PEGASYSTEMS INC.
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.
19
--------------------------------------------------------------------------------
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.
[[Image Removed: pega-20210630_g1.jpg]]* Foreign currency exchange rate changes contributed 3-4% to total ACV growth in 2021.
20
--------------------------------------------------------------------------------
Remaining performance obligations ("Backlog") | Increased 26% since June 30,
2020
•Backlog represents expected future revenue on existing non-cancellable
contracts.
[[Image Removed: pega-20210630_g2.jpg]]
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.
[[Image Removed: pega-20210630_g3.jpg]]
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.
21
--------------------------------------------------------------------------------
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.
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands) 2021 2020 Change 2021 2020 Change
Pega Cloud $ 73,293 23 % $ 48,838 21
%
$ 183,078 56 %$ 116,488 52
%
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 Six Months Ended
June 30, June 30,
(Dollars in thousands) 2021 2020 Change 2021 2020 Change
Software license $ 116,236 99 % $ 52,344 98
%
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.
22
--------------------------------------------------------------------------------Operating expenses
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands) 2021 2020 Change 2021 2020 Change
% 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
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands) 2021 2020 Change 2021 2020 Change
Foreign currency $ (403) $ 4,256 $ (4,659) $ (5,501) $ (1,691) $ (3,810) (225) %
transaction (loss) gain *
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 6,890 6,365 770 %
transactions 26,309 19,419 35 % 7,192 827
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 Six Months Ended
June 30, June 30,
(in thousands) 2021 2020 Change 2021 2020 Change
Contractual interest expense (0.75% $ - $ 675
coupon) $ 1,125 $ 1,125 $ 2,250 $ 1,575
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 .
23
--------------------------------------------------------------------------------
(Benefit from) income taxes
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands) 2021 2020 2021 2020
(Benefit from) income taxes
(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) 485,293Effect of exchange rates on cash and cash equivalents (1,207)
(942)
Net (decrease) increase in cash and cash equivalents$ (32,021) $ 443,748 December 31, (in thousands) June 30, 2021 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
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 payU.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, particularlyPega 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 ofPega 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 endedJune 30, 2021 was primarily due to a significant increase in client collections. Corporate headquarters InFebruary 2021 , we agreed to accelerate our exit from our existingCambridge, Massachusetts corporate headquarters toOctober 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 . OnMarch 31, 2021 we leased office space atOne 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. NewWaltham Office OnJuly 6, 2021 , we entered into an office space lease (the "Lease") for 131 thousand square feet inWaltham, Massachusetts . The lease term of approximately 11 years is expected to commence onAugust 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 onAugust 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 . 24 -------------------------------------------------------------------------------- Investing activities The change in cash provided by (used in) investing activities in the six months endedJune 30, 2021 was primarily driven by investments in financial instruments, an acquisition, and a decrease in office space related capital expenditures. Financing activities InFebruary 2020 , we issued$600 million in aggregate principal amount of convertible senior notes dueMarch 1, 2025 . InNovember 2019 , and as amended as ofFebruary 2020 ,July 2020 , andSeptember 2020 , we entered into a five-year$100 million senior secured revolving credit agreement withPNC Bank, National Association . As ofJune 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: Six Months Ended (in thousands) June 30, 2021 December 31, 2020 $ 37,726 Authorizations (1) 38,467 Repurchases (2) (19,392) June 30, 2021 $ 56,801 (1) OnJune 8, 2021 , we announced that our Board of Directors extended the current stock repurchase program's expiration date toJune 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 endedJune 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$0.03 per share. However, the Board of Directors may terminate or modify the dividend program at any time without prior notice. Six Months Ended June 30, (in thousands) 2021 2020
Dividend payments to stockholders
Contractual obligations As ofJune 30, 2021 , our contractual obligations were: Payments due by period 2026 and (in thousands) 2021 2022 2023 2024 2025 thereafter Other Total Convertible senior notes (1)$ 2,250 $ 4,500 $ 4,500
$ 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 theWaltham lease, which we entered into onJuly 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. 25
--------------------------------------------------------------------------------
© Edgar Online, source
