PEGASYSTEMS INC - Quarter Report: 2021 March (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 March 31, 2021
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, 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 | x | 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 81,281,726 shares of the Registrant’s common stock, $0.01 par value per share, outstanding on April 19, 2021.
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 March 31, 2021 and December 31, 2020 | |||||
Unaudited Condensed Consolidated Statements of Operations for the three months ended March 31, 2021 and 2020 | |||||
Unaudited Condensed Consolidated Statements of Comprehensive (Loss) for the three months ended March 31, 2021 and 2020 | |||||
Unaudited Condensed Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2021 and 2020 | |||||
Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2021 and 2020 | |||||
| Notes to Unaudited Condensed Consolidated Financial Statements | |||||
| Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations | |||||
| Item 3. Quantitative and Qualitative Disclosures About Market Risk | |||||
| Item 4. Controls and Procedures | |||||
| PART II - OTHER INFORMATION | |||||
| Item 1A. Risk Factors | |||||
| Item 2. Unregistered Sales of Equity Securities and Use of Proceeds | |||||
| Item 6. Exhibits | |||||
| Signature | |||||
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) | |||||||||||
| March 31, 2021 | December 31, 2020 | ||||||||||
| Assets | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | 172,708 | $ | 171,899 | |||||||
| Marketable securities | 269,650 | 293,269 | |||||||||
| Total cash, cash equivalents, and marketable securities | 442,358 | 465,168 | |||||||||
| Accounts receivable | 159,324 | 215,827 | |||||||||
| Unbilled receivables | 228,603 | 207,155 | |||||||||
| Other current assets | 91,868 | 88,760 | |||||||||
| Total current assets | 922,153 | 976,910 | |||||||||
Unbilled receivables | 108,048 | 113,278 | |||||||||
| Goodwill | 82,037 | 79,231 | |||||||||
| Other long-term assets | 416,265 | 434,843 | |||||||||
| Total assets | $ | 1,528,503 | $ | 1,604,262 | |||||||
| Liabilities and stockholders’ equity | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable | $ | 24,426 | $ | 24,028 | |||||||
| Accrued expenses | 59,765 | 59,261 | |||||||||
| Accrued compensation and related expenses | 59,490 | 123,012 | |||||||||
| Deferred revenue | 244,170 | 232,865 | |||||||||
| Other current liabilities | 16,599 | 20,969 | |||||||||
| Total current liabilities | 404,450 | 460,135 | |||||||||
| Convertible senior notes, net | 588,418 | 518,203 | |||||||||
| Operating lease liabilities | 36,471 | 59,053 | |||||||||
| Other long-term liabilities | 20,239 | 24,699 | |||||||||
| Total liabilities | 1,049,578 | 1,062,090 | |||||||||
| Stockholders’ equity: | |||||||||||
Preferred stock, 1,000 shares authorized; none issued | — | — | |||||||||
Common stock, 200,000 shares authorized; 81,246 and 80,890 shares issued and outstanding at March 31, 2021 and December 31, 2020, respectively | 812 | 809 | |||||||||
| Additional paid-in capital | 140,558 | 204,432 | |||||||||
| Retained earnings | 340,223 | 339,879 | |||||||||
| Accumulated other comprehensive (loss) | (2,668) | (2,948) | |||||||||
| Total stockholders’ equity | 478,925 | 542,172 | |||||||||
| Total liabilities and stockholders’ equity | $ | 1,528,503 | $ | 1,604,262 | |||||||
See notes to unaudited condensed consolidated financial statements.
3
PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts) | |||||||||||
| Three Months Ended March 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| Revenue | |||||||||||
| Software license | $ | 116,961 | $ | 93,916 | |||||||
| Maintenance | 75,561 | 73,695 | |||||||||
| Pega Cloud | 67,858 | 43,466 | |||||||||
| Consulting | 53,119 | 54,514 | |||||||||
| Total revenue | 313,499 | 265,591 | |||||||||
| Cost of revenue | |||||||||||
| Software license | 650 | 684 | |||||||||
| Maintenance | 5,786 | 5,576 | |||||||||
| Pega Cloud | 22,557 | 17,533 | |||||||||
| Consulting | 53,454 | 55,735 | |||||||||
| Total cost of revenue | 82,447 | 79,528 | |||||||||
| Gross profit | 231,052 | 186,063 | |||||||||
| Operating expenses | |||||||||||
| Selling and marketing | 148,739 | 136,024 | |||||||||
| Research and development | 62,442 | 58,727 | |||||||||
| General and administrative | 18,270 | 15,630 | |||||||||
| Total operating expenses | 229,451 | 210,381 | |||||||||
| Income (loss) from operations | 1,601 | (24,318) | |||||||||
| Foreign currency transaction (loss) | (5,098) | (5,947) | |||||||||
| Interest income | 153 | 607 | |||||||||
| Interest expense | (1,880) | (2,306) | |||||||||
| (Loss) on capped call transactions | (19,117) | (18,592) | |||||||||
| Other income, net | 106 | 1,374 | |||||||||
| (Loss) before (benefit from) income taxes | (24,235) | (49,182) | |||||||||
| (Benefit from) income taxes | (17,618) | (23,810) | |||||||||
| Net (loss) | $ | (6,617) | $ | (25,372) | |||||||
| (Loss) per share | |||||||||||
| Basic | $ | (0.08) | $ | (0.32) | |||||||
| Diluted | $ | (0.08) | $ | (0.32) | |||||||
| Weighted-average number of common shares outstanding | |||||||||||
| Basic | 81,004 | 79,808 | |||||||||
| Diluted | 81,004 | 79,808 | |||||||||
See notes to unaudited condensed consolidated financial statements.
4
PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) (in thousands) | |||||||||||
| Three Months Ended March 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| Net (loss) | $ | (6,617) | $ | (25,372) | |||||||
| Other comprehensive income (loss), net of tax | |||||||||||
| Unrealized gain on available-for-sale securities | 1,010 | 100 | |||||||||
| Foreign currency translation adjustments | (730) | (514) | |||||||||
| Total other comprehensive income (loss), net of tax | 280 | (414) | |||||||||
| Comprehensive (loss) | $ | (6,337) | $ | (25,786) | |||||||
See notes to unaudited condensed consolidated financial statements.
5
| PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (in thousands, except per share amounts) | |||||||||||||||||||||||||||||||||||
Common Stock | Additional Paid-In Capital | Retained Earnings | Accumulated 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 | ||||||||||||||||||||||||
| 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 | ||||||||||||||||||||||||
See notes to unaudited condensed consolidated financial statements.
6
PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) | |||||||||||
| Three Months Ended March 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| Operating activities | |||||||||||
| Net (loss) | $ | (6,617) | $ | (25,372) | |||||||
| Adjustments to reconcile net (loss) to cash provided by (used in) operating activities | |||||||||||
| Stock-based compensation | 30,100 | 23,175 | |||||||||
| Loss on capped call transactions | 19,117 | 18,592 | |||||||||
| Deferred income taxes | (15,068) | (9,231) | |||||||||
| Amortization of deferred commissions | 11,496 | 8,497 | |||||||||
| Amortization of debt discount and issuance costs | 673 | 1,719 | |||||||||
| Amortization of intangible assets and depreciation | 7,006 | 4,919 | |||||||||
| Amortization of investments | 1,019 | — | |||||||||
| Foreign currency transaction loss | 5,098 | 5,947 | |||||||||
| Other non-cash | (556) | 2,478 | |||||||||
| Change in operating assets and liabilities, net | (30,618) | (49,047) | |||||||||
| Cash provided by (used in) operating activities | 21,650 | (18,323) | |||||||||
| Investing activities | |||||||||||
| Purchases of investments | (21,051) | (1,490) | |||||||||
| Proceeds from maturities and called investments | 40,867 | — | |||||||||
| Sales of investments | 2,450 | 1,424 | |||||||||
| Payments for acquisitions, net of cash acquired | (4,993) | — | |||||||||
| Investment in property and equipment | (1,784) | (12,496) | |||||||||
| Cash provided by (used in) investing activities | 15,489 | (12,562) | |||||||||
| 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 | 2,288 | — | |||||||||
| Dividend payments to stockholders | (2,427) | (2,388) | |||||||||
| Common stock repurchases | (34,655) | (29,011) | |||||||||
| Cash (used in) provided by financing activities | (34,794) | 502,174 | |||||||||
| Effect of exchange rate changes on cash and cash equivalents | (1,536) | (1,510) | |||||||||
| Net increase in cash and cash equivalents | 809 | 469,779 | |||||||||
| Cash and cash equivalents, beginning of period | 171,899 | 68,363 | |||||||||
| Cash and cash equivalents, end of period | $ | 172,708 | $ | 538,142 | |||||||
See notes to unaudited condensed consolidated financial statements.
7
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. The 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 the separation of 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
| March 31, 2021 | December 31, 2020 | ||||||||||||||||||||||||||||||||||||||||||||||
| (in thousands) | Amortized Cost | Unrealized Gains | Unrealized Losses | Fair Value | Amortized Cost | Unrealized Gains | Unrealized Losses | Fair Value | |||||||||||||||||||||||||||||||||||||||
| Government debt | $ | 13,000 | $ | 1 | $ | — | $ | 13,001 | $ | 39,996 | $ | — | $ | (8) | $ | 39,988 | |||||||||||||||||||||||||||||||
| Corporate debt | 257,003 | 15 | (369) | 256,649 | 253,345 | 88 | (152) | 253,281 | |||||||||||||||||||||||||||||||||||||||
| $ | 270,003 | $ | 16 | $ | (369) | $ | 269,650 | $ | 293,341 | $ | 88 | $ | (160) | $ | 293,269 | ||||||||||||||||||||||||||||||||
As of March 31, 2021, marketable securities’ maturities ranged from April 2021 to January 2024, with a weighted-average remaining maturity of approximately 1.4 years.
NOTE 4. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE
Receivables
(in thousands) | March 31, 2021 | December 31, 2020 | |||||||||
| Accounts receivable | $ | 159,324 | $ | 215,827 | |||||||
| Unbilled receivables | 228,603 | 207,155 | |||||||||
| Long-term unbilled receivables | 108,048 | 113,278 | |||||||||
| $ | 495,975 | $ | 536,260 | ||||||||
8
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
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) | March 31, 2021 | |||||||
| 1 year or less | $ | 228,603 | 68 | % | ||||
| 1-2 years | 80,688 | 24 | % | |||||
| 2-5 years | 27,360 | 8 | % | |||||
| $ | 336,651 | 100 | % | |||||
Unbilled receivables by contract effective date:
(Dollars in thousands) | March 31, 2021 | |||||||
| 2021 | $ | 46,625 | 14 | % | ||||
| 2020 | 163,226 | 48 | % | |||||
| 2019 | 63,600 | 19 | % | |||||
| 2018 | 28,885 | 9 | % | |||||
| 2017 and prior | 34,315 | 10 | % | |||||
| $ | 336,651 | 100 | % | |||||
Major clients
No client represented 10% or more of the Company’s total receivables as of March 31, 2021 or December 31, 2020.
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) | March 31, 2021 | December 31, 2020 | |||||||||
Contract assets (1) | $ | 13,454 | $ | 15,296 | |||||||
Long-term contract assets (2) | 7,284 | 7,777 | |||||||||
| $ | 20,738 | $ | 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) | March 31, 2021 | December 31, 2020 | |||||||||
| Deferred revenue | $ | 244,170 | $ | 232,865 | |||||||
Long-term deferred revenue (1) | 7,565 | 8,991 | |||||||||
| $ | 251,735 | $ | 241,856 | ||||||||
(1) Included in other long-term liabilities.
The change in deferred revenue in the three months ended March 31, 2021 was primarily due to new billings in advance of revenue recognition offset by $107.0 million of revenue recognized that was included in deferred revenue as of December 31, 2020.
NOTE 5. DEFERRED COMMISSIONS
(in thousands) | March 31, 2021 | December 31, 2020 | |||||||||
Deferred commissions (1) | $ | 103,474 | $ | 108,624 | |||||||
(1) Included in other long-term assets.
| Three Months Ended March 31, | |||||||||||
| (in thousands) | 2021 | 2020 | |||||||||
Amortization of deferred commissions (1) | $ | 11,496 | $ | 8,497 | |||||||
(1) Included in selling and marketing expense.
9
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 6. GOODWILL AND OTHER INTANGIBLES
Goodwill
Change in goodwill:
| Three Months Ended March 31, | |||||||||||
(in thousands) | 2021 | 2020 | |||||||||
| January 1, | $ | 79,231 | $ | 79,039 | |||||||
| Acquisition | 2,701 | — | |||||||||
| Currency translation adjustments | 105 | (541) | |||||||||
| March 31, | $ | 82,037 | $ | 78,498 | |||||||
Intangibles
Intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives.
| March 31, 2021 | |||||||||||||||||||||||
| (in thousands) | Useful Lives | Cost | Accumulated Amortization | Net Book Value (1) | |||||||||||||||||||
Client-related | 4-10 years | $ | 63,180 | $ | (56,260) | $ | 6,920 | ||||||||||||||||
Technology | 2-10 years | 67,142 | (57,014) | 10,128 | |||||||||||||||||||
Other | 1-5 years | 5,361 | (5,361) | — | |||||||||||||||||||
| $ | 135,683 | $ | (118,635) | $ | 17,048 | ||||||||||||||||||
(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.
Amortization of intangible assets:
| Three Months Ended March 31, | |||||||||||
| (in thousands) | 2021 | 2020 | |||||||||
Cost of revenue | $ | 629 | $ | 647 | |||||||
Selling and marketing | 373 | 371 | |||||||||
| $ | 1,002 | $ | 1,018 | ||||||||
Future estimated intangibles assets amortization:
(in thousands) | March 31, 2021 | ||||
| 2021 | $ | 2,985 | |||
| 2022 | 3,886 | ||||
| 2023 | 3,618 | ||||
| 2024 | 2,849 | ||||
| 2025 | 2,509 | ||||
| 2026 and thereafter | 1,201 | ||||
| $ | 17,048 | ||||
10
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 7. LEASES
Corporate headquarters
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. Upon modification, the Company reduced its lease liabilities by $21.1 million and accelerated depreciation of property, plant, and equipment related to the corporate headquarters.
Expense
| Three Months Ended March 31, | |||||||||||
| (in thousands) | 2021 | 2020 | |||||||||
| Fixed lease costs | $ | 300 | $ | 4,818 | |||||||
| Short-term lease costs | 459 | 455 | |||||||||
| Variable lease costs | 1,387 | 1,278 | |||||||||
| $ | 2,146 | $ | 6,551 | ||||||||
Right of use assets and lease liabilities
| (in thousands) | March 31, 2021 | December 31, 2020 | |||||||||
Right of use assets (1) | $ | 44,330 | $ | 67,651 | |||||||
Lease liabilities (2) | $ | 14,161 | $ | 18,541 | |||||||
| Long-term lease liabilities | $ | 36,471 | $ | 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:
| March 31, 2021 | December 31, 2020 | ||||||||||
| Weighted-average remaining lease term | 5.1 years | 4.7 years | |||||||||
Weighted-average discount rate (1) | 4.7 | % | 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.
Maturities of lease liabilities:
| (in thousands) | March 31, 2021 | ||||
| 1 year or less | $ | 13,216 | |||
| 1-2 years | 11,538 | ||||
| 2-3 years | 10,896 | ||||
| 3-4 years | 7,571 | ||||
| Greater than 4 years | 14,274 | ||||
| Total lease payments | 57,495 | ||||
Less: imputed interest (1) | (6,863) | ||||
| $ | 50,632 | ||||
(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
| Three Months Ended March 31, | |||||||||||
| (in thousands) | 2021 | 2020 | |||||||||
| Cash paid for leases | $ | 6,716 | $ | 5,520 | |||||||
| Right of use assets recognized for new leases and amendments (non-cash) | $ | 714 | $ | 551 | |||||||
11
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 8. DEBT
Convertible senior notes and capped calls
Convertible senior notes
In February 2020, the Company issued Convertible Senior Notes (the "Notes") with an aggregate principal of $600 million, due March 1, 2025, in a private placement. No principal payments are 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 March 31, 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.
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 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.
12
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Carrying value of the Notes:
| (in thousands) | March 31, 2021 | December 31, 2020 | |||||||||
| Principal | $ | 600,000 | $ | 600,000 | |||||||
| Unamortized debt discount | — | (71,222) | |||||||||
| Unamortized issuance costs | (11,582) | (10,575) | |||||||||
| Convertible senior notes, net | $ | 588,418 | $ | 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 March 31, | |||||||||||
| (in thousands) | 2021 | 2020 | |||||||||
Contractual interest expense (0.75% coupon) | $ | 1,125 | $ | 450 | |||||||
Amortization of debt discount | — | 1,497 | |||||||||
Amortization of issuance costs | 673 | 222 | |||||||||
| $ | 1,798 | $ | 2,169 | ||||||||
| Weighted-average effective interest rate | 1.2 | % | 4.3 | % | |||||||
Future payments of principal and contractual interest:
| March 31, 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 (“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 is required to 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.
13
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Change in capped call transactions:
| Three Months Ended March 31, | |||||||||||
| (in thousands) | 2021 | 2020 | |||||||||
| January 1, | $ | 83,597 | $ | — | |||||||
| Issuance | — | 51,900 | |||||||||
| Fair value adjustment | (19,117) | (18,592) | |||||||||
| March 31, | $ | 64,480 | $ | 33,308 | |||||||
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 (“PNC”). 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 on 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 on 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 March 31, 2021 and December 31, 2020, the Company had no outstanding borrowings under the Credit Facility.
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:
| March 31, 2021 | December 31, 2020 | ||||||||||||||||||||||||||||||||||||||||||||||
| (in thousands) | Level 1 | Level 2 | Level 3 | Total | Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||||||||||||||||||||||
| Cash equivalents | $ | 26,657 | $ | — | $ | — | $ | 26,657 | $ | 42,339 | $ | 14,000 | $ | — | $ | 56,339 | |||||||||||||||||||||||||||||||
| Marketable securities | $ | — | $ | 269,650 | $ | — | $ | 269,650 | $ | — | $ | 293,269 | $ | — | $ | 293,269 | |||||||||||||||||||||||||||||||
Capped Call Transactions (1) | $ | — | $ | 64,480 | $ | — | $ | 64,480 | $ | — | $ | 83,597 | $ | — | $ | 83,597 | |||||||||||||||||||||||||||||||
Venture investments (1) (2) | $ | — | $ | — | $ | 9,756 | $ | 9,756 | $ | — | $ | — | $ | 8,345 | $ | 8,345 | |||||||||||||||||||||||||||||||
(1) Included in other long-term assets. (2) Investments in privately-held companies.
14
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Change in venture investments:
| Three Months Ended March 31, | |||||||||||
| (in thousands) | 2021 | 2020 | |||||||||
| January 1, | $ | 8,345 | $ | 4,871 | |||||||
| New investments | 500 | 1,490 | |||||||||
| Sales of investments | (400) | (1,424) | |||||||||
| Changes in foreign exchange rates | (9) | (73) | |||||||||
| Changes in fair value: | |||||||||||
| included in other income | 100 | 1,374 | |||||||||
| included in other comprehensive income | 1,220 | 100 | |||||||||
| March 31, | $ | 9,756 | $ | 6,338 | |||||||
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 $665.9 million as of March 31, 2021. 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.
NOTE 10. REVENUE
Geographic revenue
| Three Months Ended March 31, | |||||||||||||||||
(Dollars in thousands) | 2021 | 2020 | |||||||||||||||
| U.S. | $ | 194,568 | 62 | % | $ | 172,417 | 65 | % | |||||||||
| Other Americas | 11,901 | 4 | % | 15,342 | 6 | % | |||||||||||
| United Kingdom (“U.K.”) | 28,212 | 9 | % | 21,837 | 8 | % | |||||||||||
| Europe (excluding U.K.), Middle East, and Africa | 51,659 | 16 | % | 31,938 | 12 | % | |||||||||||
| Asia-Pacific | 27,159 | 9 | % | 24,057 | 9 | % | |||||||||||
| $ | 313,499 | 100 | % | $ | 265,591 | 100 | % | ||||||||||
Revenue streams
| Three Months Ended March 31, | |||||||||||
(in thousands) | 2021 | 2020 | |||||||||
| Perpetual license | $ | 5,452 | $ | 3,659 | |||||||
| Term license | 111,509 | 90,257 | |||||||||
| Revenue recognized at a point in time | 116,961 | 93,916 | |||||||||
| Maintenance | 75,561 | 73,695 | |||||||||
| Pega Cloud | 67,858 | 43,466 | |||||||||
| Consulting | 53,119 | 54,514 | |||||||||
| Revenue recognized over time | 196,538 | 171,675 | |||||||||
| $ | 313,499 | $ | 265,591 | ||||||||
15
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
| (in thousands) | Three Months Ended March 31, | ||||||||||
| 2021 | 2020 | ||||||||||
| Pega Cloud | $ | 67,858 | $ | 43,466 | |||||||
| Maintenance | 75,561 | 73,695 | |||||||||
| Term license | 111,509 | 90,257 | |||||||||
Subscription (1) | 254,928 | 207,418 | |||||||||
| Perpetual license | 5,452 | 3,659 | |||||||||
| Consulting | 53,119 | 54,514 | |||||||||
| $ | 313,499 | $ | 265,591 | ||||||||
(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:
| March 31, 2021 | ||||||||||||||||||||||||||||||||||||||
(Dollars in thousands) | Perpetual license | Term license | Maintenance | Pega Cloud | Consulting | Total | ||||||||||||||||||||||||||||||||
| 1 year or less | $ | 9,649 | $ | 41,025 | $ | 220,100 | $ | 252,104 | $ | 21,068 | $ | 543,946 | 55 | % | ||||||||||||||||||||||||
| 1-2 years | 629 | 9,874 | 52,366 | 187,456 | 914 | 251,239 | 26 | % | ||||||||||||||||||||||||||||||
| 2-3 years | — | 7,055 | 33,337 | 91,861 | 1,756 | 134,009 | 14 | % | ||||||||||||||||||||||||||||||
| Greater than 3 years | — | 377 | 16,834 | 32,895 | 510 | 50,616 | 5 | % | ||||||||||||||||||||||||||||||
| $ | 10,278 | $ | 58,331 | $ | 322,637 | $ | 564,316 | $ | 24,248 | $ | 979,810 | 100 | % | |||||||||||||||||||||||||
| March 31, 2020 | ||||||||||||||||||||||||||||||||||||||
(Dollars in thousands) | Perpetual license | Term license | Maintenance | Pega Cloud | Consulting | Total | ||||||||||||||||||||||||||||||||
| 1 year or less | $ | 3,995 | $ | 30,962 | $ | 205,083 | $ | 174,277 | $ | 18,945 | $ | 433,262 | 58 | % | ||||||||||||||||||||||||
| 1-2 years | 2,168 | 5,088 | 34,633 | 125,473 | 1,215 | 168,577 | 22 | % | ||||||||||||||||||||||||||||||
| 2-3 years | — | 6,504 | 19,411 | 81,187 | 107 | 107,209 | 14 | % | ||||||||||||||||||||||||||||||
| Greater than 3 years | — | 635 | 10,596 | 33,537 | 10 | 44,778 | 6 | % | ||||||||||||||||||||||||||||||
| $ | 6,163 | $ | 43,189 | $ | 269,723 | $ | 414,474 | $ | 20,277 | $ | 753,826 | 100 | % | |||||||||||||||||||||||||
NOTE 11. STOCK-BASED COMPENSATION
Expense
| Three Months Ended March 31, | |||||||||||
| (in thousands) | 2021 | 2020 | |||||||||
Cost of revenue | $ | 5,925 | $ | 5,152 | |||||||
Selling and marketing | 13,720 | 9,718 | |||||||||
Research and development | 6,770 | 5,496 | |||||||||
General and administrative | 3,685 | 2,809 | |||||||||
| $ | 30,100 | $ | 23,175 | ||||||||
Income tax benefit | $ | (5,991) | $ | (4,582) | |||||||
As of March 31, 2021, the Company had $183.4 million of unrecognized stock-based compensation expense, net of estimated forfeitures, which is expected to be recognized over a weighted-average period of 2.3 years.
Grants
| Three Months Ended March 31, 2021 | |||||||||||
| (in thousands) | Shares | Total Fair Value | |||||||||
RSUs | 684 | $ | 89,291 | ||||||||
Non-qualified stock options | 1,248 | $ | 47,380 | ||||||||
16
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12. INCOME TAXES
Effective income tax rate
| Three Months Ended March 31, | |||||||||||
| (Dollars in thousands) | 2021 | 2020 | |||||||||
| (Benefit from) income taxes | $ | (17,618) | $ | (23,810) | |||||||
| Effective income tax benefit rate | 73 | % | 48 | % | |||||||
The increase in the Company’s effective income tax benefit rate was primarily due to excess tax benefits from stock-based compensation and fair value adjustments for the capped call transactions, which were proportionally larger on a lower loss before income taxes.
NOTE 13. (LOSS) PER SHARE
Basic (loss) per share is calculated using the weighted-average number of common shares outstanding during the period. Diluted (loss) per share is calculated using the weighted-average number of common shares outstanding during the period, plus the dilutive effect of outstanding stock options, RSUs, and convertible senior notes.
Calculation of (loss) per share:
| Three Months Ended March 31, | |||||||||||
| (in thousands, except per share amounts) | 2021 | 2020 | |||||||||
| Net (loss) | $ | (6,617) | $ | (25,372) | |||||||
| Weighted-average common shares outstanding | 81,004 | 79,808 | |||||||||
| (Loss) per share, basic | $ | (0.08) | $ | (0.32) | |||||||
| Net (loss) | $ | (6,617) | $ | (25,372) | |||||||
Weighted-average common shares outstanding, assuming dilution (1) (2) (3) | 81,004 | 79,808 | |||||||||
| (Loss) per share, diluted | $ | (0.08) | $ | (0.32) | |||||||
Outstanding anti-dilutive stock options and RSUs (4) | 6,465 | 5,948 | |||||||||
(1) In periods of loss, all dilutive securities are excluded as their inclusion would be anti-dilutive.
(2) The shares underlying the conversion options in the Company’s Notes are included using the if-converted method, if dilutive in the period. If the outstanding conversion options were fully exercised, the Company would issue an additional 4.4 million shares.
(3) The Company’s Capped Call Transactions cover 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 is required to 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 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 (loss) per share. These awards may be dilutive in the future.
17
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;
•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 as the result of new information, future events, or otherwise.
The forward-looking statements contained in this Quarterly Report represent our views as of April 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.
18
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 late 2022 or early 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 March 31, 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 20% since March 31, 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. Reported amounts have not been adjusted for changes in foreign exchange rates. Foreign currency exchange rate changes contributed 3% to total ACV growth in 2021.
19
Remaining performance obligations (“Backlog”) | Increased 30% since March 31, 2020
•Backlog represents expected future revenue on existing non-cancellable contracts.
Year to date Pega Cloud revenue | Increased 56% since the three months ended March 31, 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:
20
•“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 March 31, | Change | ||||||||||||||||||||||||
| 2021 | 2020 | |||||||||||||||||||||||||
| Pega Cloud | $ | 67,858 | 22 | % | $ | 43,466 | 16 | % | $ | 24,392 | 56 | % | ||||||||||||||
| Maintenance | 75,561 | 23 | % | 73,695 | 28 | % | 1,866 | 3 | % | |||||||||||||||||
| Term license | 111,509 | 36 | % | 90,257 | 34 | % | 21,252 | 24 | % | |||||||||||||||||
Subscription (1) | 254,928 | 81 | % | 207,418 | 78 | % | 47,510 | 23 | % | |||||||||||||||||
| Perpetual license | 5,452 | 2 | % | 3,659 | 1 | % | 1,793 | 49 | % | |||||||||||||||||
| Consulting | 53,119 | 17 | % | 54,514 | 21 | % | (1,395) | (3) | % | |||||||||||||||||
| $ | 313,499 | 100 | % | $ | 265,591 | 100 | % | $ | 47,908 | 18 | % | |||||||||||||||
(1) Reflects client arrangements subject to renewal (Pega Cloud, maintenance, and term license).
The total revenue change in the three months ended March 31, 2021 generally reflects 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 periods. 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 March 31, 2021, multi-year committed maintenance contributed $3.4 million to maintenance revenue growth and reduced term revenue growth by $5.5 million.
•Maintenance renewal rates of higher than 90%.
•The decrease in consulting revenue in the three months ended March 31, 2021 was primarily due to a decrease in billable travel expenses as a result of COVID-19. 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 March 31, | Change | |||||||||||||||||||||||||
| (Dollars in thousands) | 2021 | 2020 | ||||||||||||||||||||||||
| Software license | $ | 116,311 | 99 | % | $ | 93,232 | 99 | % | $ | 23,079 | 25 | % | ||||||||||||||
| Maintenance | 69,775 | 92 | % | 68,119 | 92 | % | 1,656 | 2 | % | |||||||||||||||||
| Pega Cloud | 45,301 | 67 | % | 25,933 | 60 | % | 19,368 | 75 | % | |||||||||||||||||
| Consulting | (335) | (1) | % | (1,221) | (2) | % | 886 | 73 | % | |||||||||||||||||
| $ | 231,052 | 74 | % | $ | 186,063 | 70 | % | $ | 44,989 | 24 | % | |||||||||||||||
•The changes in gross profit in the three months ended March 31, 2021 were primarily due to our Cloud Transition, revenue growth, and cost-efficiency gains as Pega Cloud grows and scales.
•The increase in consulting gross profit in the three months ended March 31, 2021 was primarily due to an increase in consultant utilization. Consultant utilization is impacted by several factors, including the timing and scope of new implementation projects and the extent of our involvement compared to our consulting partners and enabled clients.
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Operating expenses
| (Dollars in thousands) | Three Months Ended March 31, | Change | ||||||||||||||||||||||||
| 2021 | 2020 | |||||||||||||||||||||||||
| % of Revenue | % of Revenue | |||||||||||||||||||||||||
| Selling and marketing | $ | 148,739 | 47 | % | $ | 136,024 | 51 | % | $ | 12,715 | 9 | % | ||||||||||||||
| Research and development | $ | 62,442 | 20 | % | $ | 58,727 | 22 | % | $ | 3,715 | 6 | % | ||||||||||||||
| General and administrative | $ | 18,270 | 6 | % | $ | 15,630 | 6 | % | $ | 2,640 | 17 | % | ||||||||||||||
•The increase in selling and marketing in the three months ended March 31, 2021 was primarily due to an increase in compensation and benefits of $25.4 million, attributable to increases in headcount and equity compensation, partially offset by decreases in travel and entertainment of $6.0 million and sales and marketing events of $7.9 million due to COVID-19. The increase in headcount reflect our efforts to increase our sales capacity to deepen relationships with existing clients and target new accounts.
•The increase in research and development in the three months ended March 31, 2021 was primarily due to an increase in compensation and benefits of $4.6 million, attributable to increases in headcount and equity compensation.
•The increase in general and administrative in the three months ended March 31, 2021 was primarily due to an increase in compensation and benefits of $1.1 million, attributable to increases in headcount and equity compensation, and an increase in professional services fees of $1.6 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 a decrease in facilities expense of $2.1 million in selling and marketing, $1.7 million in research and development, and $0.3 million in general and administrative in the three months ended March 31, 2021.
Other income (expense), net
| (Dollars in thousands) | Three Months Ended March 31, | Change | ||||||||||||||||||
| 2021 | 2020 | |||||||||||||||||||
| Foreign currency transaction (loss) | $ | (5,098) | $ | (5,947) | $ | 849 | 14 | % | ||||||||||||
| Interest income | 153 | 607 | (454) | (75) | % | |||||||||||||||
| Interest expense | (1,880) | (2,306) | 426 | 18 | % | |||||||||||||||
| (Loss) on capped call transactions | (19,117) | (18,592) | (525) | (3) | % | |||||||||||||||
| Other income, net | 106 | 1,374 | (1,268) | (92) | % | |||||||||||||||
| $ | (25,836) | $ | (24,864) | $ | (972) | (4) | % | |||||||||||||
•The change in foreign currency transaction (loss) in the three months ended March 31, 2021 was 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 decrease in interest income in the three months ended March 31, 2021 was primarily due to a decrease in market interest rates.
•The decrease in interest expense in the three months ended March 31, 2021 was 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 March 31, | Change | ||||||||||||||||
| (in thousands) | 2021 | 2020 | |||||||||||||||
Contractual interest expense (0.75% coupon) | $ | 1,125 | $ | 450 | $ | 675 | |||||||||||
| Amortization of debt discount | — | 1,497 | (1,497) | ||||||||||||||
| Amortization of issuance costs | 673 | 222 | 451 | ||||||||||||||
| $ | 1,798 | $ | 2,169 | $ | (371) | ||||||||||||
•The increase in the (loss) on capped call transactions in the three months ended March 31, 2021 was due to fair value adjustments.
•The decrease in other income, net in the three months ended March 31, 2021 was due to an increase in the value of our venture investments portfolio in the three months ended March 31, 2020.
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(Benefit from) income taxes
| Three Months Ended March 31, | |||||||||||
| (Dollars in thousands) | 2021 | 2020 | |||||||||
| (Benefit from) income taxes | $ | (17,618) | $ | (23,810) | |||||||
| Effective income tax benefit rate | 73 | % | 48 | % | |||||||
During the three months ended March 31, 2021, the increase in our effective income tax benefit rate was primarily due to excess tax benefits from stock-based compensation and fair value adjustments for the capped call transactions, which were proportionally larger on a lower loss before income taxes.
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
| Three Months Ended March 31, | |||||||||||
| (in thousands) | 2021 | 2020 | |||||||||
| Cash provided by (used in): | |||||||||||
| Operating activities | $ | 21,650 | $ | (18,323) | |||||||
| Investing activities | 15,489 | (12,562) | |||||||||
| Financing activities | (34,794) | 502,174 | |||||||||
| Effect of exchange rates on cash and cash equivalents | (1,536) | (1,510) | |||||||||
| Net increase in cash and cash equivalents | $ | 809 | $ | 469,779 | |||||||
(in thousands) | March 31, 2021 | December 31, 2020 | |||||||||
Held by U.S. entities | $ | 342,016 | $ | 399,138 | |||||||
Held by foreign entities | 100,342 | 66,030 | |||||||||
Total cash, cash equivalents, and marketable securities | $ | 442,358 | $ | 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 became 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 and is expected to continue to impact our billings and timing of 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 three months ended March 31, 2021 was primarily due to a significant increase in client collections. 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, 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.
Investing activities
The change in cash provided by (used in) investing activities in the three months ended March 31, 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 March 31, 2021, we had no outstanding borrowings under the Credit Facility. See "Note 8. Debt" in Item 1 of this Quarterly Report for additional information.
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Stock repurchase program
Changes in the remaining stock repurchase authority:
| (in thousands) | Three Months Ended March 31, 2021 | ||||
| December 31, 2020 | $ | 37,726 | |||
Repurchases (1) | (9,146) | ||||
| March 31, 2021 | $ | 28,580 | |||
(1) Purchases under this program have been made on the open market.
Common stock repurchases
| Three Months Ended March 31, | |||||||||||||||||||||||
| 2021 | 2020 | ||||||||||||||||||||||
| (in thousands) | Shares | Amount | Shares | Amount | |||||||||||||||||||
| Tax withholdings for net settlement of equity awards | 197 | $ | 25,509 | 257 | $ | 23,011 | |||||||||||||||||
| Stock repurchase program | 70 | 9,146 | 87 | 6,000 | |||||||||||||||||||
| 267 | $ | 34,655 | 344 | $ | 29,011 | ||||||||||||||||||
During the three months ended March 31, 2021 and 2020, instead of receiving cash from the equity holders, we withheld shares with a value of $10.1 million and $15.3 million, respectively, for the exercise price of options. These amounts have been excluded from 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.
| Three Months Ended March 31, | |||||||||||
| (in thousands) | 2021 | 2020 | |||||||||
| Dividend payments to stockholders | $ | 2,427 | $ | 2,388 | |||||||
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:
| Three Months Ended March 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| (Decrease) increase in revenue | (4) | % | (3) | % | |||||||
| (Decrease) increase in net income | 20 | % | (14) | % | |||||||
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:
| Three Months Ended March 31, | |||||||||||
| (in thousands) | 2021 | 2020 | |||||||||
| Foreign currency gain (loss) | $ | (7,522) | $ | 7,190 | |||||||
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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 March 31, 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 March 31, 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 March 31, 2021 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
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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 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 March 31, 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) | |||||||||||||||||||
| January 1, 2021 - January 31, 2021 | 29 | $ | 134.92 | 21 | $ | 34,877 | |||||||||||||||||
| February 1, 2021 - February 28, 2021 | 81 | 140.75 | 20 | $ | 32,028 | ||||||||||||||||||
| March 1, 2021 - March 31, 2021 | 234 | 125.62 | 29 | $ | 28,580 | ||||||||||||||||||
| 344 | $ | 129.95 | 70 | ||||||||||||||||||||
(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 15, 2020, we announced that our Board of Directors extended the current stock repurchase program’s expiration date to June 30, 2021 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 | |||||||
| 3.1 | ||||||||
| 3.2 | ||||||||
| 31.1+ | ||||||||
| 31.2+ | ||||||||
| 32++ | ||||||||
| 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) | |||||||
+ Filed herewith.
++ Indicates that the exhibit is being furnished with this report and is not filed as a part of it.
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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: | April 28, 2021 | By: | /s/ KENNETH STILLWELL | ||||||||
| Kenneth Stillwell | |||||||||||
| Chief Operating Officer and Chief Financial Officer | |||||||||||
| (Principal Financial Officer) | |||||||||||