assets, are recognized at fair value when they are impaired. During the nine months ended September 30, 2018 and 2017, the Company did not recognize any impairments of its assets recorded at fair value on a nonrecurring basis.

9. REVENUE

Revenue policy

The Company’s revenue is primarily derived from:

 

   

Software license revenue is primarily derived from sales of the Company’s Pega Platform and software applications.

 

   

Maintenance revenue includes revenue from client support including software upgrades on a when and-if available basis, telephone support, and bug fixes or patches.

 

   

Services revenue is primarily derived from cloud revenue, which is sales of the Company’s hosted Pega Platform and software applications, and consulting revenue, which is primarily related to new license implementations.

Contracts with multiple performance obligations

The Company’s license and cloud arrangements often contain multiple performance obligations. For contracts with multiple performance obligations, the Company accounts for individual performance obligations separately if they are distinct. The transaction price is allocated to the separate performance obligations on a relative stand-alone selling price basis. If the transaction price contains discounts or the Company expects to provide a future price concession, these elements are considered when determining the transaction price prior to allocation. Variable fees within the transaction price are estimated and recognized in revenue as the Company satisfies each performance obligation to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable fee is resolved. If the contract grants the client the option to acquire additional products or services, the Company assesses whether any discount on the included products and services is in excess of levels normally available to similar clients and, if so, accounts for that discount as an additional performance obligation.

Software licenses

The Company has concluded that its software licenses are distinct performance obligations, as the client can benefit from the software on its own. Software license revenue is typically recognized at a point in time when control is transferred to the client, which is defined as the point in time when the client can use and benefit from the license. The software license is delivered before related services are provided and is functional without services, updates, and technical support.

Stand-alone selling price for software licenses is determined using the residual approach. The Company utilizes the residual approach as license performance obligations are sold for a broad range of amounts (the selling price is highly variable) and a stand-alone selling price is not discernible from past transactions or other observable evidence. Periodically, the Company reevaluates whether the residual approach is appropriate for its license performance obligations when sold with other performance obligations. If the standalone selling price analysis illustrates that software license performance obligations are no longer highly variable, the Company will utilize the relative allocation method for such arrangements.

 

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

Term license fees are usually payable in advance on a monthly, quarterly, or annual basis over the term of the license agreement, which is typically three to five years and may be renewed for additional terms at the client’s option. Perpetual license fees are usually payable when the contract is executed.

Maintenance

Maintenance contracts entitle clients to receive technical support and software updates, on a when and if available basis, during the term of the maintenance contract. Technical support and software updates are considered distinct services but accounted for as a single performance obligation, as they each constitute a series of distinct services that are substantially the same and have the same pattern of transfer to the client. Maintenance revenue is recognized over time on a straight-line basis over the contract period.

The maintenance performance obligation is priced as a percentage of the selling price of the related software license, which is highly variable. The Company determined the standalone selling price based on this pricing relationship, which has remained constant within a narrow range, and observable data from standalone sales of maintenance, along with all other observable data.

Maintenance fees are usually payable in advance on a monthly, quarterly, or annual basis over the term of the agreement.

Services

Services revenue is comprised of consulting, including software license implementations, training, reimbursable expenses, and cloud, which is derived from sales of the Company’s hosted Pega Platform and software application environments. The Company has concluded that most services are distinct performance obligations. Consulting may be provided on a stand-alone basis or bundled with other performance obligations.

 

   

The stand-alone selling price for time and materials consulting is determined by observable prices in similar transactions without multiple performance obligations and recognized as revenue as the services are performed. Fees for time and materials consulting contracts are usually payable shortly after the service is provided.

 

   

The stand-alone selling price for fixed price consulting is based on the estimated hours versus actual hours in similar geographies and for similar contract sizes. Revenue for fixed price consulting is recognized over time as the services are provided. Fees for fixed price consulting are usually payable as contract milestones are achieved.

 

   

The stand-alone selling price of cloud sales of production environments is determined based on the residual approach when sold with other performance obligations and is recognized over the term of the service. The Company utilizes the residual approach as cloud performance obligations are sold for a broad range of amounts (the selling price is highly variable) and a stand-alone selling price is not discernible from past transactions or other observable evidence. Cloud fees for production environments are usually payable in advance on a monthly, quarterly, or annual basis over the term of the service.

 

   

The stand-alone selling price for cloud sales of development and testing environments is developed using observable prices in similar transactions without multiple performance obligations and is recognized over the term of the service. Cloud fees for development and testing environments are usually payable in advance on a monthly, quarterly, or annual basis over the term of the service.

Contract modifications

The Company enters into amendments to previously executed contracts which constitute contract modifications. The Company assesses each of these contract modifications to determine:

 

  1.

if the additional products and services are distinct from the products and services in the original arrangement, and

 

  2.

if the amount of consideration expected for the added products and services reflects the stand-alone selling price of those products and services.

A contract modification meeting both criteria is accounted for as a separate contract. A contract modification not meeting both criteria is considered a change to the original contract and is accounted for on either:

 

  1.

a prospective basis as a termination of the existing contract and the creation of a new contract; or

 

  2.

a cumulative catch-up basis.

 

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

Geographic revenue

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
(Dollars in thousands)    2018      2017      2018      2017  

U.S.

   $ 103,075        51%      $ 105,059        55%      $ 327,409        51%      $ 376,819        59%  

Other Americas

     10,424        5%        9,307        5%        37,766        6%        32,890        5%  

United Kingdom (“U.K.”)

     19,277        9%        18,537        10%        68,450        11%        67,403        11%  

Europe (excluding U.K.), Middle East, and Africa

     42,254        21%        31,109        16%        101,150        16%        81,557        13%  

Asia-Pacific

     28,233        14%        26,945        14%        100,449        16%        75,193        12%  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $       203,263              100%      $       190,957                100%      $       635,224              100%      $         633,862              100%  
  

 

 

    

 

 

    

 

 

    

 

 

 

Revenue streams

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
(in thousands)                2018                              2017                              2018                              2017              

Perpetual license

   $         20,276       $         12,623       $         56,829       $         81,819   

Term license

     32,066         40,611         128,070         149,573   
  

 

 

    

 

 

    

 

 

    

 

 

 

Revenue recognized at a point in time

     52,342         53,234         184,899         231,392   

Maintenance

     66,017         61,812         196,448         179,949   

Cloud

     22,184         13,280         57,967         36,207   

Consulting

     62,720         62,631         195,910         186,314   
  

 

 

    

 

 

    

 

 

    

 

 

 

Revenue recognized over time

     150,921         137,723         450,325         402,470   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 203,263       $ 190,957       $ 635,224       $ 633,862   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
(in thousands)                2018                              2017                              2018                              2017          

Term license

   $         32,066       $         40,611       $         128,070       $         149,573   

Cloud

     22,184         13,280         57,967         36,207   

Maintenance

     66,017         61,812         196,448         179,949   
  

 

 

    

 

 

    

 

 

    

 

 

 

Subscription(1)

     120,267         115,703         382,485         365,729   

Perpetual license

     20,276         12,623         56,829         81,819   

Consulting

     62,720         62,631         195,910         186,314   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 203,263       $ 190,957       $ 635,224       $ 633,862   
  

 

 

    

 

 

    

 

 

    

 

 

 

  (1) Subscription revenue reflects client arrangements (term license, cloud, and maintenance) which may be subject to a renewal.

During the nine months ended September 30, 2018 and 2017, there were no material changes in the Company’s estimate of variable fees.

Remaining performance obligations (formerly reported as “committed not yet recognized revenue”)

Revenue for the remaining performance obligations on existing contracts is expected to be recognized in the future as follows:

 

     September 30, 2018  
(Dollars in thousands)    Perpetual license      Term license      Maintenance      Cloud      Consulting      Total  

1 year or less

   $ 25,343       $ 44,283       $ 140,591       $ 88,529       $ 14,107       $ 312,853                     60%   

1-2 years

     6,490         10,063         8,877         70,815         1,830         98,075         19%   

2-3 years

     360         1,598         2,586         54,646         449         59,639         11%   

Greater than 3 years

     1,306         218         1,079         49,110         50         51,763         10%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $         33,499       $         56,162       $         153,133       $         263,100       $         16,436       $         522,330         100%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

Major clients

Clients accounting for 10% or more of the Company’s total revenue were as follows:

 

                 Three Months Ended             
September 30,
                 Nine Months Ended             
September 30,
 
(in thousands)    2018      2017      2018      2017  

Total revenue

   $           203,263         $           190,957         $ 635,224      $ 633,862  

Client A

     10%        10%        *        *  

  *Client accounted for less than 10% of total revenue.

10. STOCK-BASED COMPENSATION

Expense

 

                     Three Months Ended                 
September 30,
                     Nine Months Ended                 
September 30,
 
(in thousands)    2018      2017      2018      2017  

Cost of revenues

   $ 4,319        $ 3,613        $ 12,277        $ 10,913    

Selling and marketing

     6,198          3,976          16,895          11,482    

Research and development

     3,917          3,420          11,356          10,306    

General and administrative

     1,974          2,480          7,045          7,228    
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 16,408        $ 13,489        $ 47,573        $ 39,929    
  

 

 

    

 

 

    

 

 

    

 

 

 

Income tax benefit

   $           (3,555)       $           (4,129)       $           (10,037)       $           (12,231)   

The Company recognizes stock-based compensation using the accelerated recognition method, treating each vesting tranche as if it were an individual grant. As of September 30, 2018, the Company had, net of estimated forfeitures, $74.2 million of unrecognized stock-based compensation expense, related to all unvested restricted stock units (“RSUs”) and stock options, which was expected to be recognized over a weighted-average period of 2.2 years.

Grants

The Company granted the following stock-based compensation awards:

 

                 Nine Months Ended             
September 30,
 
(in thousands)            Shares                     Total Fair Value          

RSUs(1)

     1,117      $ 65,569   

Non-qualified stock options

     1,623      $ 29,372   

 

(1) 

Includes approximately 0.1 million RSUs which were granted in connection with the election by certain employees to receive 50% of their 2018 target incentive compensation under the Company’s Corporate Incentive Compensation Plan in the form of RSUs instead of cash. Stock-based compensation of approximately $8.2 million associated with this RSU grant is expected to be recognized over a one-year period beginning on the grant date.

RSU vestings and stock option exercises

During the nine months ended September 30, 2018, 1.2 million shares of common stock were issued due to stock option exercises and RSU vestings under the Company’s stock-based compensation plans.

11. INCOME TAXES

Effective income tax rate

 

     Nine Months Ended
September 30,
 
(Dollars in thousands)            2018                     2017          

Benefit from income taxes

   $ (23,692   $ (9,009

Effective income tax rate

     80     (18 )% 

 

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

During the nine months ended September 30, 2018, the Company’s effective income tax rate changed primarily due to the following factors:

 

   

excess tax benefits from stock-based compensation were disproportionately greater than the (loss) income before benefit from income taxes;

 

   

a decrease in the estimated annual effective income tax rate primarily due to the reduction of the U.S. statutory federal tax rate from 35% to 21% pursuant to the Tax Reform Act;

 

   

an increase in utilization of U.S. research and development tax credits; and

 

   

a decrease in uncertain tax provisions as a result of the settlement of a foreign tax audit for 2012 through 2015.

Tax reform act

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“Tax Reform Act”) was enacted into law, which significantly changed U.S. tax law and included many provisions, such as a reduction of the U.S. federal statutory tax rate, a one-time transition tax on deemed repatriation of deferred foreign earnings, and a provision to tax global intangible low-taxed income (“GILTI”) of foreign subsidiaries, a special tax deduction for foreign derived intangible income, and a base erosion anti-abuse tax measure (“BEAT”) that may tax payments between a U.S. corporation and its foreign subsidiaries, among other tax changes.

In the three months ended December 31, 2017, the Company recognized, under SEC Staff Accounting Bulletin No. 118 (“SAB 118”), provisional income taxes, including $20.4 million of income tax expense to re-measure its net deferred tax assets to the 21% enacted rate. Also, during the same period, the Company reduced its provisional income taxes by a $12.6 million income tax benefit as a result of the remeasurement of its net deferred tax liabilities under the retrospective adoption of ASC 606.

The final income tax amounts may differ from those provisional amounts, possibly materially, due to, among other things, additional analysis, changes in interpretations and assumptions by the Company, additional regulatory guidance that may be issued, and actions the Company may take as a result of the Tax Reform Act.

The Tax Reform Act also provided for a one-time deemed mandatory repatriation of post-1986 undistributed foreign subsidiary earnings and profits through December 31, 2017. However, based on the Company’s provisional analysis performed as of that date, the Company does not expect to be subject to the one-time transition tax due to the Company’s foreign subsidiaries being in a net accumulated deficit position. During the nine months ended September 30, 2018, the Company recognized no material adjustments to these estimates.

The Tax Reform Act provides the following new anti-abuse provisions beginning in 2018:

 

   

The GILTI provisions require the Company to include in its U.S. income tax base foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary’s tangible assets. The Company expects that it will be subject to incremental U.S. tax resulting from GILTI inclusions beginning in 2018. As of September 30, 2018, the Company has included an estimate of the effect of its GILTI provisions in its estimated annual effective tax rate. The Company continues to monitor IRS guidance and will update its estimates as guidance is issued.

 

   

The BEAT provisions in the Tax Reform Act impose an alternative minimum tax on taxpayers with substantial base-erosion payments. The Company’s preliminary assessment is that the Company will not be subject to the BEAT in 2018. The Company continues to monitor IRS guidance and will update its estimates as guidance is issued.

12. EARNINGS PER SHARE

Basic earnings per share is computed using the weighted-average number of common shares outstanding during the applicable period. Diluted earnings per share is computed using the weighted-average number of common shares outstanding during the applicable period, plus the dilutive effect of outstanding stock options and RSUs, using the treasury stock method. In periods of loss, all stock options and RSUs are excluded, as their inclusion would be anti-dilutive.

 

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

The calculation of the basic and diluted earnings per share is as follows:

 

               Three Months Ended          
September 30,
               Nine Months Ended          
September 30,
 
(in thousands, except per share amounts)    2018      2017      2018      2017  

Basic

           

Net (loss) income

   $             (7,587)      $             1,288       $             (5,796)      $             57,953   

Weighted-average common shares outstanding

                 78,700                     77,691                     78,525         77,258   
  

 

 

    

 

 

    

 

 

    

 

 

 

(Loss) earnings per share, basic

   $ (0.10)      $ 0.01       $ (0.07)      $ 0.75   
  

 

 

    

 

 

    

 

 

    

 

 

 
           

Diluted

           

Net (loss) income

   $ (7,587)      $ 1,288       $ (5,796)      $ 57,953   

Weighted-average effect of dilutive securities:

           

Stock options

     —         3,681         —         3,519   

RSUs

     —         1,951         —         1,940   
  

 

 

    

 

 

    

 

 

    

 

 

 

Effect of dilutive securities

     —         5,632         —         5,459   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted-average common shares outstanding, assuming dilution

     78,700         83,323         78,525         82,717   
  

 

 

    

 

 

    

 

 

    

 

 

 

(Loss) earnings per share, diluted

   $ (0.10)      $ 0.01       $ (0.07)      $ 0.70   
  

 

 

    

 

 

    

 

 

    

 

 

 
           

Outstanding anti-dilutive stock options and RSUs(1)

     6,119         105         6,380         219   

 

(1) 

Certain outstanding stock options and RSUs were excluded from the computation of diluted earnings per share because they were anti-dilutive in the period presented. These awards may be dilutive in the future.

 

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ITEM 2.             MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains or incorporates forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, statements about our future financial performance and business plans, the adequacy of our liquidity and capital resources, the continued payment of quarterly dividends, and the timing of revenue recognition are described more completely in Part I of our Annual Report on Form 10-K for the year ended December 31, 2017.

These forward-looking statements are based on current expectations, estimates, forecasts, and projections about the industry and markets in which we operate, and management’s beliefs and assumptions. In addition, other written or oral statements that constitute forward-looking statements may be made by us or on our behalf. Words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “could,” “estimate,” “may,” “target,” “strategy,” “is intended to,” “project,” “guidance,” “likely,” “usually,” or variations of such words and similar expressions are intended to identify such forward-looking statements.

These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict. Important factors that could cause actual future activities and results to differ materially from those expressed in such forward-looking statements include, among others, variation in demand for our products and services; reliance on third party relationships; our beliefs and the timing of the completion of our analysis regarding the impact of the Tax Cuts and Jobs Act of 2017, including its impact on income tax expense and deferred tax assets; the inherent risks associated with international operations and the continued uncertainties in the global economy; our continued effort to market and sell both domestically and internationally; foreign currency exchange rates; the financial impact of any future acquisitions; the potential legal and financial liabilities and reputation damage due to cyber-attacks and security breaches; and management of our growth. These risks and other factors that could cause actual results to differ materially from those expressed in such forward-looking statements are described more completely in Part I of our Annual Report on Form 10-K for the year ended December 31, 2017 as well as 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 contained 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 specifically disclaim any obligation to publicly update or revise these forward-looking statements whether as the result of new information, future events, or otherwise.

BUSINESS OVERVIEW

We develop, market, license, and support software applications for customer engagement and digital process automation, in addition to licensing our Pega Platform application development product for clients that wish to build and extend their own applications. The Pega Platform and applications help connect enterprises to their customers in real-time across channels, streamline business operations, and adapt to meet changing requirements.

Our clients include Global 3000 companies and government agencies that seek to manage complex enterprise systems and customer service issues with greater agility and cost-effectiveness. Our strategy is to sell a client a series of licenses, each focused on a specific purpose or area of operations in support of longer term enterprise-wide digital transformation initiatives.

Performance metrics

 

(Dollars in thousands, except per share amounts)    Three Months Ended
September 30,
                   Nine Months Ended
September 30,
               
   2018      2017      Change      2018      2017      Change  

Total revenue

   $     203,263       $     190,957       $     12,306         6%      $     635,224       $     633,862       $ 1,362         —%  

Subscription(1)

   $ 120,267       $ 115,703       $ 4,564         4%      $ 382,485       $ 365,729       $ 16,756         5%  

Net (loss) income

   $ (7,587)      $ 1,288       $ (8,875)        *      $ (5,796)      $ 57,953       $     (63,749)        *  

Diluted (loss) earnings per share

   $ (0.10)      $ 0.01       $ (0.11)        *      $ (0.07)      $ 0.70       $ (0.77)        *  

* not meaningful

(1) 

Subscription revenue reflects client arrangements (term license, cloud, and maintenance) which may be subject to a renewal.

 

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Annual Contract Value (“ACV”)(1)

The change in ACV measures the growth and predictability of future cash flows from committed term, cloud, and maintenance arrangements as of the end of the particular reporting period.

 

LOGO

 

     September 30,                
(Dollars in thousands)    2018      2017      Change  

Term and cloud ACV

   $         272,693       $         200,180       $         72,513                 36%  

Maintenance ACV

     264,068         247,248         16,820         7%  
  

 

 

    

 

 

       

Total ACV

   $ 536,761       $ 447,428       $ 89,333         20%  
  

 

 

    

 

 

       

 

  (1) 

ACV, as of a given date, is the sum of the following two components:

 

   

the sum of the annual value of each term and cloud contract in effect on such date, with the annual value of a term or cloud contract being equal to the total value of the contract divided by the total number of years of the contract.

 

   

maintenance revenue reported for the quarter ended on such date, multiplied by four.

Remaining performance obligations (formerly reported as “committed not yet recognized revenue”)

Revenue for the remaining performance obligations on existing contracts is expected to be recognized as follows:

 

     September 30, 2018  
(Dollars in thousands)    Perpetual license      Term license      Maintenance      Cloud      Consulting      Total  

1 year or less

   $         25,343       $ 44,283       $ 140,591       $ 88,529       $ 14,107       $ 312,853                     60%   

1-2 years

     6,490         10,063         8,877         70,815         1,830         98,075         19%   

2-3 years

     360         1,598         2,586         54,646         449         59,639         11%   

Greater than 3 years

     1,306         218         1,079         49,110         50         51,763         10%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 33,499       $         56,162       $         153,133       $         263,100       $         16,436       $         522,330         100%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

CRITICAL ACCOUNTING POLICES

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 in accordance with accounting principles generally accepted in the United States and the rules and regulations of the SEC for interim financial reporting. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and 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 given available information.

 

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For more information regarding our critical accounting policies, we encourage you to read the discussion contained in the following locations:

 

   

“Critical Accounting Estimates and Significant Judgments” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 2. “Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary Data” both of which are contained in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

   

Note 2. “New Accounting Pronouncements”, Note 4. “Receivables, Contract Assets, and Deferred Revenue”, and Note 9. “Revenue” contained in Item 1. “Unaudited Condensed Consolidated Financial Statements” of this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2018.

Except as described below, there have been no significant changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017.

Revenue

We account for revenue in accordance with ASC 606. Our revenue recognition policies require us to make significant judgments and estimates.

Our clients’ contracts with us typically contain promises by us to provide multiple products and services. Judgment is required to determine whether each product and service is considered to be a distinct performance obligation that should be accounted for separately under the contract. We allocate the transaction price to the distinct performance obligations based on relative stand-alone selling price. We estimate stand-alone selling price based on the prices charged to clients, or by using information such as market conditions and other observable inputs. However, the selling price of our software licenses and cloud performance obligations are highly variable. Thus, we estimate stand-alone selling price for software licenses and cloud performance obligations using the residual approach, determined based on total transaction price minus the stand-alone selling price of other performance obligations promised in the contract.

In applying our revenue recognition policy, we must determine which portions of our revenue are recognized in the current period and which portions must be deferred and recognized in future periods. We analyze various factors including, but not limited to, the selling price of undelivered services when sold on a stand-alone basis, our pricing policies, and contractual terms and conditions to help us make such judgments about revenue recognition. Changes in judgment on any of these factors could materially impact the timing and amount of revenue recognized in a given period.

RESULTS OF OPERATIONS

 

     Three Months Ended
September 30,
                   Nine Months Ended
September 30,
               
(Dollars in thousands)    2018      2017      Change      2018      2017      Change  

Total revenue

   $     203,263       $     190,957       $ 12,306         6 %      $ 635,224       $     633,862       $ 1,362         — %  

Gross profit

   $ 128,840       $ 121,226       $ 7,614         6 %      $ 411,370       $ 428,166       $ (16,796)        (4)%  

(Loss) income from operations

   $ (17,258)      $ (2,301)      $     (14,957)        650 %      $     (32,485)      $ 54,659       $ (87,144)        *  

Net (loss) income

   $ (7,587)      $ 1,288       $ (8,875)        *      $ (5,796)      $ 57,953       $     (63,749)        *  

* not meaningful

Revenue

 

    Three Months Ended
September 30,
                Nine Months Ended
September 30,
             
(Dollars in thousands)   2018     2017     Change     2018     2017     Change  

Term license

  $ 32,066       16%     $ 40,611       21%     $     (8,545)       (21)%     $ 128,070       20%     $ 149,573       24%     $ (21,503)       (14)%  

Cloud

    22,184       11%       13,280       7%       8,904       67 %       57,967       9%       36,207       6%       21,760        60 %  

Maintenance

    66,017       32%       61,812       33%       4,205       7 %       196,448       31%       179,949       28%       16,499        9 %  
 

 

 

   

 

 

       

 

 

   

 

 

     

Subscription(1)

    120,267       59%       115,703       61%       4,564       4 %       382,485       60%       365,729       58%       16,756        5 %  

Perpetual license

    20,276       10%       12,623       7%       7,653       61 %       56,829       9%       81,819       13%       (24,990)       (31)%  

Consulting

    62,720       31%       62,631       32%       89       — %       195,910       31%       186,314       29%       9,596        5 %  
 

 

 

   

 

 

       

 

 

   

 

 

     

Total revenue

  $     203,263       100%     $     190,957       100%     $ 12,306       6 %     $     635,224       100%     $     633,862       100%     $     1,362        — %  
 

 

 

   

 

 

       

 

 

   

 

 

     

 

(1) 

Subscription revenue reflects client arrangements (term license, cloud, and maintenance) which may be subject to a renewal.

Our license revenue is primarily derived from sales of our applications and Pega Platform. Our cloud revenue is derived from our hosted Pega Platform and software applications. Our consulting revenue is primarily related to new license implementations.

 

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We expect our revenue mix to continue to shift in favor of our subscription offerings, particularly cloud arrangements, which could result in slower total revenue growth in the near term. Revenue from cloud arrangements is generally recognized over time throughout the service period, while revenue from license arrangements is generally recognized upfront when the license rights become effective.

Subscription revenue

The decrease in term license revenue in the three months ended September 30, 2018 was primarily due to $17 million of revenue recognized in the three months ended September 30, 2017 from a large term license renewal. The decrease in term license revenue in the nine months ended September 30, 2018 was primarily due to $35.3 million of revenue recognized in the three months ended March 31, 2017 from a large term license renewal.

The increases in cloud revenue in the three and nine months ended September 30, 2018 reflect the shift in client preferences to cloud arrangements from other types of arrangements.

The increases in maintenance revenue were primarily due to the continued growth in the aggregate value of the installed base of our software and strong renewal rates in excess of 90%.

Perpetual license

The increase in perpetual license revenue in the three months ended September 30, 2018 was primarily due to revenue recognized from license rights which became effective in the current period from perpetual arrangements executed in prior periods, primarily the three months ended June 30, 2018. The decrease in perpetual license revenue in the nine months ended September 30, 2018 reflects the shift in client preferences away from perpetual license arrangements.

Consulting

Our consulting revenue fluctuates depending upon the mix of new implementation projects we perform as compared to those performed by our enabled clients or led by our partners.

The increase in consulting revenue in the nine months ended September 30, 2018 was primarily due to higher billable hours driven by an increase in the number of projects performed.

Gross profit

 

    Three Months Ended
September 30,
                Nine Months Ended
September 30,
             
(Dollars in thousands)   2018     2017     Change     2018     2017     Change  

Software license

  $ 51,087       98%     $ 51,958       98%     $ (871     (2)%     $   181,127       98%     $   227,566       98%     $   (46,439)       (20)%  

Maintenance

    59,938       91%       55,096       89%       4,842       9 %       178,413       91%       159,004       88%       19,409        12 %  

Cloud

    12,569       57%       7,269       55%       5,300       73 %       31,853       55%       18,938       52%       12,915        68 %  

Consulting

    5,246       8%       6,903       11%         (1,657     (24)%       19,977       10%       22,658       12%       (2,681)       (12)%  
 

 

 

   

 

 

       

 

 

   

 

 

     

Total gross profit

  $   128,840       63%     $   121,226       63%     $ 7,614       6 %     $ 411,370       65%     $ 428,166       68%     $ (16,796)       (4)%  
 

 

 

   

 

 

       

 

 

   

 

 

     

The increase in total gross profit in the three months ended September 30, 2018 was primarily due to an increase in maintenance revenue, due to growth in the aggregate value of the installed base of our software, and an increase in cloud revenue, due to a shift in client preferences to cloud arrangements from other types of arrangements.

The decrease in total gross profit in the nine months ended September 30, 2018 was primarily due to $35.3 million of revenue recognized in the three months ended March 31, 2017 from a large term license renewal and the decrease in perpetual license revenue reflecting the shift in client preferences toward our cloud offerings, partially offset by the margin growth in our maintenance and cloud revenue streams. The current shift in our revenue mix toward cloud arrangements may result in slower total gross profit growth in the near term as our cloud business continues to grow and scale.

Maintenance and cloud gross profit percent

The increases in maintenance gross profit percent in the three and nine months ended September 30, 2018 were driven by decreases of $0.3 million and $1.5 million in compensation and benefits due to decreased headcount and a decrease in client support expenses as we transferred resources to provide dedicated support to our growing cloud business.

The increases in cloud gross profit percent in the three and nine months ended September 30, 2018 were primarily due to continued growth and scale in our cloud business, partially offset by an increase in client support expenses as we expanded our cloud client support function to sustain our growing cloud business.

 

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Consulting gross profit percent

The decreases in consulting gross profit percent in the three and nine months ended September 30, 2018 were driven primarily by increases in compensation and benefits, lower utilization rates, and the impact of our policy introduced late in the three months ended June 30, 2017 to offer our web-based training free of charge to users which reduced training revenue for the three and nine months ended September 30, 2018.

Operating expenses

Selling and marketing

 

     Three Months Ended
September 30,
                   Nine Months Ended
September 30,
               
(Dollars in thousands)            2018                      2017                      Change                      2018                      2017                      Change          

Selling and marketing

   $     87,490         $     69,363         $     18,127        26%      $     269,845         $     214,244         $     55,601        26%  

As a percent of total revenue

     43%        36%              42%        34%        

Selling and marketing headcount, end of period

                 1,194           934           260        28%  

Includes compensation, benefits, and other headcount-related expenses associated with our selling and marketing personnel as well as advertising, promotions, trade shows, seminars, and the amortization of client-related intangibles.

The increases in the three and nine months ended September 30, 2018 were primarily due to increases in compensation and benefits of $15.2 million and $40.6 million, as a result of increased headcount, increased deferred contract commission costs amortization of $1.2 million and $3.3 million, and an increase in marketing programs in the nine months ended September 30, 2018 of $3.1 million. The increase in headcount reflects our efforts to increase our sales capacity to deepen relationships with existing clients and target new accounts.

Research and development

 

     Three Months Ended
September 30,
                   Nine Months Ended
September 30,
               
(Dollars in thousands)            2018                      2017                      Change                      2018                      2017                      Change          

Research and development

   $     46,504         $     41,031         $     5,473        13%      $     135,261         $     121,089         $     14,172        12%  

As a percent of total revenue

     23%        21%              21%        19%        

Research and development headcount, end of period

                 1,595           1,474           121        8%  

Includes compensation, benefits, contracted services, and other headcount-related expenses associated with the creation and development of our products, as well as enhancements and design changes to existing products and the integration of acquired technologies.

The increases in the three and nine months ended September 30, 2018 were primarily due to increases in compensation and benefits of $4 million and $9.5 million, attributable to increased headcount and the expansion of our application development team to support the continued development of our expanding suite of software.

General and administrative

 

     Three Months Ended
September 30,
                   Nine Months Ended
September 30,
               
(Dollars in thousands)            2018                      2017                      Change                      2018                      2017                      Change          

General and administrative

   $ 12,104         $ 13,133         $ (1,029)        (8)%      $ 38,749         $ 38,174         $ 575         2 %  

As a percent of total revenue

     6%        7%              6%        6%        

General and administrative headcount,

end of period

                 326            407           (81)        (20)%  

Includes compensation, benefits, and other headcount-related expenses associated with finance, legal, corporate governance, and other administrative headcount. They also include accounting, legal, and other professional consulting and administrative fees. The general and administrative headcount includes employees in information technology and corporate services departments, whose costs are partially allocated to other operating expense areas.

The decrease in the three months ended September 30, 2018 was primarily due to a decrease in compensation and benefits of $1.2 million due to decreased headcount, reflecting the realignment of contract negotiation and product development resources to augment our selling and marketing and research and development functions.

 

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The increase in the nine months ended September 30, 2018 was primarily due to an increase of $2.1 million in legal and tax fees partially offset by a decrease of $1.7 million in compensation and benefits, due to decreased headcount reflecting the realignment of contract negotiation and product development resources to augment our selling and marketing and research and development functions.

Stock-based compensation

 

     Three Months Ended
September 30,
                   Nine Months Ended
September 30,
               
(Dollars in thousands)    2018      2017      Change      2018      2017      Change  

Cost of revenues

   $ 4,319       $ 3,613       $ 706                 20 %      $ 12,277       $ 10,913       $         1,364                 12 %  

Selling and marketing

     6,198         3,976         2,222         56 %        16,895         11,482         5,413         47 %  

Research and development

     3,917         3,420         497         15 %        11,356         10,306         1,050         10 %  

General and administrative

     1,974         2,480         (506)        (20)%        7,045         7,228         (183)        (3)%  
  

 

 

    

 

 

          

 

 

    

 

 

       
   $ 16,408       $ 13,489       $         2,919         22 %      $ 47,573       $ 39,929       $ 7,644         19 %  
  

 

 

    

 

 

          

 

 

    

 

 

       

Income tax benefit

   $         (3,555)      $         (4,129)      $ 574         (14)%      $         (10,037)      $         (12,231)      $ 2,194         (18)%  

The increase in the three and nine months ended September 30, 2018 was primarily due to the increased value of our annual periodic equity awards granted in March 2018 and 2017. These awards generally have a five-year vesting schedule.

Non-operating income (expense), net

 

     Three Months Ended
September 30,
                   Nine Months Ended
September 30,
               
(Dollars in thousands)    2018      2017      Change      2018      2017      Change  

Foreign currency transaction gain (loss)

   $ 399       $         (5,052)      $         5,451        *      $ 558       $ (6,549)      $         7,107        *  

Interest income, net

     683         140         543            388 %        2,076         547         1,529            280 %  

Other income, net

     —         —                — %        363         287         76        26 %  
  

 

 

    

 

 

          

 

 

    

 

 

       
   $         1,082       $ (4,912)      $ 5,994        *      $         2,997       $         (5,715)      $ 8,712        *  
  

 

 

    

 

 

          

 

 

    

 

 

       

* not meaningful

The change in foreign currency transaction gain (loss) was primarily due to unrealized gains on foreign currency denominated cash and receivables.

The change in interest income, net was primarily due to an increase in prevailing interest rates and an increase in the size of our holdings in marketable securities.

Benefit from income taxes

 

     Three Months Ended
September 30,
                   Nine Months Ended
September 30,
               
(Dollars in thousands)    2018      2017      Change      2018      2017      Change  

Benefit from income taxes

   $          (8,589)      $         (8,501)      $         (88)        1%      $         (23,692)          $         (9,009)          $         (14,683)                163%  

Effective income tax rate

                 80%        (18)%        

During the nine months ended September 30, 2018, our effective income tax rate changed primarily due to the following factors:

 

   

excess tax benefits from stock-based compensation for the nine months ended September 30, 2018 and 2017 of $15.1 million and $22.4 million were disproportionately greater than (loss) income before benefit from income taxes;

 

   

a decrease in the estimated annual effective income tax rate primarily due to the reduction of the U.S. statutory federal tax rate from 35% to 21% pursuant to the Tax Reform Act;

 

   

an increase in utilization of U.S. research and development tax credits; and

 

   

a decrease in uncertain tax provisions as a result of the settlement of a foreign tax audit for 2012 through 2015.

The inclusion of excess tax benefits from stock-based compensation in the provision for income taxes has increased the variability of the effective tax rates in recent periods. This fluctuation may continue in future periods, as the amount of excess tax benefits from stock-based compensation awards varies depending on our future stock price in relation to the fair value of awards, the timing of RSU vestings, exercise behavior of our stock option holders, and the total value of future grants of stock-based compensation awards.

 

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LIQUIDITY AND CAPITAL RESOURCES

 

     Nine Months Ended
September 30,
 
(in thousands)    2018      2017  

Cash provided by (used in):

     

Operating activities

   $                 67,088       $                 113,926   

Investing activities

     (49,595)        (11,966)  

Financing activities

     (71,664)        (44,040)  

Effect of exchange rates on cash and cash equivalents

     (1,913)        2,054   
  

 

 

    

 

 

 

Net (decrease) increase in cash and cash equivalents

   $ (56,084)      $ 59,974   
  

 

 

    

 

 

 
(in thousands)    September 30,
2018
     December 31,
2017
 

Held by U.S. entities

   $ 134,634       $ 136,444   

Held by foreign entities

     71,343         87,304   
  

 

 

    

 

 

 

Total cash, cash equivalents, and marketable securities

   $ 205,977       $ 223,748   
  

 

 

    

 

 

 

We believe that our current cash, cash equivalents, marketable securities, and cash flow from operations will be sufficient to fund our operations, quarterly cash dividends, and stock repurchases for at least the next 12 months.

If it became necessary to repatriate foreign funds, we may be required to pay U.S. state and local taxes, as well as foreign taxes, upon repatriation. Due to the complexity of income tax laws and regulations, and the effects of the Tax Reform Act, it is impracticable to estimate the amount of taxes we would have to pay.

Cash provided by operating activities

As client preferences continue to shift in favor of cloud arrangements, we could experience slower operating cash flow growth in the near term. Cash from cloud arrangements is generally collected throughout the service period, while cash from perpetual license arrangements is generally collected upfront, shortly after the license rights become effective.

The primary driver during the nine months ended September 30, 2018 was $57.6 million in cash generated from receivables and contract assets, largely due to cash collections and the timing of billings.

The primary driver during the nine months ended September 30, 2017 was net income of $58 million and $36.8 million in cash generated from receivables and contract assets, largely due to cash collections and the timing of billings.

Cash used in investing activities

Cash used in investing activities is primarily driven by the timing of investment maturities and purchases of new investments.

Cash used in financing activities

We used cash primarily for repurchases of our common stock under our publicly announced stock repurchase programs, stock repurchases for tax withholdings for the net settlement of our equity awards, and the payment of our quarterly dividend.

Stock repurchase program(1)

Remaining authority under existing programs is as follows:

 

                           
     Nine Months Ended
September  30,
 
(in thousands)    2018  

January 1

   $ 34,892  

Authorizations

     27,003  

Repurchases

     (30,149
  

 

 

 

September 30,

   $                 31,746  
  

 

 

 

 

 

  (1) 

Purchases under these programs have been made on the open market.

 

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Common stock repurchases

 

                                                                                                               
     Nine Months Ended
September 30,
 
     2018      2017  
    (in thousands)    Shares      Amount      Shares      Amount  

Tax withholdings for net settlement of equity awards

     591        $ 35,530          682        $ 34,791    

    Stock repurchase program(1)

           

    Repurchases paid

     512          29,949          68          2,986    

    Repurchases unsettled at period end

     3          200          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

 

    Activity in period(2)

     1,106        $ 65,679          750        $ 37,777    
  

 

 

    

 

 

    

 

 

    

 

 

 

 

  (1) 

Represents activity under our publicly announced stock repurchase programs.

  (2) 

During the nine months ended September 30, 2018 and 2017, instead of receiving cash from the equity holders, we withheld shares with a value of $28.2 million and $23.7 million for the exercise price of options. These amounts have been excluded from the table above.

Dividends

 

   

Nine Months Ended
September 30,

(in thousands)  

            2018

 

                2017             

Dividend payments to shareholders

  $            7,067   $            6,941

It is our current intention to pay a quarterly cash dividend of $0.03 per share, however, the Board of Directors may terminate or modify the dividend program at any time without prior notice.

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk represents the risk of loss from adverse changes in financial market prices and rates. Our market risk exposure is primarily related to fluctuations in foreign exchange rates.

See Item 7A. “Quantitative and Qualitative Disclosures about Market Risk” and Item 1A. “Risk Factors—We are exposed to fluctuations in currency exchange rates that could negatively impact our financial results and cash flows” included in our Annual Report on Form 10-K for the year ended December 31, 2017 for a more complete discussion of our market risk exposure.

Foreign currency exposure

Translation risk

Our international sales are usually denominated in foreign currencies. However, the operating expenses of our foreign operations are also primarily denominated in foreign currencies, which partially offset our foreign currency exposure.

A hypothetical 10% strengthening in the U.S. dollar against other currencies would result in the following impact:

 

   

Nine Months Ended
September 30,

Increase (decrease)  

            2018             

 

            2017             

Total revenue

  (4)%   (4)%

Net (loss) income

  12%   (1)%

Remeasurement risk

We have experienced and expect to continue to experience fluctuations in our results of operations as a result of transaction gains or losses related to remeasuring monetary assets and liabilities that are denominated in currencies other than the functional currency of the entities in which they are recorded.

We are primarily exposed to changes in foreign currency exchange rates associated with Australian dollar, Euro, and U.S. dollar denominated cash and cash equivalents, accounts receivable, unbilled receivables, and intercompany receivables and payables held by our U.K. subsidiary, a British pound functional entity.

 

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A hypothetical 10% strengthening in the British pound exchange rate in comparison to the Australian dollar, Euro, and U.S. dollar would result in an incremental foreign currency transaction loss of $8 million and $6 million, at September 30, 2018 and December 31, 2017.

 

ITEM 4.

CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)) as of September 30, 2018. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of September 30, 2018.

(b) Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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Table of Contents

PART II - OTHER INFORMATION

 

ITEM 1A.

RISK FACTORS

We encourage you to carefully consider the risk factors identified in Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2017. These risk factors could materially affect our business, financial condition, and future results and could cause our actual business and financial results to differ materially from those contained in forward-looking statements made in this Quarterly Report on Form 10-Q or elsewhere by management from time to time. There have been no material changes during the nine months ended September 30, 2018 to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table sets forth information regarding our repurchases of our common stock during the three months ended September 30, 2018.

 

(in thousands, except per share

 

amounts)

 

 

Total Number
of Shares
Purchased(1)

  

Average

Price Paid
per
Share(1)

  

Total Number
of Shares Purchased as Part
of Publicly Announced
Share Repurchase
Program

      Approximate Dollar
Value of Shares That
May Yet Be Purchased at Period End
Under Publicly Announced Share
Repurchase Programs(2)
 

July 1, 2018 - July 31, 2018

  138      $     57.34      119       $                                                    39,189  

August 1, 2018 - August 31, 2018

  172      $     59.89      93       $                                                    33,645  

September 1, 2018 - September 30, 2018

  182      $     63.96      30       $                                                    31,746  
 

 

         

Total

  492      $     60.68         
 

 

         

 

  (1)

Shares withheld to cover the option exercise price and tax withholding obligations under the net settlement provisions of our stock compensation awards have been included in these amounts.

  (2) 

Since 2004, our Board of Directors has approved stock repurchase programs that have authorized the repurchase, in the aggregate, of up to $221.8 million of our common stock. On June 21, 2018, we announced that our Board of Directors extended the expiration date of the current stock repurchase program to June 30, 2019 and increased the amount of common stock we are authorized to repurchase to $50 million between June 15, 2018 and June 30, 2019 (the “Current Program”). Under the Current Program, purchases may be made from time to time on the open market or in privately negotiated transactions. Shares may be repurchased in such amounts as market conditions warrant, subject to regulatory and other considerations. We have established a pre-arranged stock repurchase plan, intended to comply with the requirements of Rule 10b5-1 under the Exchange Act, and Rule 10b-18 under the Exchange Act (the “10b5-1 Plan”). All stock repurchases under the Current Program during closed trading window periods will be made pursuant to the 10b5-1 Plan.

 

ITEM 6.

EXHIBITS

 

 Exhibit No.  

 

Description

31.1

  Certification pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief Executive Officer.

31.2

  Certification pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief Financial Officer.

32+

  Certification pursuant to 18 U.S.C. Section 1350 of the Chief Executive Officer and the Chief Financial Officer.

101.INS

  XBRL Instance document.

101.SCH

  XBRL Taxonomy Extension Schema Document.

101.CAL

  XBRL Taxonomy Calculation Linkbase Document.

101.DEF

  XBRL Taxonomy Extension Definition Linkbase Document.

101.LAB

  XBRL Taxonomy Label Linkbase Document.

101.PRE

  XBRL Taxonomy Presentation Linkbase Document.

   + Indicates that the exhibit is being furnished with this report and is not filed as a part of it.

   ++ Management contracts and compensatory plan or arrangements

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    Pegasystems Inc.
  Dated:  November 7, 2018     By:     /s/ KENNETH STILLWELL
      Kenneth Stillwell
      Chief Financial Officer and Chief Administrative Officer
      (Principal Financial Officer)

 

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