PEGASYSTEMS INC - Quarter Report: 2021 June (Form 10-Q)

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 June 30, 2021


☐			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, including zip code)

(617) 374-9600

(Registrant’s telephone number, including area code)

____________________________

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading symbol(s)	Name of each exchange on which registered
Common Stock, $.01 par value per share	PEGA	NASDAQ Global Select Market

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 x 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 x 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 81,455,672 shares of the Registrant’s common stock, $0.01 par value per share, outstanding on July 19, 2021.

Table of Contents

PEGASYSTEMS INC.

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS


			Page
PART I - FINANCIAL INFORMATION

Item 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of June 30, 2021 and December 31, 2020			3
Unaudited Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2021 and 2020			4
Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2021 and 2020			5
Unaudited Condensed Consolidated Statements of Stockholders’ Equity for the six months ended June 30, 2021 and 2020			6
Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2021 and 2020			7
Notes to Unaudited Condensed Consolidated Financial Statements			8
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			26

PART II - OTHER INFORMATION

Item 1A. Risk Factors			27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			27
Item 6. Exhibits			27

Signature			28

Table of Contents

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS


PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands)
	June 30, 2021		December 31, 2020
Assets
Current assets:
Cash and cash equivalents	$	139,878	$	171,899
Marketable securities	271,459		293,269
Total cash, cash equivalents, and marketable securities	411,337		465,168
Accounts receivable	166,226		215,827
Unbilled receivables	236,451		207,155
Other current assets	96,215		88,760
Total current assets	910,229		976,910
Unbilled receivables	144,065		113,278
Goodwill	82,173		79,231
Other long-term assets	466,103		434,843
Total assets	$	1,602,570	$	1,604,262
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	22,931	$	24,028
Accrued expenses	64,093		59,261
Accrued compensation and related expenses	84,900		123,012
Deferred revenue	242,194		232,865
Other current liabilities	16,126		20,969
Total current liabilities	430,244		460,135
Convertible senior notes, net	589,092		518,203
Operating lease liabilities	42,063		59,053
Other long-term liabilities	18,703		24,699
Total liabilities	1,080,102		1,062,090
Stockholders’ equity:
Preferred stock, 1,000 shares authorized; none issued	—		—
Common stock, 200,000 shares authorized; 81,456 and 80,890 shares issued and outstanding at June 30, 2021 and December 31, 2020, respectively	815		809
Additional paid-in capital	147,670		204,432
Retained earnings	375,069		339,879
Accumulated other comprehensive (loss)	(1,086)		(2,948)
Total stockholders’ equity	522,468		542,172
Total liabilities and stockholders’ equity	$	1,602,570	$	1,604,262

See notes to unaudited condensed consolidated financial statements.


PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts)
	Three Months Ended June 30,				Six Months Ended June 30,
	2021		2020		2021		2020
Revenue
Software license	$	116,892	$	53,323	$	233,853	$	147,239
Maintenance	78,782		72,222		154,343		145,917
Pega Cloud	73,293		48,838		141,151		92,304
Consulting	56,735		52,992		109,854		107,506
Total revenue	325,702		227,375		639,201		492,966
Cost of revenue
Software license	656		979		1,306		1,663
Maintenance	4,995		5,591		10,781		11,167
Pega Cloud	24,051		18,988		46,608		36,521
Consulting	54,829		51,133		108,283		106,868
Total cost of revenue	84,531		76,691		166,978		156,219
Gross profit	241,171		150,684		472,223		336,747
Operating expenses
Selling and marketing	156,423		127,607		305,162		263,631
Research and development	64,395		58,869		126,837		117,596
General and administrative	19,161		15,655		37,431		31,285
Total operating expenses	239,979		202,131		469,430		412,512
Income (loss) from operations	1,192		(51,447)		2,793		(75,765)
Foreign currency transaction (loss) gain	(403)		4,256		(5,501)		(1,691)
Interest income	236		242		389		849
Interest expense	(1,959)		(5,529)		(3,839)		(7,835)
Gain on capped call transactions	26,309		19,419		7,192		827
Other income, net	—		—		106		1,374
Income (loss) before (benefit from) income taxes	25,375		(33,059)		1,140		(82,241)
(Benefit from) income taxes	(11,916)		(12,319)		(29,534)		(36,129)
Net income (loss)	$	37,291	$	(20,740)	$	30,674	$	(46,112)
Earnings (loss) per share
Basic	$	0.46	$	(0.26)	$	0.38	$	(0.58)
Diluted	$	0.43	$	(0.26)	$	0.36	$	(0.58)
Weighted-average number of common shares outstanding
Basic	81,316		80,224		81,161		80,016
Diluted	90,320		80,224		86,006		80,016

See notes to unaudited condensed consolidated financial statements.


PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (in thousands)
	Three Months Ended June 30,				Six Months Ended June 30,
	2021		2020		2021		2020
Net income (loss)	$	37,291	$	(20,740)	$	30,674	$	(46,112)
Other comprehensive income, net of tax
Unrealized gain on available-for-sale securities	121		—		1,131		100
Foreign currency translation adjustments	1,461		2,028		731		1,514
Total other comprehensive income, net of tax	$	1,582	$	2,028	$	1,862	$	1,614
Comprehensive income (loss)	$	38,873	$	(18,712)	$	32,536	$	(44,498)

See notes to unaudited condensed consolidated financial statements.


PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (in thousands, except per share amounts)
	Common Stock			Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive (Loss)		Total Stockholders’ Equity
	Number of Shares	Amount
December 31, 2019	79,599	$	796	$	140,523	$	410,919	$	(13,228)	$	539,010
Equity component of convertible senior notes, net	—	—		61,604		—		—		61,604
Repurchase of common stock	(87)	(1)		(5,999)		—		—		(6,000)
Issuance of common stock for stock compensation plans	564	6		(23,017)		—		—		(23,011)
Stock-based compensation	—	—		23,199		—		—		23,199
Cash dividends declared ($0.03 per share)	—	—		—		(2,405)		—		(2,405)
Other comprehensive (loss)	—	—		—		—		(414)		(414)
Net (loss)	—	—		—		(25,372)		—		(25,372)
March 31, 2020	80,076	$	801	$	196,310	$	383,142	$	(13,642)	$	566,611
Repurchase of common stock	(23)	—		(2,199)		—		—		(2,199)
Issuance of common stock for stock compensation plans	349	3		(14,085)		—		—		(14,082)
Issuance of common stock under the employee stock purchase plan	18	—		1,403		—		—		1,403
Stock-based compensation	—	—		25,674		—		—		25,674
Cash dividends declared ($0.03 per share)	—	—		—		(2,413)		—		(2,413)
Other comprehensive income	—	—		—		—		2,028		2,028
Net (loss)	—	—		—		(20,740)		—		(20,740)
June 30, 2020	80,420	$	804	$	207,103	$	359,989	$	(11,614)	$	556,282








December 31, 2020	80,890	$	809	$	204,432	$	339,879	$	(2,948)	$	542,172
Cumulative-effect adjustment from adoption of ASU 2020-06, net	—	—		(61,604)		9,399		—		(52,205)
Repurchase of common stock	(70)	(1)		(9,145)		—		—		(9,146)
Issuance of common stock for stock compensation plans	402	4		(25,513)		—		—		(25,509)
Issuance of common stock under the employee stock purchase plan	24	—		2,288		—		—		2,288
Stock-based compensation	—	—		30,100		—		—		30,100
Cash dividends declared ($0.03 per share)	—	—		—		(2,438)		—		(2,438)
Other comprehensive income	—	—		—		—		280		280
Net (loss)	—	—		—		(6,617)		—		(6,617)
March 31, 2021	81,246	$	812	$	140,558	$	340,223	$	(2,668)	$	478,925
Repurchase of common stock	(81)	(1)		(10,245)		—		—		(10,246)
Issuance of common stock for stock compensation plans	267	3		(16,199)		—		—		(16,196)
Issuance of common stock under the employee stock purchase plan	24	1		2,858		—		—		2,859
Stock-based compensation	—	—		30,698		—		—		30,698
Cash dividends declared ($0.03 per share)	—	—		—		(2,445)		—		(2,445)
Other comprehensive income	—	—		—		—		1,582		1,582
Net income	—	—		—		37,291		—		37,291
June 30, 2021	81,456	$	815	$	147,670	$	375,069	$	(1,086)	$	522,468

See notes to unaudited condensed consolidated financial statements.


PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
	Six Months Ended June 30,
	2021		2020
Operating activities
Net income (loss)	$	30,674	$	(46,112)
Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities
Stock-based compensation	60,788		48,831
(Gain) on capped call transactions	(7,192)		(827)
Deferred income taxes	(28,232)		(18,399)
Amortization of deferred commissions	21,202		16,061
Amortization of debt discount and issuance costs	1,348		6,033
Amortization of intangible assets and depreciation	15,504		10,134
Amortization of investments	1,988		—
Foreign currency transaction loss	5,501		1,691
Other non-cash	(4,869)		6,445
Change in operating assets and liabilities, net	(77,302)		(45,056)
Cash provided by (used in) operating activities	19,410		(21,199)
Investing activities
Purchases of investments	(51,601)		(1,769)
Proceeds from maturities and called investments	68,798		—
Sales of investments	2,450		1,424
Payments for acquisitions, net of cash acquired	(4,993)		—
Investment in property and equipment	(4,161)		(19,059)
Cash provided by (used in) investing activities	10,493		(19,404)
Financing activities
Proceeds from issuance of convertible senior notes	—		600,000
Purchase of capped calls related to convertible senior notes	—		(51,900)
Payment of debt issuance costs	—		(14,527)
Proceeds from employee stock purchase plan	5,146		1,403
Dividend payments to stockholders	(4,865)		(4,793)




Common stock repurchases	(60,998)		(44,890)
Cash (used in) provided by financing activities	(60,717)		485,293
Effect of exchange rate changes on cash and cash equivalents	(1,207)		(942)
Net (decrease) increase in cash and cash equivalents	(32,021)		443,748
Cash and cash equivalents, beginning of period	171,899		68,363
Cash and cash equivalents, end of period	$	139,878	$	512,111

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION

Pegasystems Inc. (together with its subsidiaries, “the Company”) has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all the information required by accounting principles generally accepted in the United States of America (“U.S.”) for complete financial statements. These financial statements 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, 2020.

In the opinion of management, the Company has prepared the accompanying unaudited condensed consolidated financial statements on the same basis as its audited financial statements, and these financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented.

All intercompany transactions and balances were eliminated in consolidation. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year 2021.

NOTE 2. NEW ACCOUNTING PRONOUNCEMENTS

Convertible debt

In August 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2020-06, “Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity” (“ASU 2020-06”), which simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts in an entity’s own equity. The standard eliminates the liability and equity separation model for convertible instruments with a cash conversion feature. As a result, after adoption, entities will no longer separately present in stockholders’ equity an embedded conversion feature for such debt. Additionally, the debt discount resulting from separating the embedded conversion feature will no longer be amortized into income as interest expense over the instrument’s life. Instead, entities will account for a convertible debt instrument wholly as debt unless (1) a convertible instrument contains features that require bifurcation as a derivative under ASC Topic 815, “Derivatives and Hedging”, or (2) a convertible debt instrument was issued at a substantial premium. The standard also requires the convertible instruments’ impact on diluted earnings per share (“EPS”) be determined using the if-converted method.

The Company adopted ASU 2020-06 using the modified retrospective approach on January 1, 2021. Upon adoption, the book value of the Company’s Convertible Senior Notes (the “Notes”) increased by $69.5 million to $587.7 million, and retained earnings increased by $9.4 million. The retained earnings adjustment reflects the tax effected difference between the value of the Notes and the embedded conversion feature before adoption and the combined convertible instrument's amortized cost after adoption.

See "Note 8. Debt" for additional information.

NOTE 3. MARKETABLE SECURITIES


	June 30, 2021								December 31, 2020
(in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value		Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
Government debt	$	2,000	$	—	$	—	$	2,000	$	39,996	$	—	$	(8)	$	39,988
Corporate debt	269,649		20		(210)		269,459		253,345		88		(152)		253,281
	$	271,649	$	20	$	(210)	$	271,459	$	293,341	$	88	$	(160)	$	293,269

As of June 30, 2021, marketable securities’ maturities ranged from July 2021 to May 2024, with a weighted-average remaining maturity of approximately 1.3 years.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 4. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE

Receivables


(in thousands)	June 30, 2021		December 31, 2020
Accounts receivable	$	166,226	$	215,827
Unbilled receivables	236,451		207,155
Long-term unbilled receivables	144,065		113,278
	$	546,742	$	536,260

Unbilled receivables

Unbilled receivables are client-committed amounts for which revenue recognition precedes billing, and billing is solely subject to the passage of time.

Unbilled receivables by expected billing date:


(Dollars in thousands)	June 30, 2021
1 year or less	$	236,451	62	%
1-2 years	88,350		23	%
2-5 years	55,715		15	%
	$	380,516	100	%

Unbilled receivables by contract effective date:


(Dollars in thousands)	June 30, 2021
2021	$	140,395	37	%
2020	131,618		34	%
2019	55,282		15	%
2018	26,688		7	%
2017 and prior	26,533		7	%
	$	380,516	100	%

Major clients

Clients accounting for 10% or more of the Company’s total receivables:


	June 30, 2021		December 31, 2020
Client A	13	%	*

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

Contract assets

Contract assets are client-committed amounts for which revenue recognized exceeds the amount billed to the client, and billing is subject to conditions other than the passage of time, such as completing a related performance obligation.


(in thousands)	June 30, 2021		December 31, 2020
Contract assets (1)	$	14,031	$	15,296
Long-term contract assets (2)	10,097		7,777
	$	24,128	$	23,073

(1) Included in other current assets. (2) Included in other long-term assets.

Deferred revenue

Deferred revenue consists of billings and payments received in advance of revenue recognition.


(in thousands)	June 30, 2021		December 31, 2020
Deferred revenue	$	242,194	$	232,865
Long-term deferred revenue (1)	6,041		8,991
	$	248,235	$	241,856

(1) Included in other long-term liabilities.

The change in deferred revenue in the six months ended June 30, 2021 was primarily due to new billings in advance of revenue recognition, offset by $172.1 million of revenue recognized that was included in deferred revenue as of December 31, 2020.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 5. DEFERRED COMMISSIONS


(in thousands)	June 30, 2021		December 31, 2020
Deferred commissions (1)	$	109,803	$	108,624

(1) Included in other long-term assets.


	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2021		2020		2021		2020
Amortization of deferred commissions (1)	$	9,706	$	7,564	$	21,202	$	16,061

(1) Included in selling and marketing expense.

NOTE 6. GOODWILL AND OTHER INTANGIBLES

Goodwill

Change in goodwill:


	Six Months Ended June 30,
(in thousands)	2021		2020
January 1,	$	79,231	$	79,039
Acquisition	2,701		—
Currency translation adjustments	241		(364)
June 30,	$	82,173	$	78,675

Intangibles

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


		June 30, 2021
(in thousands)	Useful Lives	Cost		Accumulated Amortization		Net Book Value (1)
Client-related	4-10 years	$	63,186	$	(56,638)	$	6,548
Technology	2-10 years	67,142		(57,644)		9,498
Other	1-5 years	5,361		(5,361)		—
		$	135,689	$	(119,643)	$	16,046

(1) Included in other long-term assets.


		December 31, 2020
(in thousands)	Useful Lives	Cost		Accumulated Amortization		Net Book Value (1)
Client-related	4-10 years	$	63,168	$	(55,877)	$	7,291
Technology	2-10 years	64,843		(56,386)		8,457
Other	1-5 years	5,361		(5,361)		—
		$	133,372	$	(117,624)	$	15,748

(1) Included in other long-term assets.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Amortization of intangible assets:


	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2021		2020		2021		2020
Cost of revenue	$	629	$	647	$	1,258	$	1,294
Selling and marketing	373		370		746		740

	$	1,002	$	1,017	$	2,004	$	2,034

Future estimated intangibles assets amortization:


(in thousands)	June 30, 2021
2021	$	1,983
2022	3,886
2023	3,618
2024	2,849
2025	2,509
2026 and thereafter	1,201
	$	16,046

NOTE 7. LEASES

Headquarters lease

In February 2021, the Company agreed to accelerate its exit from its Cambridge, Massachusetts headquarters to October 1, 2021, in exchange for a one-time payment from the Company’s landlord of $18 million, which is being amortized over the remaining lease term. Upon modification, the Company reduced its lease liabilities by $21.1 million and accelerated depreciation related to its corporate headquarters.

Expense


	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2021		2020		2021		2020
Fixed lease costs (1)	$	(3,972)	$	4,943	$	(3,672)	$	9,761
Short-term lease costs	515		371		974		826
Variable lease costs	1,340		969		2,727		2,247
	$	(2,117)	$	6,283	$	29	$	12,834

(1) The decrease in fixed lease costs in three and six months ended June 30, 2021 was due to the modification of the Headquarters Lease.

Right of use assets and lease liabilities


(in thousands)	June 30, 2021		December 31, 2020
Right of use assets (1)	$	51,058	$	67,651
Lease liabilities (2)	$	13,682	$	18,541
Long-term lease liabilities	$	42,063	$	59,053

(1) Represents the Company’s right to use the leased asset during the lease term. Included in other long-term assets.

(2) Included in other current liabilities.

Weighted-average remaining lease term and discount rate for the Company’s leases were:


	June 30, 2021		December 31, 2020
Weighted-average remaining lease term	4.9 years		4.7 years
Weighted-average discount rate (1)	4.6	%	5.4	%

(1) The rates implicit in most of the Company’s leases are not readily determinable. Therefore, the Company uses its incremental borrowing rate as the discount rate when measuring operating lease liabilities. The incremental borrowing rate represents an estimate of the interest rate the Company would incur to borrow an amount equal to the lease payments on a collateralized basis over the lease term in a similar economic environment.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Maturities of lease liabilities:


(in thousands)	June 30, 2021
Remainder of 2021	$	8,783
2022	13,888
2023	13,300
2024	10,021
2025	6,913
2026	2,653
Thereafter	7,170
Total lease payments	62,728
Less: imputed interest (1)	(6,983)
	$	55,745

(1) Lease liabilities are measured at the present value of the remaining lease payments using a discount rate determined at lease commencement, unless the discount rate is updated due to a lease reassessment event.

Cash flow information


	Six Months Ended June 30,
(in thousands)	2021		2020
Cash paid for leases	$	11,605	$	10,945
Right of use assets recognized for new leases and amendments (non-cash)	$	10,160	$	10,077

NOTE 8. DEBT

Convertible senior notes and capped calls

Convertible senior notes

In February 2020, the Company issued Convertible Senior Notes (the "Notes") with an aggregate principal of $600 million, due March 1, 2025, in a private placement. No principal payments are required before maturity. The Notes accrue interest at an annual rate of 0.75%, payable semi-annually in arrears on March 1 and September 1, beginning on September 1, 2020.

Conversion rights

The conversion rate is 7.4045 shares of common stock per $1,000 principal amount of the Notes, representing an initial conversion price of $135.05 per share of common stock. The Company will settle conversions by paying or delivering cash, shares of its common stock, or a combination of cash and shares of its common stock, at the Company’s election, based on the applicable conversion rate. The conversion rate will be adjusted upon certain events, including spin-offs, tender offers, exchange offers, and certain stockholder distributions.

Beginning on September 1, 2024, noteholders may convert their Notes at any time at their election.

Before September 1, 2024, noteholders may convert their Notes in the following circumstances:

•During any calendar quarter commencing after June 30, 2020 (and only during such calendar quarter), if the last reported sale price per share of the Company’s common stock exceeds 130% of the conversion price for each of at least 20 trading days (whether or not consecutive) during the 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter.

•During the five consecutive business days immediately after any five consecutive trading day period (the “Measurement Period”), if the trading price per $1,000 principal amount of Notes for each trading day of the Measurement Period was less than 98% of the product of the last reported sale price per share of common stock on such trading day and the conversion rate on such trading day.

•Upon certain corporate events or distributions or if the Company calls any Notes for redemption, noteholders may convert before the close of business on the business day immediately before the related redemption date (or, if the Company fails to pay the redemption price in full on the redemption date, until the Company pays the redemption price).

As of June 30, 2021, the Notes were not eligible for conversion at the noteholders’ election.

Repurchase rights

On or after March 1, 2023 and on or before the 40th scheduled trading day immediately before the maturity date, the Company may redeem for cash all or part of the Notes at a repurchase price equal to 100% of the principal amount, plus accrued and unpaid interest, if the last reported sale price of the Company’s common stock exceeded 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period ending on, and including, the trading day immediately preceding the date on which the Company provides a redemption notice.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

If certain corporate events that constitute a “Fundamental Change” occur, each noteholder will have the right to require the Company to repurchase for cash all of such noteholder’s Notes, or any portion of the principal thereof that is equal to $1,000 or a multiple of $1,000, at a repurchase price equal to 100% of the principal amount thereof, plus accrued and unpaid interest. A Fundamental Change relates to mergers, changes in control of the Company, liquidation/dissolution of the Company, or the delisting of the Company’s common stock.

Impact of the Notes

The Company adopted ASU 2020-06 using the modified retrospective approach on January 1, 2021. The standard eliminates the liability and equity separation model for convertible instruments with a cash conversion feature. See "Note 2. New Accounting Pronouncements" for additional information.

Until January 1, 2021, the Notes were separated into liability and equity components.

•The initial carrying amount of the liability component was calculated by measuring a similar debt instrument’s fair value that does not have an associated conversion feature. The excess of the Notes’ principal amount over the initial carrying amount of the liability component, the debt discount, was amortized as interest expense over the Notes’ contractual term.

•The equity component was recorded as an increase to additional paid-in capital and not remeasured.

Upon adoption of ASU 2020-06, the book value of the Notes increased by $69.5 million to $587.7 million, and retained earnings increased by $9.4 million. The retained earnings adjustment reflects the tax effected difference between the value of the Notes and the embedded conversion feature before adoption and the combined convertible instrument's amortized cost after adoption.

Carrying value of the Notes:


(in thousands)	June 30, 2021		December 31, 2020
Principal	$	600,000	$	600,000
Unamortized debt discount	—		(71,222)
Unamortized issuance costs	(10,908)		(10,575)
Convertible senior notes, net	$	589,092	$	518,203

Conversion options	$	—	$	84,120
Issuance costs	—		(2,037)
Deferred taxes	—		(20,479)
Additional paid-in capital	$	—	$	61,604

Interest expense related to the Notes:


	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2021		2020		2021		2020
Contractual interest expense (0.75% coupon)	$	1,125	$	1,125	$	2,250	$	1,575
Amortization of debt discount	—		3,757		—		5,253
Amortization of issuance costs	675		558		1,348		780
	$	1,800	$	5,440	$	3,598	$	7,608

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The effective interest rate for the Notes:


	Six Months Ended June 30,
	2021		2020
Weighted-average effective interest rate	1.2	%	4.3	%

Future payments of principal and contractual interest:


	June 30, 2021
(in thousands)	Principal		Interest		Total
2021	$	—	$	2,250	$	2,250
2022	—		4,500		4,500
2023	—		4,500		4,500
2024	—		4,500		4,500
2025	600,000		1,488		601,488
	$	600,000	$	17,238	$	617,238

Capped call transactions

In February 2020, the Company entered into privately negotiated capped call transactions (the “Capped Call Transactions”) with certain financial institutions. The Capped Call Transactions cover approximately 4.4 million shares (representing the number of shares for which the Notes are initially convertible) of the Company’s common stock. The Capped Call Transactions are generally expected to reduce common stock dilution and/or offset any potential cash payments the Company must make, other than for principal and interest, upon conversion of the Notes, with such reduction and/or offset subject to a cap of $196.44. The cap price of the Capped Call Transactions is subject to adjustment upon the occurrence of specified extraordinary events affecting the Company, including mergers and tender offers.

The Capped Call Transactions are accounted for as derivative instruments and do not qualify for the Company’s own equity scope exception in ASC 815 since, in some cases of early settlement, the settlement value of the Capped Call Transactions, calculated in accordance with the governing documents, may not represent a fair value measurement. The Capped Call Transactions are classified as other long-term assets and remeasured to fair value at the end of each reporting period, resulting in a non-operating gain or loss.

Change in capped call transactions:


	Six Months Ended June 30,
(in thousands)	2021		2020
January 1,	$	83,597	$	—
Issuance	—		51,900
Fair value adjustment	7,192		827
June 30,	$	90,789	$	52,727

Credit facility

In November 2019, and as amended as of February 2020, July 2020, and September 2020, the Company entered into a five-year $100 million senior secured revolving credit agreement (the “Credit Facility”) with PNC Bank, National Association. The Company may use borrowings to finance working capital needs and for general corporate purposes. Subject to specific conditions, the Credit Facility allows the Company to increase the aggregate commitment to $200 million. The commitments expire on November 4, 2024, and any outstanding loans will be payable on such date. The Credit Facility, as amended, contains customary covenants, including, but not limited to, those relating to additional indebtedness, liens, asset divestitures, and affiliate transactions.

The Company is also required to comply with financial covenants, including:

•Beginning with the fiscal quarter ended September 30, 2020 and ending with the fiscal quarter ended December 31, 2021, at least $200 million in cash and investments held by Pegasystems Inc.

•Beginning with the quarter ended March 31, 2022, a maximum net consolidated leverage ratio of 3.5 to 1.0 (with a step-up in the event of certain acquisitions) and a minimum consolidated interest coverage ratio of 3.5 to 1.0.

As of June 30, 2021 and December 31, 2020, the Company had no outstanding borrowings under the Credit Facility.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 9. FAIR VALUE MEASUREMENTS

Assets and liabilities measured at fair value on a recurring basis

The Company records its cash equivalents, marketable securities, Capped Call Transactions, and venture investments at fair value on a recurring basis. Fair value is an exit price, representing the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants based on assumptions that market participants would use in pricing an asset or liability.

As a basis for classifying the fair value measurements, a three-tier fair value hierarchy, which classifies the fair value measurements based on the inputs used in measuring fair value, was established as follows:

•Level 1 - observable inputs such as quoted prices in active markets for identical assets or liabilities;

•Level 2 - significant other inputs that are observable either directly or indirectly; and

•Level 3 - significant unobservable inputs 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 minimize unobservable inputs when determining fair value.

The fair value of the Capped Call Transactions at the end of each reporting period is determined using a Black-Scholes option-pricing model. The valuation models use various market-based inputs, including stock price, remaining contractual term, expected volatility, risk-free interest rate, and expected dividend yield. The Company applies judgment when determining expected volatility. The Company considers both historical and implied volatility levels of the underlying equity security. The Company’s venture investments are recorded at fair value based on valuation methods, including observable public companies and transaction prices and unobservable inputs, including the volatility, rights, and obligations of the securities the Company holds.

Assets and liabilities measured at fair value on a recurring basis:


	June 30, 2021								December 31, 2020
(in thousands)	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Cash equivalents	$	4,650	$	—	$	—	$	4,650	$	42,339	$	14,000	$	—	$	56,339
Marketable securities	$	—	$	271,459	$	—	$	271,459	$	—	$	293,269	$	—	$	293,269
Capped Call Transactions (1)	$	—	$	90,789	$	—	$	90,789	$	—	$	83,597	$	—	$	83,597
Venture investments (1) (2)	$	—	$	—	$	9,779	$	9,779	$	—	$	—	$	8,345	$	8,345

(1) Included in other long-term assets. (2) Investments in privately-held companies.

Changes in venture investments:


	Six Months Ended June 30,
(in thousands)	2021		2020
January 1,	$	8,345	$	4,871
New investments	500		1,769
Sales of investments	(400)		(1,424)
Changes in foreign exchange rates	14		(50)
Changes in fair value:
included in other income	100		1,374
included in other comprehensive income	1,220		100
June 30,	$	9,779	$	6,640

The carrying value of certain other financial instruments, including receivables and accounts payable, approximates fair value due to these items’ relatively short maturity.

Fair value of the Notes

The Notes’ fair value (inclusive of the conversion feature embedded in the Notes) was $726.2 million as of June 30, 2021 and $706.5 million as of December 31, 2020. The fair value was determined based on the Notes’ quoted price in an over-the-counter market on the last trading day of the reporting period and classified within Level 2 in the fair value hierarchy. See "Note 8. Debt" for additional information.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 10. REVENUE

Geographic revenue


	Three Months Ended June 30,								Six Months Ended June 30,
(Dollars in thousands)	2021				2020				2021				2020
U.S.	$	189,297	58	%	$	142,811	63	%	$	383,865	60	%	$	315,228	63	%
Other Americas	14,058		4	%	8,930		4	%	25,959		4	%	24,272		5	%
United Kingdom (“U.K.”)	32,553		10	%	21,259		9	%	60,765		10	%	43,096		9	%
Europe (excluding U.K.), Middle East, and Africa	45,798		14	%	34,878		15	%	97,457		15	%	66,816		14	%
Asia-Pacific	43,996		14	%	19,497		9	%	71,155		11	%	43,554		9	%
	$	325,702	100	%	$	227,375	100	%	$	639,201	100	%	$	492,966	100	%

Revenue streams


	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2021		2020		2021		2020
Perpetual license	$	12,596	$	9,057	$	18,048	$	12,716
Term license	104,296		44,266		215,805		134,523
Revenue recognized at a point in time	116,892		53,323		233,853		147,239
Maintenance	78,782		72,222		154,343		145,917
Pega Cloud	73,293		48,838		141,151		92,304
Consulting	56,735		52,992		109,854		107,506
Revenue recognized over time	208,810		174,052		405,348		345,727
	$	325,702	$	227,375	$	639,201	$	492,966


(in thousands)	Three Months Ended June 30,				Six Months Ended June 30,
	2021		2020		2021		2020
Pega Cloud	$	73,293	$	48,838	$	141,151	$	92,304
Client Cloud	$	183,078	$	116,488	$	370,148	$	280,440
Maintenance	78,782		72,222		154,343		145,917
Term license	104,296		44,266		215,805		134,523
Subscription (1)	256,371		165,326		511,299		372,744
Perpetual license	12,596		9,057		18,048		12,716
Consulting	56,735		52,992		109,854		107,506
	$	325,702	$	227,375	$	639,201	$	492,966

(1) Reflects client arrangements subject to renewal (Pega Cloud, maintenance, and term license).

Remaining performance obligations ("Backlog")

Expected future revenue on existing non-cancellable contracts:


	June 30, 2021
(Dollars in thousands)	Perpetual license		Term license		Maintenance		Pega Cloud		Consulting		Total
1 year or less	$	6,707	$	46,146	$	214,645	$	281,793	$	17,863	$	567,154	56	%
1-2 years	234		15,708		59,164		194,841		2,675		272,622		26	%
2-3 years	—		909		36,076		88,855		762		126,602		12	%
Greater than 3 years	—		255		26,564		37,246		693		64,758		6	%
	$	6,941	$	63,018	$	336,449	$	602,735	$	21,993	$	1,031,136	100	%


	June 30, 2020
(Dollars in thousands)	Perpetual license		Term license		Maintenance		Pega Cloud		Consulting		Total
1 year or less	$	8,120	$	53,550	$	186,618	$	191,187	$	21,923	$	461,398	57	%
1-2 years	1,700		6,187		40,153		140,860		1,986		190,886		23	%
2-3 years	—		6,460		20,671		88,273		631		116,035		14	%
Greater than 3 years	—		646		10,517		37,071		626		48,860		6	%
	$	9,820	$	66,843	$	257,959	$	457,391	$	25,166	$	817,179	100	%

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Major clients

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


	Three Months Ended June 30,					Six Months Ended June 30,
(Dollars in thousands)	2021			2020		2021		2020
Total revenue	$	325,702		$	227,375	$	639,201	$	492,966
Client A	13		%	*		*		*

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

NOTE 11. STOCK-BASED COMPENSATION

Expense


	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2021		2020		2021		2020
Cost of revenue	$	5,849	$	5,384	$	11,774	$	10,536
Selling and marketing	14,748		11,592		28,468		21,310
Research and development	6,343		5,805		13,113		11,302
General and administrative	3,748		2,874		7,433		5,683
	$	30,688	$	25,655	$	60,788	$	48,831
Income tax benefit	$	(6,192)	$	(5,107)	$	(12,183)	$	(9,689)

As of June 30, 2021, the Company had $157.3 million of unrecognized stock-based compensation expense, net of estimated forfeitures, which is expected to be recognized over a weighted-average period of 2.2 years.

Grants


	Six Months Ended June 30, 2021
(in thousands)	Shares	Total Fair Value
RSUs	753	$	97,483
Non-qualified stock options	1,368	$	51,594

NOTE 12. INCOME TAXES

Effective income tax rate


	Three Months Ended June 30,				Six Months Ended June 30,
(Dollars in thousands)	2021		2020		2021			2020
(Benefit from) income taxes	$	(11,916)	$	(12,319)	$	(29,534)		$	(36,129)
Effective income tax benefit rate					(2,591)		%	44		%

The change in the effective income tax benefit rate was primarily due to the impact of discrete tax items on a proportionately larger income (loss) before income taxes in the prior period. The most significant discrete items were excess tax benefits from stock-based compensation and the impact of changes in statutory tax rates applicable to our U.K.-based deferred tax assets.

NOTE 13. EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share is calculated using the weighted-average number of common shares outstanding during the period. Diluted earnings (loss) per share is calculated using the weighted-average number of common shares outstanding during the period, plus the dilutive effect of outstanding stock options, RSUs, and convertible senior notes.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Calculation of earnings (loss) per share:


	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands, except per share amounts)	2021		2020		2021		2020
Net income (loss)	$	37,291	$	(20,740)	$	30,674	$	(46,112)
Weighted-average common shares outstanding	81,316		80,224		81,161		80,016
Earnings (loss) per share, basic	$	0.46	$	(0.26)	$	0.38	$	(0.58)

Net income (loss)	$	37,291	$	(20,740)	$	30,674	$	(46,112)
Interest expense associated with convertible debt instruments, net of tax	1,351		—		—		—
Numerator for diluted EPS	$	38,642	$	(20,740)	$	30,674	$	(46,112)
Weighted-average effect of dilutive securities:
Convertible debt (1)	4,443		—		—		—
Stock options	3,266		—		3,416		—
RSUs	1,295		—		1,429		—
Effect of dilutive securities (2)	9,004		—		4,845		—
Weighted-average common shares outstanding, assuming dilution (1) (2) (3)	90,320		80,224		86,006		80,016
Earnings (loss) per share, diluted	$	0.43	$	(0.26)	$	0.36	$	(0.58)

Outstanding anti-dilutive stock options and RSUs (4)	19		5,929		22		5,939

(1) The shares underlying the conversion options in the Company’s Notes are included using the if-converted method, if dilutive in the period. If the outstanding conversion options were fully exercised, the Company would issue an additional 4.4 million shares.

(2) In periods of loss, all dilutive securities are excluded as their inclusion would be anti-dilutive.

(3) The Company’s Capped Call Transactions convert to approximately 4.4 million shares of the Company’s common stock (representing the number of shares for which the Notes are initially convertible). The Capped Call Transactions are generally expected to reduce common stock dilution and/or offset any potential cash payments the Company must make, other than for principal and interest, upon conversion of the Notes, with such reduction and/or offset subject to a cap of $196.44. The Capped Call Transactions are excluded from weighted-average common shares outstanding, assuming dilution, in all periods as their effect would be anti-dilutive.

(4) Outstanding stock options and RSUs that were anti-dilutive under the treasury stock method in the period were excluded from the computation of diluted earnings (loss) per share. These awards may be dilutive in the future.

NOTE 14. SUBSEQUENT EVENTS

On July 6, 2021, the Company entered into an office space lease (the “Lease”) for 131 thousand square feet in Waltham, Massachusetts. The lease term of approximately 11 years is expected to commence on August 1, 2021 (the “Lease Commencement Date”), subject to certain adjustments for the initial occupancy date. The annual rent equals the base rent plus the Company’s portion of building operating costs and real estate taxes for the year. Rent first becomes payable on August 1, 2022, subject to adjustment based on the Lease Commencement Date. Base rent for the first year is $6 million and will increase by 3% annually. In addition, the Company will receive an improvement allowance from the landlord of $11.8 million.

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

FORWARD-LOOKING STATEMENTS

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

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

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

•our future financial performance and business plans;

•the adequacy of our liquidity and capital resources;

•the continued payment of our quarterly dividends;

•the timing of revenue recognition;

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

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

•the impact of actual or threatened public health emergencies, such as the Coronavirus (“COVID-19”);

•reliance on third-party service providers;

•compliance with our debt obligations and covenants;

•the potential impact of our convertible senior notes and Capped Call Transactions;

•reliance on key personnel;

•the relocation of our corporate headquarters;

•the continued uncertainties in the global economy;

•foreign currency exchange rates;

•the potential legal and financial liabilities and reputation damage due to cyber-attacks;

•security breaches and security flaws;

•our ability to protect our intellectual property rights and costs associated with defending such rights;

•our client retention rate; and

•management of our growth.

These risks and others that may cause actual results to differ materially from those expressed in such forward-looking statements are described further in Part I of our Annual Report on Form 10-K for the year ended December 31, 2020, and other filings we make with the U.S. Securities and Exchange Commission (“SEC”). Except as required by applicable law, we do not undertake and expressly disclaim any obligation to update or revise these forward-looking statements publicly, whether from new information, future events, or otherwise.

The forward-looking statements contained in this Quarterly Report represent our views as of July 28, 2021.

BUSINESS OVERVIEW

We develop, market, license, host, and support enterprise software applications that help organizations simplify business complexity. Our intelligent technology and scalable architecture enables the world’s leading brands and government agencies to solve problems quickly and transform for tomorrow. Our clients are able to make better decisions and get work done using real-time artificial intelligence (“AI”) and intelligent automation on applications built on the low-code, cloud-native Pega Platform™, enabling our clients to streamline service, increase customer lifetime value, and boost efficiency. Our consulting and client success teams, along with our world-class partners, leverage our Pega Express™ methodology and low code to allow clients to design and deploy critical applications quickly and collaboratively.

Our target clients are Global 3000 organizations and government agencies that require applications to differentiate themselves in the markets they serve. Our applications achieve and facilitate differentiation by increasing business agility, driving growth, improving productivity, attracting and retaining customers, and reducing risk. We deliver applications tailored to our clients’ specific industry needs.

Cloud Transition

We are in the process of transitioning our business to sell software primarily through subscription arrangements, particularly Pega Cloud. Until we substantially complete our Cloud Transition, which we anticipate will occur in 2023, we may experience lower revenue growth and lower operating cash flow growth or negative cash flow. Operating performance and the actual mix of revenue and new arrangements in a given period can fluctuate based on client preferences for our perpetual and subscription offerings. See the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2020 for additional information.

Coronavirus (“COVID-19”)

As of June 30, 2021, COVID-19 has not had a material impact on our results of operations or financial condition. See “Coronavirus (“COVID-19”)” in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2020 for additional information.

Performance metrics

We utilize performance metrics to analyze and assess our overall performance, make operating decisions, and forecast and plan for future periods, including:

Annual contract value (“ACV”) | Increased 22% since June 30, 2020

•ACV, as reported, represents the annualized value of our active contracts as of the measurement date. The contract's total value is divided by its duration in years to calculate ACV for term license and Pega Cloud contracts. Maintenance revenue for the quarter then ended is multiplied by four to calculate ACV for maintenance. Client Cloud ACV is composed of maintenance ACV and term license ACV. ACV is a performance measure that we believe provides useful information to our management and investors, particularly during our Cloud Transition.

* Foreign currency exchange rate changes contributed 3-4% to total ACV growth in 2021.

Remaining performance obligations (“Backlog”) | Increased 26% since June 30, 2020

•Backlog represents expected future revenue on existing non-cancellable contracts.

Year to date Pega Cloud revenue | Increased 53% since the six months ended June 30, 2020

•Pega Cloud revenue is revenue under U.S. GAAP for cloud contracts.

CRITICAL ACCOUNTING POLICIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our unaudited condensed consolidated financial statements, which have been prepared following accounting principles generally accepted in the United States 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, 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 the available information.

For more information regarding our critical accounting policies, we encourage you to read the discussion in the following locations in our Annual Report on Form 10-K for the year ended December 31, 2020:

•“Critical Accounting Estimates and Significant Judgments” in Item 7; and

•“Note 2. Significant Accounting Policies” in Item 8.

There have been no significant changes other than those disclosed in “Note 2. New Accounting Pronouncements” in Item 1 of this Quarterly Report on Form 10-Q to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2020.

RESULTS OF OPERATIONS

Revenue

Cloud Transition

We are in the process of transitioning our business to sell software primarily through subscription arrangements, particularly Pega Cloud. Revenue growth has been slower because of this transition. Revenue from Pega Cloud and maintenance arrangements is typically recognized over the contract term. In contrast, revenue from license sales is recognized when the license rights become effective, typically upfront.


(Dollars in thousands)	Three Months Ended June 30,								Change				Six Months Ended June 30,								Change
	2021				2020								2021				2020
Pega Cloud	$	73,293	23	%	$	48,838	21	%	$	24,455	50	%	$	141,151	22	%	$	92,304	19	%	$	48,847	53	%
Client Cloud	$	183,078	56	%	$	116,488	52	%	$	66,590	57	%	$	370,148	58	%	$	280,440	57	%	$	89,708	32	%
Maintenance	78,782		24	%	72,222		33	%	6,560		9	%	154,343		24	%	145,917		30	%	8,426		6	%
Term license	104,296		32	%	44,266		19	%	60,030		136	%	215,805		34	%	134,523		27	%	81,282		60	%
Subscription (1)	$	256,371	79	%	$	165,326	73	%	91,045		55	%	511,299		80	%	372,744		76	%	138,555		37	%
Perpetual license	12,596		4	%	9,057		4	%	3,539		39	%	18,048		3	%	12,716		3	%	5,332		42	%
Consulting	56,735		17	%	52,992		23	%	3,743		7	%	109,854		17	%	107,506		21	%	2,348		2	%
	$	325,702	100	%	$	227,375	100	%	$	98,327	43	%	$	639,201	100	%	$	492,966	100	%	$	146,235	30	%

(1) Reflects client arrangements subject to renewal (Pega Cloud, maintenance, and term license).

The total revenue changes in the three and six months ended June 30, 2021 generally reflect our Cloud Transition. Other factors impacting our revenue include:

•An increasing portion of our term license contracts include multi-year committed maintenance periods instead of annually renewable maintenance. Under multi-year committed maintenance arrangements, a larger portion of the total contract value is recognized as maintenance revenue over the contract term rather than as term license revenue upon the effectiveness of the license rights. In the three months ended June 30, 2021, multi-year committed maintenance contributed $4.3 million to maintenance revenue growth and reduced term revenue growth by $15.4 million. In the six months ended June 30, 2021, multi-year committed maintenance contributed $7.8 million to maintenance revenue growth and reduced term revenue growth by $20.9 million.

•Maintenance renewal rates of higher than 90%.

•The increases in term license revenue in the three and six months ended June 30, 2021 were driven by a large, existing customer that expanded their use of our software, renewed an existing multi-year contract, and extended the term of the agreement earlier in the year than anticipated.

•The increases in perpetual license revenue were primarily due to several large perpetual license contracts recognized in revenue in the three and six months ended June 30, 2021.

•The increases in consulting revenue in the three and six months ended June 30, 2021 were primarily due to increases in billable hours. As part of our long-term strategy, we intend to continue growing and leveraging our ecosystem of partners on implementation projects, potentially reducing our future consulting revenue growth.

Gross profit


	Three Months Ended June 30,								Change				Six Months Ended June 30,								Change
(Dollars in thousands)	2021				2020								2021				2020
Software license	$	116,236	99	%	$	52,344	98	%	$	63,892	122	%	$	232,547	99	%	$	145,576	99	%	$	86,971	60	%
Maintenance	73,787		94	%	66,631		92	%	7,156		11	%	143,562		93	%	134,750		92	%	8,812		7	%
Pega Cloud	49,242		67	%	29,850		61	%	19,392		65	%	94,543		67	%	55,783		60	%	38,760		69	%
Consulting	1,906		3	%	1,859		4	%	47		3	%	1,571		1	%	638		1	%	933		146	%
	$	241,171	74	%	$	150,684	66	%	$	90,487	60	%	$	472,223	74	%	$	336,747	68	%	$	135,476	40	%

•The changes in gross profit in the three and six months ended June 30, 2021 were primarily due to our Cloud Transition, revenue growth, and cost-efficiency gains as Pega Cloud grows and scales.

Operating expenses


(Dollars in thousands)	Three Months Ended June 30,								Change				Six Months Ended June 30,								Change
	2021				2020								2021				2020
			% of Revenue				% of Revenue								% of Revenue				% of Revenue
Selling and marketing	$	156,423	48	%	$	127,607	56	%	$	28,816	23	%	$	305,162	48	%	$	263,631	53	%	$	41,531	16	%
Research and development	$	64,395	20	%	$	58,869	26	%	$	5,526	9	%	$	126,837	20	%	$	117,596	24	%	$	9,241	8	%
General and administrative	$	19,161	6	%	$	15,655	7	%	$	3,506	22	%	$	37,431	6	%	$	31,285	6	%	$	6,146	20	%

•The increases in selling and marketing in the three and six months ended June 30, 2021 were primarily due to increases in compensation and benefits of $22.6 million and $48.0 million, attributable to increases in headcount and equity compensation. The increase in headcount reflects our efforts to increase our sales capacity to deepen relationships with existing clients and target new accounts.

•The increases in research and development in the three and six months ended June 30, 2021 were primarily due to increases in compensation and benefits of $7.2 million and $11.8 million, attributable to increases in headcount and equity compensation.

•The increases in general and administrative in the three and six months ended June 30, 2021 were primarily due to increases in compensation and benefits of $2.2 million and $3.5 million, attributable to increases in headcount and equity compensation, and increases in professional services fees of $1.8 million and $3.4 million.

•In February 2021, we agreed to accelerate our exit from our Cambridge, Massachusetts headquarters to October 1, 2021, in exchange for a one-time payment from our landlord of $18 million. This agreement was the primary contributor to decreases in facilities expenses of $2.1 million and $3.3 million in selling and marketing, $2.4 million and $3.6 million in research and development, and $1.1 million and $1.6 million in general and administrative, in the three and six months ended June 30, 2021.

Other income (expense), net


(Dollars in thousands)	Three Months Ended June 30,				Change				Six Months Ended June 30,				Change
	2021		2020						2021		2020
Foreign currency transaction (loss) gain	$	(403)	$	4,256	$	(4,659)	*		$	(5,501)	$	(1,691)	$	(3,810)	(225)	%
Interest income	236		242		(6)		(2)	%	389		849		(460)		(54)	%
Interest expense	(1,959)		(5,529)		3,570		65	%	(3,839)		(7,835)		3,996		51	%
Gain on capped call transactions	26,309		19,419		6,890		35	%	7,192		827		6,365		770	%
Other income, net	—		—		—		*		106		1,374		(1,268)		(92)	%
	$	24,183	$	18,388	$	5,795	32	%	$	(1,653)	$	(6,476)	$	4,823	74	%

* not meaningful

•The changes in foreign currency transaction (loss) gain in the three and six months ended June 30, 2021 were primarily due to the impact of fluctuations in foreign currency exchange rates associated with our foreign currency-denominated cash, receivables, and intercompany balances held by our subsidiary in the United Kingdom.

•The decreases in interest income in the three and six months ended June 30, 2021 were primarily due to declines in market interest rates.

•The decreases in interest expense in the three and six months ended June 30, 2021 were primarily due to our adoption of ASU 2020-06 on January 1, 2021. See "Note 2. New Accounting Pronouncements" in Item 1 of this Quarterly Report for additional information.

Interest expense related to the Notes:


	Three Months Ended June 30,				Change		Six Months Ended June 30,				Change
(in thousands)	2021		2020				2021		2020
Contractual interest expense (0.75% coupon)	$	1,125	$	1,125	$	—	$	2,250	$	1,575	$	675
Amortization of debt discount	—		3,757		(3,757)		—		5,253		(5,253)
Amortization of issuance costs	675		558		117		1,348		780		568
	$	1,800	$	5,440	$	(3,640)	$	3,598	$	7,608	$	(4,010)

•The increases in the gain on capped call transactions in the three and six months ended June 30, 2021, were due to fair value adjustments driven by increases in our stock price.

•The decrease in other income, net in the six months ended June 30, 2021, was due to larger fair value adjustments on equity securities held in our venture investments portfolio in the six months ended June 30, 2020.

(Benefit from) income taxes


	Three Months Ended June 30,				Six Months Ended June 30,
(Dollars in thousands)	2021		2020		2021			2020
(Benefit from) income taxes	$	(11,916)	$	(12,319)	$	(29,534)		$	(36,129)
Effective income tax benefit rate					(2,591)		%	44		%

During the six months ended June 30, 2021, the change in our effective income tax benefit rate was primarily due to the impact of discrete tax items on a proportionately larger income (loss) before income taxes in the prior period. The most significant discrete items were excess tax benefits from stock-based compensation and the impact of changes in statutory tax rates applicable to our U.K.-based deferred tax assets.

Stock-based compensation increases the variability of our effective tax rates. The impact of stock-based compensation on a given period depends on our profitability, the attributes of our stock compensation awards we grant, and award holders' exercise behavior.

LIQUIDITY AND CAPITAL RESOURCES


	Six Months Ended June 30,
(in thousands)	2021		2020
Cash provided by (used in):
Operating activities	$	19,410	$	(21,199)
Investing activities	10,493		(19,404)
Financing activities	(60,717)		485,293
Effect of exchange rates on cash and cash equivalents	(1,207)		(942)
Net (decrease) increase in cash and cash equivalents	$	(32,021)	$	443,748


(in thousands)	June 30, 2021		December 31, 2020
Held by U.S. entities	$	306,754	$	399,138
Held by foreign entities	104,583		66,030
Total cash, cash equivalents, and marketable securities	$	411,337	$	465,168

We believe that our current cash, cash flow from operations, and borrowing capacity will be sufficient to fund our operations, stock repurchases, and quarterly cash dividends for at least the next 12 months. Whether these resources are adequate to meet our liquidity needs beyond that period will depend on our future growth, operating results, and the investments required to support our operations. If we require additional capital resources to grow our business, we may seek to finance our operations from available funds or additional external financing.

If it becomes necessary to repatriate foreign funds, we may be required to pay U.S. and foreign taxes upon repatriation. Due to the complexity of income tax laws and regulations, it is impracticable to estimate the amount of taxes we would have to pay.

Operating activities

We are in the process of transitioning our business to sell software primarily through subscription arrangements, particularly Pega Cloud. This transition has impacted and is expected to continue to impact the timing of our billings and cash collections. Pega Cloud, term license, and maintenance arrangements are generally billed and collected over the contract term, while perpetual license arrangements are generally billed and collected upfront when the license rights become effective. As client preferences shift in favor of Pega Cloud arrangements, we could experience slower operating cash flow growth, or negative cash flow, in the near term.

The change in cash provided by (used in) operating activities in the six months ended June 30, 2021 was primarily due to a significant increase in client collections.

Corporate headquarters

In February 2021, we agreed to accelerate our exit from our existing Cambridge, Massachusetts corporate headquarters to October 1, 2021, in exchange for a one-time payment from our landlord of $18 million, which is expected to be paid in the last quarter of 2021. The accelerated exit from this lease reduced our future lease liabilities by $21.1 million. On March 31, 2021 we leased office space at One Main Street, Cambridge, Massachusetts, to serve as our future corporate headquarters. The approximately 4.5 year lease includes base rent of approximately $2 million per year.

New Waltham Office

On July 6, 2021, we entered into an office space lease (the “Lease”) for 131 thousand square feet in Waltham, Massachusetts. The lease term of approximately 11 years is expected to commence on August 1, 2021 (the “Lease Commencement Date”), subject to certain adjustments for the initial occupancy date. The annual rent equals the base rent plus our portion of building operating costs and real estate taxes. Rent first becomes payable on August 1, 2022, subject to adjustment based on the Lease Commencement Date. Base rent for the first year is $6 million and will increase by 3% annually. In addition, we will receive an improvement allowance from the landlord of $11.8 million.

Investing activities

The change in cash provided by (used in) investing activities in the six months ended June 30, 2021 was primarily driven by investments in financial instruments, an acquisition, and a decrease in office space related capital expenditures.

Financing activities

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

In November 2019, and as amended as of February 2020, July 2020, and September 2020, we entered into a five-year $100 million senior secured revolving credit agreement with PNC Bank, National Association. As of June 30, 2021, we had no outstanding borrowings under the Credit Facility. See "Note 8. Debt" in Item 1 of this Quarterly Report for additional information.

Stock repurchase program

Changes in the remaining stock repurchase authority:


(in thousands)	Six Months Ended June 30, 2021
December 31, 2020	$	37,726
Authorizations (1)	38,467
Repurchases (2)	(19,392)
June 30, 2021	$	56,801

(1) On June 8, 2021, we announced that our Board of Directors extended the current stock repurchase program’s expiration date to June 30, 2022 and increased the remaining common stock repurchase authority to $60 million.

(2) Purchases under this program have been made on the open market.

Common stock repurchases


	Six Months Ended June 30,
	2021			2020
(in thousands)	Shares	Amount		Shares	Amount
Tax withholdings for net settlement of equity awards	328	$	41,706	411	$	37,093
Stock repurchase program	151	19,392		110	8,199
	479	$	61,098	521	$	45,292

During the six months ended June 30, 2021 and 2020, instead of receiving cash from the equity holders, we withheld shares with a value of $27.8 million and $31.2 million, respectively, for the exercise price of options. These amounts are not included in the table above.

Dividends

We intend to pay a quarterly cash dividend of $0.03 per share. However, the Board of Directors may terminate or modify the dividend program at any time without prior notice.


	Six Months Ended June 30,
(in thousands)	2021		2020
Dividend payments to stockholders	$	4,865	$	4,793

Contractual obligations

As of June 30, 2021, our contractual obligations were:


	Payments due by period
(in thousands)	2021		2022		2023		2024		2025		2026 and thereafter		Other		Total
Convertible senior notes (1)	$	2,250	$	4,500	$	4,500	$	4,500	$	601,488	$	—	$	—	$	617,238
Purchase obligations (2)	28,215		60,242		12,539		1,938		429		—		—		103,363
Operating lease obligations (3)	8,783		13,888		13,300		10,021		6,913		9,823		—		62,728
Liability for uncertain tax positions (4)	—		—		—		—		—		—		1,665		1,665
	$	39,248	$	78,630	$	30,339	$	16,459	$	608,830	$	9,823	$	1,665	$	784,994

(1) Includes principal and interest.

(2) Represents the fixed or minimum amounts due under purchase obligations for hosting services and sales and marketing programs

(3) Excludes the Waltham lease, which we entered into on July 6, 2021. See "Note 14. Subsequent Events" in Item 1 of this Quarterly Report for additional information.

(4) We are unable to reasonably estimate the timing of the cash outflow due to uncertainties in the timing of the effective settlement of tax positions.

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.

Foreign currency exposure

Translation risk

Our foreign operations’ operating expenses are primarily denominated in foreign currencies. However, our international sales are also primarily denominated in foreign currencies, which partially offsets our foreign currency exposure.

A hypothetical 10% strengthening in the U.S. dollar against other currencies would have resulted in:


	Six Months Ended June 30,
	2021		2020
(Decrease) increase in revenue	(4)	%	(3)	%
(Decrease) increase in net income	(1)	%	(15)	%

Remeasurement risk

We experience fluctuations in transaction gains and losses from the remeasurement of monetary assets and liabilities 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 the Australian dollar, Euro, and U.S. dollar-denominated cash and cash equivalents, receivables, and intercompany receivables and payables held by our U.K. subsidiary, a British pound functional entity.

A hypothetical 10% strengthening in the British pound exchange rate in comparison to the Australian dollar, Euro, and U.S. dollar would have resulted in the following impact:


	Six Months Ended June 30,
(in thousands)	2021		2020
Foreign currency gain (loss)	$	(5,676)	$	8,932

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 June 30, 2021. 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 June 30, 2021.

(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 June 30, 2021 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1A. RISK FACTORS

We encourage you to consider carefully the risk factors identified in Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the U.S. Securities and Exchange Commission. These risk factors could materially affect our business, financial condition, and future results, and may 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.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Issuer purchases of equity securities

Common stock repurchased in the three months ended June 30, 2021:


(in thousands, except per share amounts)	Total Number of Shares Purchased (1) (2)	Average Price Paid per Share (1) (2)		Total Number of Shares Purchased as Part of Publicly Announced Share Repurchase Program (2)	Approximate Dollar Value of Shares That May Yet Be Purchased at Period End Under Publicly Announced Share Repurchase Programs (2)
April 1, 2021 - April 30, 2021	53	$	125.24	25	$	25,430
May 1, 2021 - May 31, 2021	96	121.41		25	$	22,431
June 1, 2021 - June 30, 2021	204	126.99		31	$	56,801
	353	$	125.20	81

(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) On June 8, 2021, we announced that our Board of Directors extended the current stock repurchase program’s expiration date to June 30, 2022 and increased the remaining stock repurchase authority to $60 million. See "Liquidity and Capital Resources" in Item 2 of this Quarterly Report for additional information.

ITEM 6. EXHIBITS

Exhibit No.

Description

Incorporation by Reference

Filed Herewith

Form

Exhibit

Filing Date

3.1

Restated Articles of Organization of the Registrant and Amendments thereto

10-Q

3.1

November 4, 2014

3.2

Amended and Restated Bylaws of Pegasystems Inc.

8-K

3.2

June 15, 2020

10.1

Sublease, dated March 31, 2021 for Office Space at One Main Street, Cambridge, MA

10.2**

Lease between Pegasystems Inc. and 275 Wyman LLC

8-K

10.1

July 9, 2021

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

Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.

101.SCH

Inline XBRL Taxonomy Extension Schema Document.

101.CAL

Inline XBRL Taxonomy Calculation Linkbase Document.

101.DEF

Inline XBRL Taxonomy Extension Definition Linkbase Document.

101.LAB

Inline XBRL Taxonomy Label Linkbase Document.

101.PRE

Inline XBRL Taxonomy Presentation Linkbase Document.

104

Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

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

** Certain portions of this exhibit are considered confidential and have been omitted as permitted under SEC rules and regulations.

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:	July 28, 2021	By:	/s/ KENNETH STILLWELL
			Kenneth Stillwell
			Chief Operating Officer and Chief Financial Officer
			(Principal Financial Officer)