PEGASYSTEMS INC.

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS


			Page
PART I - FINANCIAL INFORMATION

			~~Page~~
~~PART I - FINANCIAL INFORMATION~~

Item 1. ~~Unaudited Condensed Consolidated~~ Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of June 30, ~~2019~~2020 and December 31, ~~2018~~2019			3
Unaudited Condensed Consolidated Statements of Operations for the three and six months ended June 30, ~~2019~~2020 and ~~2018~~2019			4
Unaudited Condensed Consolidated Statements of Comprehensive (Loss) for the three and six months ended June 30, ~~2019~~2020 and ~~2018~~2019			5
Unaudited Condensed Consolidated Statements of Stockholders’ Equity for the six months ended June 30, ~~2019~~2020 and ~~2018~~2019			6
Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, ~~2019~~2020 and ~~2018~~2019			7
Notes to Unaudited Condensed Consolidated Financial Statements			8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			16
Item 3. Quantitative and Qualitative Disclosures About Market Risk			22
Item 4. Controls and Procedures			23

PART II - OTHER INFORMATION

Item 1A. Risk Factors			2324
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			2327
Item 6. Exhibits			2428

Signature			2529

Table of Contents

PART I - FINANCIAL INFORMATION

ITEM 1. ~~UNAUDITED CONDENSED CONSOLIDATED~~ FINANCIAL STATEMENTS

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)


	June 30, 2020		December 31, 2019
Assets
Current assets:
Cash and cash equivalents	$	512,111	$	68,363


Accounts receivable	181,686		199,720
Unbilled receivables	198,253		180,219
Other current assets	77,889		57,308
Total current assets	969,939		505,610
Unbilled receivables	109,308		121,736
Goodwill	78,675		79,039
Other long-term assets	338,363		278,427
Total assets	$	1,496,285	$	984,812
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	18,426	$	17,475
Accrued expenses	44,228		48,001
Accrued compensation and related expenses	78,834		104,126
Deferred revenue	195,996		190,080
Other current liabilities	18,613		18,273
Total current liabilities	356,097		377,955
Convertible senior notes, net	509,423		—
Operating lease liabilities	53,057		52,610
Other long-term liabilities	21,426		15,237
Total liabilities	940,003		445,802
Stockholders’ equity:
Preferred stock, 1,000 shares authorized; NaN issued	—		—
Common stock, 200,000 shares authorized; 80,420 and 79,599 shares issued and outstanding at June 30, 2020 and December 31, 2019, respectively	804		796
Additional paid-in capital	207,103		140,523
Retained earnings	359,989		410,919
Accumulated other comprehensive (loss)	(11,614)		(13,228)
Total stockholders’ equity	556,282		539,010
Total liabilities and stockholders’ equity	$	1,496,285	$	984,812

June 30, 2019 December 31, 2018
Assets
Current assets:
Cash and cash equivalents $ 95,500

$ 114,422
Marketable securities 59,549

93,001
Total cash, cash equivalents, and marketable securities 155,049
207,423
Accounts receivable 134,965

180,872
Unbilled receivables 169,554

172,656
Other current assets 77,290

49,684
Total current assets 536,858
610,635
Long-term unbilled receivables 117,889

151,237
Goodwill 79,037

72,858
Other long-term assets 206,833

147,823
Total assets $ 940,617
$ 982,553
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable $ 14,586

$ 16,487
Accrued expenses 50,372

45,506
Accrued compensation and related expenses 62,880

84,671
Deferred revenue 169,009

185,145
Other current liabilities 14,576
—
Total current liabilities 311,423
331,809
Operating lease liabilities 54,292
—
Deferred income tax liabilities 6,918

6,939
Other long-term liabilities 10,697

22,274
Total liabilities 383,330
361,022
Stockholders’ equity:
Preferred stock, 1,000 shares authorized; none issued —
—
Common stock, 200,000 shares authorized; 79,144 and 78,526 shares issued and outstanding at
June 30, 2019 and December 31, 2018, respectively
791

785
Additional paid-in capital 122,880

123,205
Retained earnings 445,108

510,863
Accumulated other comprehensive (loss) (11,492 ) (13,322 )
Total stockholders’ equity 557,287
621,531
Total liabilities and stockholders’ equity $ 940,617
$ 982,553

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)


	Three Months Ended June 30,						Six Months Ended June 30,
	2020		2019		2020		2019
Revenue
Software license	$	53,323	$	44,274	$	147,239	$	107,538
Maintenance	72,222		69,329		145,917		137,035
Pega Cloud	48,838		31,699		92,304		59,457
Consulting	52,992		60,290		107,506		114,108
Total revenue	227,375		205,592		492,966		418,138
Cost of revenue
Software license	979		928		1,663		2,306
Maintenance	5,591		6,292		11,167		12,627
Pega Cloud	18,988		16,647		36,521		29,945
Consulting	51,133		53,213		106,868		106,639
Total cost of revenue	76,691		77,080		156,219		151,517
Gross profit	150,684		128,512		336,747		266,621
Operating expenses
Selling and marketing	127,607		116,962		263,631		225,827
Research and development	58,869		49,714		117,596		100,310
General and administrative	15,655		14,174		31,285		26,850
Total operating expenses	202,131		180,850		412,512		352,987
(Loss) from operations	(51,447)		(52,338)		(75,765)		(86,366)
Foreign currency transaction gain (loss)	4,256		2,105		(1,691)		(1,607)
Interest income	242		544		849		1,267
Interest expense	(5,529)		—		(7,835)		—
Gain on capped call transactions	19,419		—		827		—
Other income, net	—		55		1,374		55
(Loss) before (benefit from) income taxes	(33,059)		(49,634)		(82,241)		(86,651)
(Benefit from) income taxes	(12,319)		(17,338)		(36,129)		(25,638)
Net (loss)	$	(20,740)	$	(32,296)	$	(46,112)	$	(61,013)
(Loss) per share
Basic	$	(0.26)	$	(0.41)	$	(0.58)	$	(0.77)
Diluted	$	(0.26)	$	(0.41)	$	(0.58)	$	(0.77)
Weighted-average number of common shares outstanding
Basic	80,224		78,987		80,016		78,787
Diluted	80,224		78,987		80,016		78,787

Three Months Ended
June 30, Six Months Ended
June 30,
2019 2018 2019 2018
Revenue
Software license $ 44,274
$ 44,784
$ 107,538
$ 132,557
Maintenance 69,329
65,906
137,035
130,431
Services 91,989
86,089
173,565
168,973
Total revenue 205,592
196,779
418,138
431,961
Cost of revenue
Software license 928
1,262
2,306
2,517
Maintenance 6,292
5,874
12,627
11,956
Services 69,860
66,681
136,584
134,958
Total cost of revenue 77,080
73,817
151,517
149,431
Gross profit 128,512
122,962
266,621
282,530
Operating expenses
Selling and marketing 116,962
93,972
225,827
182,355
Research and development 49,714
41,972
100,310
88,757
General and administrative 14,174
10,181
26,850
26,645
Total operating expenses 180,850
146,125
352,987
297,757
(Loss) from operations (52,338 ) (23,163 ) (86,366 ) (15,227 )
Foreign currency transaction gain (loss) 2,105
1,244
(1,607 ) 159
Interest income, net 544
629
1,267
1,393
Other income, net 55
—
55
363
(Loss) before (benefit from) income taxes (49,634 ) (21,290 ) (86,651 ) (13,312 )
(Benefit from) income taxes (17,338 ) (10,881 ) (25,638 ) (15,103 )
Net (loss) income $ (32,296 ) $ (10,409 ) $ (61,013 ) $ 1,791
(Loss) earnings per share
Basic $ (0.41 ) $ (0.13 ) $ (0.77 ) $ 0.02
Diluted $ (0.41 ) $ (0.13 ) $ (0.77 ) $ 0.02
Weighted-average number of common shares outstanding
Basic 78,987
78,635
78,787
78,436
Diluted 78,987
78,635
78,787
83,247

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS)

(in thousands)


	Three Months Ended June 30,						Six Months Ended June 30,
	2020		2019		2020		2019
Net (loss)	$	(20,740)	$	(32,296)	$	(46,112)	$	(61,013)
Other comprehensive income (loss), net of tax
Unrealized gain on available-for-sale securities	—		238		100		612
Foreign currency translation adjustments	2,028		(409)		1,514		1,218
Total other comprehensive income (loss), net of tax	2,028		(171)		1,614		1,830
Comprehensive (loss)	$	(18,712)	$	(32,467)	$	(44,498)	$	(59,183)

Three Months Ended
June 30, Six Months Ended
June 30,
2019 2018 2019 2018
Net (loss) income $ (32,296 ) $ (10,409 ) $ (61,013 ) $ 1,791
Other comprehensive (loss) income, net of tax
Unrealized gain (loss) on available-for-sale marketable securities 238
73
612
(115 )
Foreign currency translation adjustments (409 ) (7,414 ) 1,218
(2,964 )
Total other comprehensive (loss) income, net of tax (171 ) (7,341 ) 1,830
(3,079 )
Comprehensive (loss) $ (32,467 ) $ (17,750 ) $ (59,183 ) $ (1,288 )

See notes to unaudited condensed consolidated financial statements.

~~PEGASYSTEMS INC.~~

~~UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY~~

~~(in thousands, except per share amounts)~~


PEGASYSTEMS INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (in thousands, except per share amounts)																				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
	Common Stock					Additional Paid-In Capital				Retained Earnings				Accumulated Other Comprehensive (Loss) Income			Total Stockholders’ Equity
	Number of Shares		Amount
December 31, 2017	78,081		$	781					$				152,097								$	509,697	$	(6,705	)		$	655,870
Repurchase of common stock	(101	)	(1		)	(5,688		)		—				—			(5,689		)
Issuance of common stock for share-based compensation plans	566		5			(15,556		)		—				—			(15,551		)
Stock-based compensation	—		—			15,109				—				—			15,109
Cash dividends declared ($0.12 per share)	—		—			—				(2,355		)		—			(2,355		)
Other comprehensive income	—		—			—								4,262			4,262
Net income	—		—			—				12,200				—			12,200
March 31, 2018	78,546		785			145,962				519,542				(2,443		)	663,846
Repurchase of common stock	(171	)	(2		)	(10,179		)		—				—			(10,181		)
Issuance of common stock for share-based compensation plans	358		4			(11,395		)		—				—			(11,391		)
Issuance of common stock under Employee Stock Purchase Plan	15		—			849				—				—			849
Stock-based compensation	—		—			16,163				—				—			16,163
Cash dividends declared ($0.12 per share)	—		—			—				(2,364		)		—			(2,364		)
Other comprehensive loss	—		—			—				—				(7,341		)	(7,341		)
Net loss	—		—			—				(10,409		)		—			(10,409		)
June 30, 2018	78,748		$	787		$	141,400			$	506,769			$	(9,784	)	$	639,172
																						Number of Shares				Amount							Additional Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive (Loss)		Total Stockholders’ Equity
December 31, 2018	78,526		$	785		$	123,205			$	510,863			$	(13,322	)	$	621,531		December 31, 2018		78,526				$	785		$	123,205
Repurchase of common stock	(144	)	(1		)	(7,586		)		—				—			(7,587		)	Repurchase of common stock		(144)				(1)			(7,586)		—					—			(7,587)
Issuance of common stock for share-based compensation plans	514		5			(14,843		)		—				—			(14,838		)	Issuance of common stock for share-based compensation plans		514				5			(14,843)		—			—			(14,838)
Stock-based compensation	—		—			18,406				—				—			18,406			Stock-based compensation		—				—			18,406		—			—			18,406
Cash dividends declared ($0.12 per share)	—		—			—				(2,367		)		—			(2,367		)
Cash dividends declared ($0.03 per share)																				Cash dividends declared ($0.03 per share)		—				—			—		(2,367)			—			(2,367)
Other comprehensive income	—		—			—				—				2,001			2,001			Other comprehensive income		—				—			—		—			2,001			2,001
Net (loss)	—		—			—				(28,717		)		—			(28,717		)	Net (loss)		—				—			—		(28,717)			—			(28,717)
March 31, 2019	78,896		789			119,182				479,779				(11,321		)	588,429			March 31, 2019		78,896				789			119,182		479,779			(11,321)			588,429
Repurchase of common stock	(88	)	(1		)	(6,301		)		—				—			(6,302		)	Repurchase of common stock		(88)				(1)			(6,301)		—			—			(6,302)
Issuance of common stock for share-based compensation plans	320		3			(11,217		)		—				—			(11,214		)	Issuance of common stock for share-based compensation plans		320				3			(11,217)		—			—			(11,214)
Issuance of common stock under Employee Stock Purchase Plan	16		—			1,103				—				—			1,103
Issuance of common stock under the employee stock purchase plan																				Issuance of common stock under the employee stock purchase plan		16				—			1,103		—			—			1,103
Stock-based compensation	—		—			20,113				—				—			20,113			Stock-based compensation		—				—			20,113		—			—			20,113
Cash dividends declared ($0.12 per share)	—		—			—				(2,375		)		—			(2,375		)
Cash dividends declared ($0.03 per share)																				Cash dividends declared ($0.03 per share)		—				—			—		(2,375)			—			(2,375)
Other comprehensive (loss)	—		—			—				—				(171		)	(171		)	Other comprehensive (loss)		—				—			—		—			(171)			(171)
Net (loss)	—		—			—				(32,296		)		—			(32,296		)	Net (loss)		—				—			—		(32,296)			—			(32,296)
June 30, 2019	79,144		$	791		$	122,880			$	445,108			$	(11,492	)	$	557,287		June 30, 2019		79,144				$	791		$	122,880	$	445,108		$	(11,492)		$	557,287

December 31, 2019																				December 31, 2019		79,599				$	796		$	140,523	$	410,919		$	(13,228)		$	539,010
Equity component of convertible senior notes, net																				Equity component of convertible senior notes, net		—				—			61,604		—			—			61,604
Repurchase of common stock																				Repurchase of common stock		(87)				(1)			(5,999)		—			—			(6,000)
Issuance of common stock for share-based compensation plans																				Issuance of common stock for share-based compensation plans		564				6			(23,017)		—			—			(23,011)
Stock-based compensation																				Stock-based compensation		—				—			23,199		—			—			23,199
Cash dividends declared ($0.03 per share)																				Cash dividends declared ($0.03 per share)		—				—			—		(2,405)			—			(2,405)
Other comprehensive (loss)																				Other comprehensive (loss)		—				—			—		—			(414)			(414)
Net (loss)																				Net (loss)		—				—			—		(25,372)			—			(25,372)
March 31, 2020																				March 31, 2020		80,076				801			196,310		383,142			(13,642)			566,611
Repurchase of common stock																				Repurchase of common stock		(23)				—			(2,199)		—			—			(2,199)
Issuance of common stock for share-based compensation plans																				Issuance of common stock for share-based compensation plans		349				3			(14,085)		—			—			(14,082)
Issuance of common stock under the employee stock purchase plan																				Issuance of common stock under the employee stock purchase plan		18				—			1,403		—			—			1,403
Stock-based compensation																				Stock-based compensation		—				—			25,674		—			—			25,674
Cash dividends declared ($0.03 per share)																				Cash dividends declared ($0.03 per share)		—				—			—		(2,413)			—			(2,413)
Other comprehensive income																				Other comprehensive income		—				—			—		—			2,028			2,028
Net (loss)																				Net (loss)		—				—			—		(20,740)			—			(20,740)
June 30, 2020																				June 30, 2020		80,420				$	804		$	207,103	$	359,989		$	(11,614)		$	556,282

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)


	Six Months Ended June 30,
	2020		2019
Operating activities
Net (loss)	$	(46,112)	$	(61,013)
Adjustments to reconcile net (loss) to cash (used in) provided by operating activities
Stock-based compensation	48,831		38,397
(Gain) on capped call transactions	(827)		—
Deferred income taxes	(18,399)		(190)
Amortization of deferred commissions	16,061		14,179
Lease expense	7,819		6,718
Amortization of debt discount and issuance costs	6,033		—
Amortization of intangible assets and depreciation	10,134		12,268
Amortization of investments	—		623
Foreign currency transaction loss	1,691		1,607
Other non-cash	(1,374)		(40)
Change in operating assets and liabilities, net	(45,056)		(4,829)
Cash (used in) provided by operating activities	(21,199)		7,720
Investing activities
Purchases of investments	(1,769)		(10,497)
Proceeds from maturities and called investments	—		13,545
Sales of investments	1,424		29,965
Payments for acquisitions, net of cash acquired	—		(10,921)
Investment in property and equipment	(19,059)		(4,882)
Cash (used in) provided by investing activities	(19,404)		17,210
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)		—
Dividend payments to shareholders	(4,793)		(4,730)




Common stock repurchases	(43,487)		(39,637)
Cash provided by (used in) financing activities	485,293		(44,367)
Effect of exchange rate changes on cash and cash equivalents	(942)		515
Net increase (decrease) in cash and cash equivalents	443,748		(18,922)
Cash and cash equivalents, beginning of period	68,363		114,422
Cash and cash equivalents, end of period	$	512,111	$	95,500

Six Months Ended
June 30,
2019 2018
Operating activities
Net (loss) income $ (61,013 ) $ 1,791
Adjustments to reconcile net (loss) income to cash provided by operating activities
Stock-based compensation 38,397
31,165
Amortization and depreciation 33,788
20,921
Foreign currency transaction loss (gain) 1,607
(159 )
Other non-cash (230 ) (846 )
Change in operating assets and liabilities, net (4,829 ) 22,560
Cash provided by operating activities 7,720
75,432
Investing activities

Purchases of investments (10,497 ) (51,395 )
Proceeds from maturities and called investments 13,545
11,546
Sales of investments 29,965
—
Payments for acquisitions, net of cash acquired (10,921 ) —
Investment in property and equipment (4,882 ) (6,520 )
Cash provided by (used in) investing activities 17,210
(46,369 )
Financing activities
Dividend payments to shareholders (4,730 ) (4,702 )
Common stock repurchases (39,637 ) (41,123 )
Cash (used in) financing activities (44,367 ) (45,825 )
Effect of exchange rate changes on cash and cash equivalents 515
(1,226 )
Net (decrease) in cash and cash equivalents (18,922 ) (17,988 )
Cash and cash equivalents, beginning of period 114,422
162,279
Cash and cash equivalents, end of period $ 95,500
$ 144,291

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

Pegasystems Inc. (together with its subsidiaries, “the Company”) has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all the information required by accounting principles generally accepted in the United States of America (“U.S.”) for complete financial statements and should be read in conjunction with the Company’s audited financial statements included in the Annual Report on Form 10-K for the year ended December 31, ~~2018.~~2019.

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 have been eliminated in consolidation. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year ~~2019.~~2020.

2. NEW ACCOUNTING PRONOUNCEMENTS

Financial instruments

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which requires measurement and recognition of expected credit losses for financial assets measured at amortized cost, including accounts receivable, upon initial recognition of that financial asset using a forward-looking expected loss model, rather than an incurred loss model. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses when the fair value is below the amortized cost of the asset, removing the concept of “other-than-temporary” impairments. The ~~effective date for the~~ Company ~~will be~~adopted this standard effective January 1, ~~2020, with early adoption permitted.~~2020. The ~~Company does not expect the~~ adoption of this standard ~~will~~did not have a material effect on ~~its~~the Company’s financial position or results of operations.

~~Leases~~

On January 1, 2019, the Company adopted Accounting Standards Codification 842 “Leases” (“ASC 842”) using the modified retrospective method, reflecting any cumulative effect as an adjustment to equity. Results for reporting periods beginning on or after January 1, 2019 are presented under ASC 842, while prior period amounts were not adjusted and continue to be reported in accordance with the Company’s historic accounting under ASC 840 “Leases”.

The Company elected the permitted practical expedients to not reassess the following related to leases that commenced before the effective date of ASC 842: (i) whether any expired or existing contracts contain leases; (ii) the lease classification for any expired or existing leases; and (iii) initial direct costs for any existing leases. Upon adoption, the Company recorded right of use assets of $41.8 million and lease liabilities of $54.2 million. The difference between the value of the right of use assets and lease liabilities is due to the reclassification of existing deferred rent, prepaid rent, and unamortized lease incentives as of January 1, 2019.

~~See Note 9. “Leases” for additional information.~~

3. ~~MARKETABLE SECURITIES~~

June 30, 2019
(in thousands) Amortized Cost Unrealized Gains Unrealized Losses Fair Value
Municipal bonds $ 29,495
$ 156
$ (5 ) $ 29,646
Corporate bonds 29,620
291
(8 ) 29,903
$ 59,115
$ 447
$ (13 ) $ 59,549

December 31, 2018
(in thousands) Amortized Cost Unrealized Gains Unrealized Losses Fair Value
Municipal bonds $ 44,802
$ 13
$ (110 ) $ 44,705
Corporate bonds 48,499
23
(226 ) 48,296
$ 93,301
$ 36
$ (336 ) $ 93,001

~~As of June 30, 2019, maturities of marketable securities ranged from January 2020 to August 2022, with a weighted-average remaining maturity of approximately 1.5 years.~~

~~PEGASYSTEMS INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)~~

4. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE

Receivables

(in thousands) June 30, 2019 December 31, 2018
Accounts receivable $ 134,965
$ 180,872
Unbilled receivables 169,554
172,656
Long-term unbilled receivables 117,889
151,237

$ 422,408
$ 504,765


(in thousands)	June 30, 2020		December 31, 2019
Accounts receivable	$	181,686	$	199,720
Unbilled receivables	198,253		180,219
Long-term unbilled receivables	109,308		121,736
	$	489,247	$	501,675

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

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


(Dollars in thousands)	June 30, 2019				(Dollars in thousands)	June 30, 2020
1 year or less	$	169,554	59	%	1 year or less	$	198,253	64	%
1-2 years	79,128		28	%	1-2 years	91,929		30	%
2-5 years	38,761		13	%	2-5 years	17,379		6	%
	$	287,443	100	%		$	307,561	100	%

Unbilled receivables based upon contract effective date:


(Dollars in thousands)	June 30, 2020
2020	$	75,893	25	%
2019	100,671		32	%
2018	46,700		15	%
2017	38,899		13	%
2016 and prior	45,398		15	%
	$	307,561	100	%

Major clients

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


	June 30, 2020		December 31, 2019
Client A	11	%	*

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

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Contract assets and deferred revenue


(in thousands)	June 30, 2019		December 31, 2018		(in thousands)	June 30, 2020		December 31, 2019
Contract assets ⁽¹⁾	$	3,770	$	3,711	Contract assets ⁽¹⁾	$	5,323	$	5,558
Long-term contract assets ⁽²⁾	2,190		2,543		Long-term contract assets ⁽²⁾	4,903		5,420
	$	5,960	$	6,254		$	10,226	$	10,978
Deferred revenue					Deferred revenue	$	195,996	$	190,080
Long-term deferred revenue ⁽³⁾					Long-term deferred revenue ⁽³⁾	6,587		5,407
						$	202,583	$	195,487

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

(in thousands) June 30, 2019 December 31, 2018
Deferred revenue $ 169,009
$ 185,145
Long-term deferred revenue ⁽¹⁾
4,342
5,344
$ 173,351
$ 190,489

⁽¹⁾ (3) Included in other long-term liabilities.

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

The change in deferred revenue in the six months ended June 30, ~~2019~~2020 was primarily due to ~~$135.8~~new billings in advance of revenue recognition, partially offset by $136.8 million of revenue recognized ~~excluding the impact of netting contract assets and deferred revenue at the contract level,~~ during the period that was included in deferred revenue at December 31, ~~2018, partially offset by new billings in advance of revenue recognition.~~2019.

5.4. DEFERRED ~~CONTRACT COSTS~~COMMISSIONS

The Company recognizes an asset for the incremental costs of obtaining a client contract, which primarily relate to sales commissions. The Company expects to benefit from those costs for more than one year, as the Company generally only pays sales commissions on the initial contract, and not any subsequent contract renewals. As a result, there are no commensurate commissions paid on contract renewals. Deferred costs are amortized on a straight-line basis over the benefit period, which is on average 5 years.


(in thousands)	June 30, 2020		December 31, 2019
Deferred commissions ⁽¹⁾	$	84,770	$	85,314

(in thousands) June 30, 2019 December 31, 2018
Deferred contract costs ⁽¹⁾
$ 64,809
$ 64,367

⁽¹⁾ Included in other long-term assets.


	Three Months Ended June 30,						Six Months Ended June 30,
(in thousands)	2020		2019		2020		2019
Amortization of deferred commissions ⁽¹⁾	$	7,564	$	5,878	$	16,061	$	14,179

Three Months Ended
June 30, Six Months Ended
June 30,
(in thousands) 2019 2018 2019 2018
Amortization of deferred contract costs ⁽¹⁾
$ 5,878
$ 3,809
$ 14,179
$ 7,598

⁽¹⁾Included in selling and marketing ~~expenses~~expenses.

5. 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 amount of $600 million, due March 1, 2025, in a private placement. The proceeds from the Notes were used or are anticipated to be used for the Capped Call Transactions (described below), working capital, and other general corporate purposes. There are no required principal payments prior to the maturity of the Notes. 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.

Proceeds from the Notes and Capped Call Transactions:


(in thousands)	Amount
Principal			$	600,000
Less: issuance costs			(14,527)
Less: Capped Call Transactions			(51,900)
	$	533,573

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 approximately $135.05 per share of common stock. The Company will settle conversions by paying or delivering, as applicable, 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 the occurrence of 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 the calendar quarter ending on June 30, 2020 (and only during such calendar quarter), if the last reported sale price per share of the Company’s common stock exceeds one hundred and thirty percent (130%) of the conversion price for each of at least twenty (20) trading days (whether or not consecutive) during the thirty (30) consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

~~6. GOODWILL AND OTHER INTANGIBLE ASSETS~~

~~Goodwill~~•During the 5 consecutive business days immediately after any 5 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 the occurrence of certain corporate events or distributions, or if the Company calls all or any Notes for redemption, then the noteholder of any Note may convert such Note at any time 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 due on such redemption date in full, at any time until the Company pays such redemption price in full).

As of June 30, 2020, no Notes were 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” (as described below) occur at any time, each noteholder will have the right, at such noteholder’s option, 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 an integral 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 events such as 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

In accounting for the transaction, the Notes have been separated into liability and equity components.

•The ~~change in the~~initial carrying amount of ~~goodwill was:~~

(in thousands) Six Months Ended
June 30, 2019
Balance as of January 1, $ 72,858
Acquisition ⁽¹⁾
6,179
Currency translation adjustments —
Balance as of June 30, $ 79,037

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

⁽¹⁾• ~~In May 2019,~~The equity component was recorded as an increase to additional paid-in capital and is not remeasured as long as it continues to meet the ~~Company acquired In the Chat Communications Inc., a privately-held software provider of digital customer service software~~conditions for ~~$10.9 million, net of cash acquired.~~ equity classification.

The Company ~~also expects~~incurred issuance costs of $14.5 million related to ~~issue up to approximately 15 thousand shares in retention-based bonus payments to a key employee upon~~ the ~~achievement of specified retention milestones. The principal assets~~Notes, which were allocated between the liability and ~~liabilities acquired as part~~equity components of the ~~business combination were additional goodwill and technology intangibles assets of $6.2 million and $5.1 million. The allocation~~Notes proportionate to the initial carrying amount of the ~~purchase price is preliminary for income taxes as~~liability and equity components.

•Issuance costs attributable to the ~~Company is still gathering information.~~

~~Intangibles~~

~~Intangible assets~~liability component are recorded ~~at cost~~as an offset to the principal balance of the Notes and are amortized as interest expense using the ~~straight-line~~effective interest method over ~~their estimated useful lives as follows:~~

June 30, 2019
(in thousands) Useful Lives Cost Accumulated
Amortization
Net Book Value ⁽¹⁾
Client-related intangibles 4-10 years $ 63,115
$ (53,608 ) $ 9,507
Technology 2-10 years 64,843
(52,605 ) 12,238
Other 1 - 5 years 5,361
(5,361 ) —
$ 133,319
$ (111,574 ) $ 21,745

⁽¹⁾~~Included in other long-term assets.~~

December 31, 2018
(in thousands) Useful Lives Cost Accumulated Amortization
Net Book Value ⁽¹⁾
Client-related intangibles 4-10 years $ 63,115
$ (51,224 ) $ 11,891
Technology 2-10 years 59,742
(50,398 ) 9,344
Other 1 - 5 years 5,361
(5,361 ) —
$ 128,218
$ (106,983 ) $ 21,235

⁽¹⁾~~Included in other long-term assets.~~the contractual term of the Notes.

~~Amortization~~•Issuance costs attributable to the equity component are recorded as an offset to the equity component in additional paid-in capital and are not amortized.

Net carrying amount of ~~intangible assets was:~~

(in thousands) Three Months Ended
June 30, Six Months Ended
June 30,
2019 2018 2019 2018
Cost of revenue $ 875
$ 1,231
$ 2,207
$ 2,463
Selling and marketing 781
1,605
2,385
3,210
$ 1,656
$ 2,836
$ 4,592
$ 5,673

the liability component:


(in thousands)	June 30, 2020
Principal	$	600,000
Unamortized debt discount	(78,867)
Unamortized issuance costs	(11,710)
	$	509,423

~~7. ACCRUED EXPENSES~~

(in thousands) June 30, 2019 December 31, 2018
Outside professional services expenses $ 8,513
$ 10,367
Income and other taxes 6,401
10,387
Marketing and sales program expenses 12,115
5,860
Dividends payable 2,375
2,363
Employee-related expenses 5,378
3,536
Cloud hosting expenses 11,978
4,604
Other 3,612
8,389
$ 50,372
$ 45,506

Net carrying amount of the equity component, included in additional paid-in capital:


(in thousands)	June 30, 2020
Conversion options ⁽¹⁾	$	61,604

(1) Net of issuance costs and taxes.

Interest expense related to the Notes:


	Three Months Ended June 30,						Six Months Ended June 30,
(in thousands)	2020		2019		2020		2019
Contractual interest expense (0.75% coupon)	$	1,125	$	—	$	1,575	$	—
Amortization of debt discount ⁽¹⁾	3,757		—		5,253		—
Amortization of issuance cost ⁽¹⁾	558		—		780		—
	$	5,440	$	—	$	7,608	$	—

(1) Amortized based upon an effective interest rate of 4.31%.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Future payments of principal and contractual interest:


	June 30, 2020
(in thousands)	Principal		Interest		Total
2020	$	—	$	2,338	$	2,338
2021	—		4,500		4,500
2022	—		4,500		4,500
2023	—		4,500		4,500
2024	—		4,500		4,500
2025	600,000		1,488		601,488
	$	600,000	$	21,826	$	621,826

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 and are generally expected to reduce potential dilution to the common stock upon any conversion of Notes and/or offset any potential cash payments the Company is required to make in excess of the principal amount of converted Notes, as the case may be, with such reduction and/or offset subject to a cap. The cap price of the Capped Call Transactions is $196.44, subject to adjustment upon the occurrence of specified extraordinary events affecting us, including merger events and tender offers. The Capped Call Transactions are classified as “other long-term assets” and remeasured to fair value at the end of each reporting period, resulting in a non-operating gain or loss.

Change in value of Capped Call Transactions:


(in thousands)	Six Months Ended June 30, 2020
Value at issuance	$	51,900
Fair value adjustment	827
Balance as of June 30,	$	52,727

Credit Facility

In November 2019, and as amended in February 2020 and July 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 Credit Facility 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 a maximum net consolidated leverage ratio of 3.5 (with a step-up in the event of certain acquisitions) and a minimum consolidated interest coverage ratio of 3.5. The commitments expire on November 4, 2024, and any outstanding loans will be payable on such date.

As of June 30, 2020 and December 31, 2019, the Company had 0 outstanding borrowings under the Credit Facility.

6. 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 ~~in privately-held companies~~ at fair value on a recurring basis. Fair value is an exit price, representing the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants based on assumptions that market participants would use in pricing an asset or liability.

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

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

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

•Level 3 - significant unobservable inputs on which there is little or no market data, which require the Company to develop its own assumptions. This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

~~If applicable, the Company will recognize transfers into and out of levels within the fair value hierarchy~~Capped Call Transactions at the end of ~~the~~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, as applicable. The Company applies judgment in ~~which~~its determination of expected volatility. The Company considers both historical and implied volatility levels of the ~~actual event or change in circumstance occurs. There were no transfers between levels during~~underlying equity security and to a lesser extent historical peer group volatility levels. The Company’s venture investments are recorded at fair value based on valuation methods using the ~~six months ended June 30, 2019.~~observable transaction price and other unobservable inputs including the volatility, rights, and obligations of the securities the Company holds.

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

basis:

June 30, 2019
(in thousands) Level 1 Level 2 Level 3 Total
Cash equivalents $ 5,653
$ —
$ —
$ 5,653
Marketable securities:
Municipal bonds $ —
$ 29,646
$ —
$ 29,646
Corporate bonds —
29,903
—
29,903
Total marketable securities $ —
$ 59,549
$ —
$ 59,549
Investments in privately-held companies ⁽¹⁾
$ —
$ —
$ 3,890
$ 3,890


	June 30, 2020														December 31, 2019
(in thousands)	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Cash equivalents ⁽¹⁾	$	450,465	$	—	$	—	$	450,465	$	—	$	—	$	—	$	—
Capped Call Transactions ^{(2) (3)}	$	—	$	52,727	$	—	$	52,727	$	—	$	—	$	—	$	—
Venture investments ^{(2) (4)}	$	—	$	—	$	6,640	$	6,640	$	—	$	—	$	4,871	$	4,871

⁽¹⁾ Composed of investments in money market funds. (2) Included in other long-term assets. (3) See "5. Debt" for additional information. (4) Composed of investments in privately-held companies.

Change in venture investments:


(in thousands)	Six Months Ended June 30, 2020
December 31, 2019	$	4,871
New investments	1,769
Sales of investments	(1,424)
Changes in foreign exchange rates	(50)
Fair value adjustment	1,474
June 30, 2020	$	6,640

December 31, 2018
(in thousands) Level 1 Level 2 Level 3 Total
Cash equivalents $ 10,155
$ 10,000
$ —
$ 20,155
Marketable securities:
Municipal bonds $ —
$ 44,705
$ —
$ 44,705
Corporate bonds —
48,296
—
48,296
Total marketable securities $ —
$ 93,001
$ —
$ 93,001
Investments in privately-held companies ⁽¹⁾
$ —
$ —
$ 3,390
$ 3,390

⁽¹⁾ ~~Included in other long-term assets.~~

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

~~9. LEASES~~Fair value of the Notes

The fair value of the Company’s ~~leases are primarily for office space~~Notes was recorded at $515.9 million upon issuance, which reflected the principal amount of the Notes less the fair value of the conversion feature. The fair value of the debt component was determined based on a discounted cash flow model. The discount rate used reflected both the time value of money and credit risk inherent in the ~~ordinary course of business.~~

~~Accounting policy~~

~~All the Company’s leases are operating leases.~~Notes. The ~~Company accounts for a contract as a lease when it has the right to control the asset for a period of time while obtaining substantially all~~carrying value of the asset’s economic benefits. The Company determines the initial classification and measurement of its operating right of use assets and lease liabilities at the lease commencement date and thereafter if modified. Fixed lease costs are recognized on a straight-line basisNotes will be accreted, over the remaining term to maturity, to their principal value of $600 million.

The fair value of the ~~lease. Variable lease costs are recognized~~Notes (inclusive of the conversion feature which is embedded in the Notes) was $602 million as of June 30, 2020. The fair value was determined based on the Notes’ quoted price in an over-the-counter market on the last trading day of the reporting period ~~in which the obligation for those payments is incurred. The Company combines lease~~ and ~~non-lease components~~has been classified within Level 2 in the ~~determination of lease costs~~fair value hierarchy. See "5. Debt" for ~~its office space leases. The lease liability includes lease payments related to options to extend or renew the lease term, if the Company is~~additional information.

7. REVENUE

Geographic revenue


	Three Months Ended June 30,															Six Months Ended June 30,
(Dollars in thousands)	2020						2019						2020					2019
U.S.	$	142,811	63	%	$	119,682	59	%	$	315,228	63	%		$	223,673	54	%
Other Americas	8,930		4	%	8,873		4	%	24,272		5	%		37,702		9	%
United Kingdom (“U.K.”)	21,259		9	%	16,686		8	%	43,096		9	%		41,235		10	%
Europe (excluding U.K.), Middle East, and Africa	34,878		15	%	33,395		16	%	66,816		14	%		67,581		16	%
Asia-Pacific	19,497		9	%	26,956		13	%	43,554		9	%		47,947		11	%
	$	227,375	100	%	$	205,592	100	%	$	492,966	100	%		$	418,138	100	%

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Revenue streams

~~reasonably certain it will exercise those options. The Company’s leases do not contain any material residual value guarantees or restrictive covenants.~~


	Three Months Ended June 30,						Six Months Ended June 30,
(in thousands)	2020		2019		2020		2019
Perpetual license	$	9,057	$	19,320	$	12,716	$	34,270
Term license	44,266		24,954		134,523		73,268
Revenue recognized at a point in time	53,323		44,274		147,239		107,538
Maintenance	72,222		69,329		145,917		137,035
Pega Cloud	48,838		31,699		92,304		59,457
Consulting	52,992		60,290		107,506		114,108
Revenue recognized over time	174,052		161,318		345,727		310,600
	$	227,375	$	205,592	$	492,966	$	418,138

~~Expense~~

(in thousands) Three Months Ended
June 30, 2019 Six Months Ended
June 30, 2019
Operating lease costs ⁽¹⁾
$ 4,281
$ 8,581
Variable lease costs 1,362
2,683
$ 5,643
$ 11,264


(in thousands)	Three Months Ended June 30,									Six Months Ended June 30,
			2020			2019			2020			2019
Term license	$	44,266		$	24,954		$	134,523		$	73,268
Pega Cloud	48,838			31,699			92,304			59,457
Maintenance	72,222			69,329			145,917			137,035
Subscription ⁽¹⁾	165,326			125,982			372,744			269,760
Perpetual license	9,057			19,320			12,716			34,270
Consulting	52,992			60,290			107,506			114,108
	$	227,375		$	205,592		$	492,966		$	418,138

⁽¹⁾ ~~Lease costs~~ Reflects client arrangements (term license, Pega Cloud, and maintenance) that are ~~fixed.~~subject to renewal.

Remaining performance obligations ("Backlog")

Expected future revenue on existing contracts:


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


	June 30, 2019
(Dollars in thousands)	Perpetual license		Term license		Maintenance		Pega Cloud		Consulting		Total
1 year or less	$	8,429	$	38,080	$	173,421	$	124,134	$	16,259	$	360,323	57	%
1-2 years	915		4,678		12,530		98,842		942		117,907		19	%
2-3 years	1,306		641		5,801		75,828		227		83,803		13	%
Greater than 3 years	—		185		2,812		63,259		—		66,256		11	%
	$	10,650	$	43,584	$	194,564	$	362,063	$	17,428	$	628,289	100	%

~~Right of use assets and lease liabilities~~

(in thousands) June 30, 2019
Right of use assets ⁽¹⁾
$ 57,772
Lease liabilities ⁽²⁾
$ 14,576
Long-term lease liabilities $ 54,292

⁽¹⁾~~An asset that 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.~~

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



	~~June 30, 2019~~
~~Weighted-average remaining lease term~~	~~4.3 years~~
~~Weighted-average discount rate~~ ⁽¹⁾	~~5.7~~	%

⁽¹⁾The rates implicit in most of the Company’s leases are not readily determinable, and 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 term of the lease.

~~Maturities of lease liabilities are:~~

(in thousands) June 30, 2019
Remainder of 2019 $ 8,290
2020 18,976
2021 17,099
2022 16,166
2023 and thereafter 17,393
Total lease payments 77,924
Less: imputed interest ⁽¹⁾
(9,056 )
$ 68,868

⁽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 as a result of a lease reassessment event.

As of December 31, 2018, the Company’s future minimum rental payments required under operating leases with noncancellable terms in excess of one year as determined prior to the adoption of ASC 842 were:

(in thousands)
Operating Leases ⁽¹⁾
2019 $ 15,993
2020 14,807
2021 13,262
2022 12,279
2023 11,084
$ 67,425

⁽¹⁾~~Operating leases include future minimum rent payments, net of estimated sublease income for facilities that the Company has vacated pursuant to its restructuring activities.~~

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

~~Cash flow information~~



~~(in thousands)~~	Six Months Ended June 30, 2019
~~Cash paid for leases~~	~~9,638~~
~~Right of use assets recognized for new leases and amendments (non-cash)~~	~~22,667~~

~~10. REVENUE~~

~~Geographic revenue~~

Three Months Ended
June 30, Six Months Ended
June 30,
(Dollars in thousands) 2019 2018 2019 2018
U.S. $ 119,682
59 % $ 110,349
55 % $ 223,673
54 % $ 224,334
52 %
Other Americas 8,873
4 % 9,627
5 % 37,702
9 % 27,342
6 %
United Kingdom (“U.K.”) 16,686
8 % 23,079
12 % 41,235
10 % 49,173
11 %
Europe (excluding U.K.), Middle East, and Africa 33,395
16 % 27,070
14 % 67,581
16 % 58,896
14 %
Asia-Pacific 26,956
13 % 26,654
14 % 47,947
11 % 72,216
17 %
$ 205,592
100 % $ 196,779
100 % $ 418,138
100 % $ 431,961
100 %

~~Revenue streams~~

Three Months Ended
June 30, Six Months Ended
June 30,
(in thousands) 2019 2018 2019 2018
Perpetual license $ 19,320
$ 13,475
$ 34,270
$ 36,553
Term license 24,954
31,309
73,268
96,004
Revenue recognized at a point in time 44,274
44,784
107,538
132,557
Maintenance 69,329
65,906
137,035
130,431
Cloud 31,699
20,201
59,457
35,783
Consulting 60,290
65,888
114,108
133,190
Revenue recognized over time 161,318
151,995
310,600
299,404
$ 205,592
$ 196,779
$ 418,138
$ 431,961

(in thousands) Three Months Ended
June 30, Six Months Ended
June 30,
2019 2018 2019 2018
Term license $ 24,954
$ 31,309
$ 73,268
$ 96,004
Cloud 31,699
20,201
59,457
35,783
Maintenance 69,329
65,906
137,035
130,431
Subscription ⁽¹⁾
125,982
117,416
269,760
262,218
Perpetual license 19,320
13,475
34,270
36,553
Consulting 60,290
65,888
114,108
133,190
$ 205,592
$ 196,779
$ 418,138
$ 431,961

⁽¹⁾~~Reflects client arrangements (term license, cloud, and maintenance) that are subject to renewal.~~

~~PEGASYSTEMS INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)~~

~~Remaining performance obligations (“RPO”)~~

~~Expected future revenue on existing contracts:~~

June 30, 2019
(Dollars in thousands) Perpetual license Term License Maintenance Cloud Consulting Total
1 year or less $ 8,429
$ 38,080
$ 173,421
$ 124,134
$ 16,259
$ 360,323
57 %
1-2 years 915
4,678
12,530
98,842
942
117,907
19 %
2-3 years 1,306
641
5,801
75,828
227
83,803
13 %
Greater than 3 years —
185
2,812
63,259
—
66,256
11 %
$ 10,650
$ 43,584
$ 194,564
$ 362,063
$ 17,428
$ 628,289
100 %

June 30, 2018
(Dollars in thousands) Perpetual license Term License Maintenance Cloud Consulting Total
1 year or less $ 28,626
$ 20,457
$ 111,086
$ 41,036
$ 12,039
$ 213,244
45 %
1-2 years 15,862
9,878
43,837
66,529
4,103
140,209
29 %
2-3 years 2,423
5,665
5,265
50,250
—
63,603
13 %
Greater than 3 years 362
944
2,103
55,995
200
59,604
13 %
$ 47,273
$ 36,944
$ 162,291
$ 213,810
$ 16,342
$ 476,660
100 %

Year to date Pega Cloud revenue ~~on existing contracts:~~

June 30, 2019
(Dollars in thousands) Perpetual license Term license Maintenance Cloud Consulting Total
1 year or less $ 8,429
$ 38,080
$ 173,421
$ 124,134
$ 16,259
$ 360,323
57 %
1-2 years 915
4,678
12,530
98,842
942
117,907
19 %
2-3 years 1,306
641
5,801
75,828
227
83,803
13 %
Greater than 3 years —
185
2,812
63,259
—
66,256
11 %
$ 10,650
$ 43,584
$ 194,564
$ 362,063
$ 17,428
$ 628,289
100 %
Change in RPO Since June 30, 2018

$ (36,623 ) $ 6,640
$ 32,273
$ 148,253
$ 1,086
$ 151,629

(77 )% 18 % 20 % 69 % 7 % 32 %
| +55% since June 30, 2019

June 30, 2018
(Dollars in thousands) Perpetual license Term license Maintenance Cloud Consulting Total
1 year or less $ 28,626
$ 20,457
$ 111,086
$ 41,036
$ 12,039
$ 213,244
45 %
1-2 years 15,862
9,878
43,837
66,529
4,103
140,209
29 %
2-3 years 2,423
5,665
5,265
50,250
—
63,603
13 %
Greater than 3 years 362
944
2,103
55,995
200
59,604
13 %
$ 47,273
$ 36,944
$ 162,291
$ 213,810
$ 16,342
$ 476,660
100 %
•Pega Cloud revenue is revenue as reported under US GAAP for cloud contracts.

CRITICAL ACCOUNTING ~~POLICES~~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 in accordance with accounting principles generally accepted in the United States (“U.S.”) and the rules and regulations of the SEC for interim financial reporting. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and the related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, knowledge of current conditions, and expectations of what could occur in the future given the available information.

For more information regarding our critical accounting policies, we encourage you to read the discussion ~~contained~~ in the following locations in our Annual Report on Form 10-K for the year ended December 31, ~~2018:~~2019:

•“Critical Accounting Estimates and Significant Judgments” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations”; and

•Note 2. “Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary ~~Data”.~~Data.”

There have been no significant changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, ~~2018.~~2019 other than those listed below.

Capped Call Transactions

In February 2020, we 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 our common stock and are generally expected to reduce potential dilution of our common stock upon any conversion of the Notes. 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, as applicable. Management applies judgment in its determination of expected volatility. We consider both historical and implied volatility levels of the underlying equity security and to a lesser extent historical peer group volatility levels.

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.

See "5. Debt" and “6. Fair Value Measurements” in Item 1 of this Quarterly Report for additional information.

RESULTS OF OPERATIONS

Revenue

(Dollars in thousands) Three Months Ended
June 30, Change Six Months Ended
June 30, Change
2019 2018 2019 2018
Cloud $ 31,699
15 % $ 20,201
10 % $ 11,498
57 % $ 59,457
14 % $ 35,783
8 % $ 23,674
66 %
Term license 24,954
12 % 31,309
16 % (6,355 ) (20 )% 73,268
18 % 96,004
22 % (22,736 ) (24 )%
Maintenance 69,329
34 % 65,906
34 % 3,423
5 % 137,035
33 % 130,431
31 % 6,604
5 %
Subscription ⁽¹⁾
125,982
61 % 117,416
60 % 8,566
7 % 269,760
65 % 262,218
61 % 7,542
3 %
Perpetual license 19,320
9 % 13,475
7 % 5,845
43 % 34,270
8 % 36,553
8 % (2,283 ) (6 )%
Consulting 60,290
30 % 65,888
33 % (5,598 ) (8 )% 114,108
27 % 133,190
31 % (19,082 ) (14 )%
$ 205,592
100 % $ 196,779
100 % $ 8,813
4 % $ 418,138
100 % $ 431,961
100 % $ (13,823 ) (3 )%

⁽¹⁾~~Reflects client arrangements (term license, cloud, and maintenance) that are subject to renewal.~~

Our license revenue is derived from sales of our applications and Pega Platform. Our ~~cloud~~Pega Cloud revenue is derived from our hosted Pega Platform and software applications.

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

~~Subscription revenue~~


(Dollars in thousands)	Three Months Ended June 30,															Change						Six Months Ended June 30,						Change
			2020						2019													2020					2019
Pega Cloud	$	48,838	21	%	$	31,699	15	%		$	17,139	54	%	$	92,304	19	%	$	59,457	14	%		$	32,847	55	%
Maintenance	72,222		33	%	69,329		34	%		2,893		4	%	145,917		30	%	137,035		33	%		8,882		6	%
Term license	44,266		19	%	24,954		12	%		19,312		77	%	134,523		27	%	73,268		18	%		61,255		84	%
Subscription ⁽¹⁾	165,326		73	%	125,982		61	%		39,344		31	%	372,744		76	%	269,760		65	%		102,984		38	%
Perpetual license	9,057		4	%	19,320		9	%		(10,263)		(53)	%	12,716		3	%	34,270		8	%		(21,554)		(63)	%
Consulting	52,992		23	%	60,290		30	%		(7,298)		(12)	%	107,506		21	%	114,108		27	%		(6,602)		(6)	%
Total revenue	$	227,375	100	%	$	205,592	100	%		$	21,783	11	%	$	492,966	100	%	$	418,138	100	%		$	74,828	18	%

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

•The increases in ~~cloud~~total revenue in the three and six months ended June 30, ~~2019 reflect~~2020 were primarily due to the increases in subscription revenue, partially offset by decreases in perpetual revenue, reflecting the shift in client preferences to ~~cloud~~subscription arrangements from other types of arrangements.

~~The decreases in term license revenue in the three and six months ended June 30, 2019 were due to revenue recognized from several large, multi-year~~•An increasing portion of our term license contracts in the three and six months ended June 30, 2018 and reflect the shift in client preferences in favor of our cloud offerings. The decreases are also attributable to revenue recognized from term license contracts in the six months ended June 30, 2019 withinclude multi-year committed maintenance ~~periods, which resulted in~~periods. Under such arrangements a greater portion of the total contract value ~~being allocated to maintenance.~~

~~The increases in~~has been reflected as maintenance revenue inover the ~~three and six months ended June 30, 2019 were primarily due to the continued growth in the aggregate value~~term of the ~~installed base of our software and strong~~contract. Additionally, renewal rates in excess of 90%. contributed to the increases in maintenance revenue.

~~Perpetual license~~

The increase in perpetual license revenue in the three months ended June 30, 2019 was primarily due to revenue recognized from a large perpetual license contract in the second quarter of 2019. The decrease in perpetual license revenue in the six months ended June 30, 2019 reflects the shift in client preferences in favor of our cloud offerings instead of our perpetual license arrangements.

~~Consulting~~

~~Our consulting revenue fluctuates depending upon the mix of new implementation projects we perform as compared to those performed by our enabled clients or led by our partners.~~ •The decreases in consulting revenue in the three and six months ended June 30, ~~2019~~2020 were primarily due to ~~a decrease~~decreases in billable ~~hours.~~hours and to a lesser extent due to reductions in billable travel expenses from reduced travel as a result of COVID-19.

Gross profit


	Three Months Ended June 30,								Change						Six Months Ended June 30,												Change							Three Months Ended June 30,																					Change										Six Months Ended June 30,										Change
(Dollars in thousands)	2019				2018									2019						2018						(Dollars in thousands)						2020									2019																			2020									2019					Change
Software license	$	43,346	98	%	$	43,522	97	%		$	(176	)	—	%		$	105,232		98	%		$	130,040		98	%			$	(24,808	)	(19	)%	Software license		$	52,344	98	%			$	43,346	98	%			$	8,998	21	%			$		145,576		99	%			$	105,232		98	%			$	40,344		38	%
Maintenance	63,037		91	%	60,032		91	%	3,005			5	%		124,408			91	%		118,475			91	%		5,933			5	%	Maintenance		66,631			92	%		63,037			91	%		3,594			6	%		134,750			92		%			124,408		91		%			10,342		8		%
Cloud	15,052		47	%	11,423		57	%	3,629			32	%		29,512			50	%		19,284			54	%		10,228			53	%
Pega Cloud																																Pega Cloud		29,850			61	%		15,052			47	%		14,798			98	%		55,783			60		%			29,512		50		%			26,271		89		%
Consulting	7,077		12	%	7,985		12	%	(908		)	(11	)%		7,469			7	%		14,731			11	%		(7,262		)	(49	)%	Consulting		1,859			4	%		7,077			12	%		(5,218)			(74)	%		638			1		%			7,469		7		%			(6,831)		(91)		%
	$	128,512	63	%	$	122,962	62	%	$	5,550		5	%		$	266,621		64	%		$	282,530		65	%		$	(15,909	)	(6	)%			$	150,684		66	%		$	128,512		63	%		$	22,172		17	%		$	336,747		68		%			$	266,621	64		%			$	70,126	26		%

LIQUIDITY AND CAPITAL RESOURCES

Six Months Ended
June 30,
(in thousands) 2019 2018
Cash provided by (used in):
Operating activities $ 7,720
$ 75,432
Investing activities 17,210
(46,369 )
Financing activities (44,367 ) (45,825 )
Effect of exchange rates on cash and cash equivalents 515
(1,226 )
Net (decrease) in cash and cash equivalents $ (18,922 ) $ (17,988 )

(in thousands) June 30, 2019 December 31, 2018
Held by U.S. entities $ 81,482
$ 143,533
Held by foreign entities 73,567
63,890
Total cash, cash equivalents, and marketable securities $ 155,049
$ 207,423


	Six Months Ended June 30,
(in thousands)	2020		2019
Cash provided by (used in):
Operating activities	$	(21,199)	$	7,720
Investing activities	(19,404)		17,210
Financing activities	485,293		(44,367)
Effect of exchange rates on cash and cash equivalents	(942)		515
Net increase (decrease) in cash and cash equivalents	$	443,748	$	(18,922)


(in thousands)	June 30, 2020		December 31, 2019
Held by U.S. entities	$	468,237	$	23,437
Held by foreign entities	43,874		44,926
Total cash and cash equivalents	$	512,111	$	68,363

We believe that our current cash, cash ~~equivalents, marketable securities, and cash~~ flow from operations, and borrowing capacity will be sufficient to fund our operations and quarterly cash dividends ~~and stock repurchases~~ for at least the next 12 months. Whether these resources are adequate to meet our liquidity needs beyond that period will depend on our growth, operating results, and the investments required to respond to the possible increased demand for our services. 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. ~~state~~ and ~~local taxes, as well as~~ foreign taxes upon repatriation. Due to the complexity of income tax laws and regulations, and the effects of the Tax Reform Act, it is impracticable to estimate the amount of taxes we would have to pay.

Cash (used in) provided by operating activities

As client preferences continue to shift in favor of ~~cloud~~Pega Cloud arrangements, we could continue to experience slower operating cash flow growth, or negative cash flow, in the near term. Cash from ~~cloud~~most Pega Cloud and term arrangements is ~~generally~~ collected over an average service period of three years, while cash from most perpetual license arrangements is ~~generally~~ collected upfront, shortly after the license rights become effective.

The primary driver of the decrease in the six months ended June 30, ~~2019~~2020 was the recent shift in our revenue mix toward ~~cloud~~Pega Cloud arrangements ~~which are generally collected over an average service period of three years,~~ and increased costs as ~~the Company~~we accelerated investments in ~~its cloud offerings~~our Pega Cloud offering and selling and marketing activities to support future growth.

In the six months ended June 30, 2020, COVID-19 did not have a material impact on our cash flows from operations. See “Coronavirus (“COVID-19”)” under Item 1A. Risk Factors for additional information.

Cash (used in) provided by investing activities

The change in cash (used in) provided by investing activities in the six months ended June 30, 2020 was primarily driven by investments in property and equipment at several of our office locations.

Cash provided by (used in) ~~investing activities~~

The change in cash provided by (used in) investing activities was primarily driven by the timing of investment maturities and sales, purchases of new investments, and the payment of consideration for the acquisition of In the Chat Communications Inc. in May 2019.

~~Cash (used in)~~ financing activities

~~We primarily used cash~~In February 2020, we issued $600 million in ~~financing activities for repurchases~~aggregate principal amount of our ~~common stock~~convertible senior notes (“Notes”) due March 1, 2025, which provided proceeds as follows:


(in thousands)	Amount
Principal			$	600,000
Less: issuance costs			(14,527)
Less: Capped Call Transactions			(51,900)
	$	533,573

A portion of the proceeds of the Notes was used to fund the Capped Call Transactions with the remainder to be used for working capital and other general corporate purposes. See "5. Debt" in Item 1 of this Quarterly Report for additional information.

In November 2019, and as amended in February 2020 and July 2020, we entered into a five-year $100 million senior secured revolving credit agreement (the “Credit Facility”) with PNC Bank, National Association (“PNC”). As of June 30, 2020 and December 31, 2019, we had 0 outstanding borrowings under ~~our publicly announced stock repurchase programs, stock repurchases for tax withholdings for~~ the ~~net settlement of our equity awards, and the payment of our quarterly dividend.~~Credit Facility.

Stock repurchase program ⁽¹⁾

~~The changes~~Changes in the remaining stock repurchase ~~authority was:~~

authority:

Six Months Ended
June 30,
(in thousands) 2019
January 1, $ 6,620
Authorizations ⁽²⁾
60,000
Repurchases (13,889 )
June 30, $ 52,731


(in thousands)	Six Months Ended June 30,
December 31, 2019	$	45,484
Authorizations ⁽²⁾	20,516
Repurchases	(8,199)
June 30, 2020	$	57,801

⁽¹⁾ Purchases under ~~these programs~~this program have been made on the open market. ⁽²⁾ On ~~March~~June 15, ~~2019,~~2020, we announced that our Board of Directors extended the expiration date of the current stock repurchase program to June 30, ~~2020~~2021 and increased the ~~amount of common~~remaining stock ~~we are authorized~~repurchase authority to ~~repurchase by~~ $60 ~~million between March 15, 2019 and June 30, 2020~~.million.

Common stock repurchases


	Six Months Ended June 30,							Six Months Ended June 30,
	2019			2018				2020				2019
(in thousands)	Shares	Amount		Shares	Amount		(in thousands)	Shares	Amount		Shares	Amount
Tax withholdings for net settlement of equity awards	390	$	26,054	454	$	26,992	Tax withholdings for net settlement of equity awards	411	$	37,093	390	$	26,054
Stock repurchase program ⁽¹⁾							Stock repurchase program ⁽¹⁾	110	8,199		232	13,889
Repurchases paid	229	13,689		254	14,871
Repurchases unsettled at period end	3	200		18	998
Activity in period ⁽²⁾	622	$	39,943	726	$	42,861	Activity in period ⁽²⁾	521	$	45,292	622	$	39,943

⁽¹⁾ Represents activity under our ~~publicly announced~~ stock repurchase ~~programs.~~program. ⁽²⁾ During the six months ended June 30, ~~2019~~2020 and ~~2018,~~2019, instead of receiving cash from the equity holders, we withheld shares with a value of ~~$23.1~~$31.2 million and ~~$21.1~~$23.1 million, respectively, for the exercise price of options. These amounts have been excluded from the table above.

~~Dividends~~

Six Months Ended
June 30,
(in thousands) 2019 2018
Dividend payments to shareholders $ 4,730
$ 4,702
Dividends

~~It is our current intention~~


	Six Months Ended June 30,
(in thousands)	2020		2019
Dividend payments to shareholders	$	4,793	$	4,730

We currently 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.

Contractual obligations

As of June 30, 2020, our contractual obligations were:


	Payments due by period
(in thousands)	2020		2021		2022-2023		2024-2025		2026 and thereafter		Other		Total
Purchase obligations ⁽¹⁾	$	43,197	$	56,689	$	57,498	$	—	$	—	$	—	$	157,384
Investment commitments ⁽²⁾	992		706		—		—		—		—		1,698
Liability for uncertain tax positions⁽³⁾	—		—		—		—		—		5,250		5,250
Operating lease obligations	9,391		20,414		37,326		7,205		1,735		—		76,071
Total	$	53,580	$	77,809	$	94,824	$	7,205	$	1,735	$	5,250	$	240,403

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

(2) Represents the maximum funding that would be expected under existing venture investment agreements. Our investment agreements generally allow us to withhold unpaid committed funds at our discretion.

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

~~There have been no material~~Market risk represents the risk of loss that may affect us due to adverse changes ~~during~~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 ~~six months ended June 30, 2019~~U.S. dollar against other currencies would result in the following impact:


	Six Months Ended June 30,
	2020		2019
(Decrease) increase in revenue	(3)	%	(4)	%
(Decrease) increase in net (loss)	(15)	%	(7)	%

Remeasurement risk

We experience fluctuations in transaction gains or losses from remeasurement of monetary assets and liabilities that are denominated in currencies other than the functional currency of the entities in which they are recorded.

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

A hypothetical 10% strengthening in the British pound exchange rate in comparison to the ~~market risk exposure disclosed~~Australian dollar, Euro, and U.S. dollar would result in ~~our Annual Report on Form 10-K for~~ the ~~year ended December 31, 2018.~~following impact:


	Six Months Ended June 30,
(in millions)	2020		2019
Foreign currency gain (loss)	$	9	$	(2)

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures

Our management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)) as of June 30, ~~2019~~.2020. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of June 30, ~~2019~~.2020.

(b) Changes in internal control over financial reporting

There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended June 30, ~~2019~~2020 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

COVID-19

In response to COVID-19, we have undertaken measures to protect our employees, partners, and clients, including encouraging employees to work remotely. These changes have compelled us to modify some of our control procedures. However, those changes have so far not been material.

PART II - OTHER INFORMATION

ITEM 1A. RISK FACTORS

We encourage you to carefully consider the risk factors identified below and in Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, ~~2018.~~2019, filed with the Securities and Exchange Commission on February 12, 2020. These risk factors could materially affect our business, financial condition, and future results, and they could cause our actual business and financial results to differ materially from those contained in forward-looking statements made in this Quarterly Report on Form 10-Q or elsewhere by ~~management~~management.

Coronavirus (“COVID-19”)

Epidemic diseases, such as the recent global COVID-19 outbreak, could harm our business and results of operations.

The recent outbreak of a novel coronavirus disease (“COVID-19”), which has been declared by the World Health Organization to be a pandemic, has spread across the globe and is impacting worldwide economic activity. A pandemic, including COVID-19, or other public health epidemics pose the risk that our employees, partners, and clients may be prevented from conducting business activities at full capacity for an indefinite period, including due to spread of the disease within these groups or due to shutdowns that are requested or mandated by governmental authorities. Moreover, these conditions can affect the rate of IT spending and may adversely affect our clients’ willingness to purchase our solutions, delay prospective clients’ purchasing decisions, reduce the value or duration of their contracts, request concessions including extended payment terms or better pricing, or affect attrition rates, all of which could adversely affect our future sales and operating results. The global spread of COVID-19 has created significant volatility, uncertainty, and economic disruption.

We have undertaken measures to protect our employees, partners, and clients, including by adopting a virtual-only meeting format for our annual PegaWorld conference and by encouraging employees to work remotely. There can be no assurance that these measures will be sufficient, however, or that we can implement them without adversely affecting our business operations.

We continue to monitor the situation and may adjust our policies as more information and public health guidance become available. Precautionary measures that have been adopted, or may be adopted in the future, could negatively affect our client success efforts, sales, and marketing efforts, delay and lengthen our sales cycles, or create operational or other challenges, any of which could harm our business and results of operations. In addition, COVID-19 may disrupt our clients’, vendors’, and partners’ operations for an indefinite period, including as a result of travel restrictions and/or business shutdowns, all of which could negatively impact our business and results of operations, including cash flows.

At this time, it is not possible to estimate the ultimate impact that COVID-19 could have on our business, as the impact will depend on future developments, which are highly uncertain and cannot be predicted. Furthermore, due to our shift to a renewable model, the effect of COVID-19 may not be fully reflected in our results of operations until future periods. The extent to which COVID-19 impacts our business, operations, and financial results will depend on numerous evolving factors that we may not be able to predict accurately, including:

•the duration and scope of the pandemic;

•governmental, business, and individual actions taken in response to the pandemic and the impact of those actions on global economic activity;

•the actions taken in response to economic disruption;

•the impact of business disruptions and reductions in our clients’ business and the resulting impact on their demand for our services and solutions; and

•our ability to provide our services and solutions, including as a result of our employees or our clients’ employees working remotely and/or closures of offices and facilities.

Risks related to our Convertible Senior Notes

We have a significant amount of debt that may decrease our business flexibility, access to capital, and/or increase our borrowing costs, and we may still incur additional debt in the future, which may adversely affect our operations and financial results.

As of June 30, 2020, we had $600 million aggregate principal amount of indebtedness under our Convertible Senior Notes due 2025 (the “Notes”).

Our indebtedness may:

•limit our ability to borrow additional funds for working capital, capital expenditures, acquisitions, or other business purposes;

•limit our ability to use our cash flow or obtain additional financing for future working capital, capital expenditures, acquisitions or other general business purposes;

•require us to use a substantial portion of our cash flow from operations to make debt service payments;

•limit our flexibility to plan for, or react to, changes in our business and industry;

•place us at a competitive disadvantage compared to our less leveraged competitors;

•dilute the interests of our existing stockholders as a result of issuing shares of our common stock upon the conversion of the Notes; and

•increase our vulnerability to the impact of adverse economic and industry conditions.

Our ability to pay our debt when due or to refinance our indebtedness, including the Notes, depends on our future performance, which is subject to economic, financial, competitive, and other factors beyond our control. Our business may not generate cash flow from operations in the future sufficient to service our debt and make necessary investments in our business. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations which could, in turn, result in that and our other indebtedness becoming immediately payable in full. In addition, we may incur additional debt to meet future financing needs. If we incur additional indebtedness, the risks related to our business and our ability to service or repay our indebtedness would increase.

The conditional conversion feature of the Notes, if triggered, may adversely affect our financial condition and operating results.

Under certain circumstances, the noteholders may convert their Notes at their option prior to the scheduled maturities. Upon conversion of the Notes, unless we elect to deliver solely shares of our common stock to settle such conversion, we will be obligated to make cash payments. In addition, holders of our Notes will have the right to require us to repurchase their Notes upon the occurrence of a fundamental change (as defined in the indenture, dated as of February 24, 2020, between U.S. Bank National Association, as trustee (the “Trustee”) and us (the “Indenture”)), at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest, if any, to, but not including, the fundamental change repurchase date. Although it is our intention and we currently expect to settle the conversion value of the Notes in cash up to the principal amount and any excess in shares, there is a risk that we may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of Notes surrendered therefor or Notes being converted. In addition, our ability to make payments may be limited by law, by regulatory authority, or by agreements governing our future indebtedness. Our failure to repurchase Notes when the Indenture requires the repurchase or to pay any cash payable on future conversions of the Notes as required by the Indenture would constitute a default under the Indenture. A default under the Indenture or the fundamental change itself could also lead to a default under agreements governing our future indebtedness. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase the Notes or make cash payments upon conversions thereof. In addition, even if holders of Notes do not elect to convert their Notes, we could be required under applicable accounting rules to reclassify all or a portion of the outstanding principal of the Notes as a current rather than long-term liability, which would result in a material reduction of our net working capital.

The accounting method for convertible debt securities that may be settled in cash, such as the Notes, could have a material impact on our reported financial results.

Under Accounting Standards Codification 470-20, Debt with Conversion and Other Options (ASC 470-20), an entity must separately account for the liability and equity components of the convertible debt instruments (such as the Notes) that may be settled entirely or partially in cash upon conversion in a manner that reflects the issuer’s economic interest cost. The effect of ASC 470-20 on the accounting for the Notes is that the equity component is required to be included in the additional paid-in capital section of stockholders’ equity on our consolidated balance sheet at the issuance date and the value of the equity component is treated as debt discount for purposes of accounting for the debt component of the Notes. As a result, we will be required to record non-cash interest expense through the amortization of the excess of the face amount over the carrying amount of the expected life of the Notes. We will report larger net losses (or lower net income) in our financial results because ASC 470-20 requires interest to include both the amortization of the debt discount and the instrument’s cash coupon interest rate, which could adversely affect our reported or future financial results, the trading price of our common stock, and the trading price of the Notes.

In addition, under certain circumstances, convertible debt instruments (such as the Notes) that may be settled entirely or partially in cash may be accounted for utilizing the treasury stock method, the effect of which is that the shares issuable upon conversion of such Notes are not included in the calculation of diluted earnings per share except to the extent that the conversion value of such Notes exceeds their principal amount. Under the treasury stock method, the number of shares of common stock that would be necessary to settle such excess, if we elected to settle such excess in shares, is included in the denominator to calculate diluted earnings per share. We cannot be sure that the accounting standards will continue to permit the use of the treasury stock method. If we are unable or otherwise elect not to use the treasury stock method in accounting for the shares issuable upon conversion of the Notes, then our diluted earnings per share could be adversely affected.

The Capped Call Transactions may affect the value of the Notes and our common stock.

In connection with the Notes’ issuance, we entered into Capped Call Transactions with certain financial institutions (“option counterparties”). The Capped Call Transactions are generally expected to reduce the potential dilution to our common stock upon any conversion of the Notes and/or offset any cash payments we are required to make in excess of the principal amount of converted Notes, as the case may be, with such reduction and/or offset subject to a cap. From time to ~~time.~~time, the option counterparties that are parties to the Capped Call Transactions or their respective affiliates may modify their hedge positions by entering into or unwinding various derivative transactions with respect to our common stock and/or purchasing or selling our common stock or other securities of ours in secondary market transactions prior to the maturity of the Notes. This activity could cause a decrease in the market price of our common stock.

~~There have been no material changes during~~

We are subject to counterparty risk with respect to the ~~six months ended June 30, 2019~~Capped Call Transactions.

The option counterparties are financial institutions, and we are subject to the risk that one or more of the option counterparties may default or otherwise fail to perform, or may exercise certain rights to terminate, their obligations under the Capped Call Transactions. Our exposure to the credit risk of the option counterparties is not secured by any collateral. Recent global economic conditions have resulted in the actual or perceived failure or financial difficulties of many financial institutions. If an option counterparty becomes subject to insolvency proceedings, we will become an unsecured creditor in those proceedings with a claim equal to our exposure at the time under such transaction. Our exposure depends on many factors ~~disclosed~~but, generally, our exposure will increase if the market price or the volatility of our common stock increases. In addition, upon a default or other failure to perform, or a termination of obligations, by an option counterparty, we may suffer more dilution than we currently anticipate with respect to our common stock. We can provide no assurances as to the financial stability or viability of the option counterparties.

Provisions in ~~our Annual Report on Form 10-K~~the indenture for the ~~year ended December 31, 2018.~~Notes may deter or prevent a business combination that may be favorable to our stockholders.

If a fundamental change occurs prior to the maturity date of the Notes, holders of the Notes will have the right, at their option, to require us to repurchase all or a portion of their Notes. In addition, if a “make-whole fundamental change” (as defined in the Indenture) occurs prior to the maturity date, we will in some cases be required to increase the conversion rate of the Notes for a holder that elects to convert its Notes in connection with such make-whole fundamental change.

Furthermore, the Indenture will prohibit us from engaging in certain mergers or acquisitions unless, among other things, the surviving entity assumes our obligations under the Notes. These and other provisions in the Indenture could deter or prevent a third party from acquiring us even when the acquisition may be favorable to our stockholders.

Conversion of the Notes may dilute the ownership interest of existing stockholders.

The conversion of some or all of the Notes will dilute the ownership interests of existing stockholders to the extent we deliver shares of our common stock upon conversion of any of the Notes. Any sales in the public market of the common stock issuable upon such conversion could adversely affect prevailing market prices of our common stock. In addition, the existence of the Notes may encourage short selling by market participants because the conversion of the Notes could be used to satisfy short positions, or anticipated conversion of the Notes into shares of our common stock could depress the price of our common stock.

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

Issuer ~~Purchases~~purchases of ~~Equity Securities~~equity securities

~~The following table sets forth information regarding our repurchases of our common~~Common stock ~~during~~repurchased in the three months ended June 30, ~~2019.~~2020 was:


(in thousands, except per share amounts)	Total Number of Shares Purchased ^{(1) (2)}	Average Price Paid per Share ^{(1) (2)}		Total Number of Shares Purchased as Part of Publicly Announced Share Repurchase Program ⁽²⁾	Approximate Dollar Value of Shares That May Yet Be Purchased at Period End Under Publicly Announced Share Repurchase Programs ⁽²⁾
April 1, 2020 - April 30, 2020	16	$	73.07	—	$	39,484
May 1, 2020 - May 31, 2020	155	$	87.87	—	$	39,484
June 1, 2020 - June 30, 2020	179	$	97.43	23	$	57,801
	350	$	92.06	23

(in thousands, except per share amounts)
Total Number of Shares Purchased ⁽¹⁾

Average
Price Paid
per Share ⁽¹⁾
Total Number of Shares Purchased as Part of Publicly Announced Share Repurchase Program
Approximate Dollar Value of Shares That May Yet Be Purchased at Period End Under Publicly Announced Share Repurchase Programs ⁽²⁾
April 1, 2019 - April 30, 2019 39
$ 70.05
30
$ 56,930
May 1, 2019 - May 31, 2019 189
$ 71.57
30
$ 54,731
June 1, 2019 - June 30, 2019 170
$ 71.19
28
$ 52,731

398
$ 71.26

⁽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 ~~March~~June 15, ~~2019,~~2020, we announced that our Board of Directors extended the expiration date of the current stock repurchase program to June 30, ~~2020~~2021 and increased the ~~amount~~remaining stock purchase authority to $60 million. See "Liquidity and Capital Resources" in Item 2 of ~~common stock we are authorized to repurchase by $60 million between March 15, 2019 and June 30, 2020~~this Quarterly Report for additional information.

(the “Current Program”). Under the Current Program, purchases may be made from time to time on the open market or in privately negotiated transactions. Shares may be repurchased in such amounts as market conditions warrant, subject to regulatory and other considerations. We have established a pre-arranged stock repurchase plan, intended to comply with the requirements of Rule 10b5-1 under the Exchange Act, and Rule 10b-18 under the Exchange Act (the “10b5-1 Plan”). All stock repurchases under the Current Program during closed trading window periods will be made pursuant to the 10b5-1 Plan.

~~Recent Sales of Unregistered Securities~~

In connection with our acquisition of In the Chat Communications Inc. on May 10, 2019 and in reliance on the Regulation D exemption from registration requirements under the Securities Act, we granted an employee the right to obtain up to 14,497 shares of our common stock, which will be issued in five equal tranches contingent upon continued employment. No general solicitation or advertising to market the securities occurred.

ITEM 6. EXHIBITS



Exhibit No.						Description
~~31.1~~3.1						Restated Articles of Organization of the Registrant and Amendments thereto. (Filed as Exhibit 3.1 to the Registrant’s September 30, 2014 Form 10-Q and incorporated herein by reference.)
3.2						Amended and Restated Bylaws of Pegasystems Inc. (Filed as Exhibit 3.2 to the Registrant’s June 15, 2020 Form 8-K and incorporated herein by reference.)
10.1						2004 Long-Term Incentive Plan (as amended and restated). (Filed as Exhibit 10.1 to the Registrant’s June 24, 2020 Form 8-K and incorporated herein by reference.)
10.2+						Amendment 2 to Loan Documents, dated July 22, 2020, between Pegasystems Inc. and PNC Bank, National Association.
10.3+*						Offer Letter, dated April 27, 2020, between Pegasystems Inc. and Hayden Stafford .
31.1+						Certification pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief Executive Officer.
~~31.2~~31.2+						Certification pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief Financial Officer.
~~32+~~32*						Certification pursuant to 18 U.S.C. Section 1350 of the Chief Executive Officer and the Chief Financial Officer.
101.INS						Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH						Inline XBRL Taxonomy Extension Schema Document.
101.CAL						Inline XBRL Taxonomy Calculation Linkbase Document.
101.DEF						Inline XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB						Inline XBRL Taxonomy Label Linkbase Document.
101.PRE						Inline XBRL Taxonomy Presentation Linkbase Document.
104						Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

+ Filed herewith.

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

* Indicates a management contract or arrangement in which an executive officer of the Company participates.

SIGNATURE

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

Pegasystems Inc.

Dated:

July 28, 2020

~~Pegasystems Inc.~~

By:

~~Dated:~~

~~August 7, 2019~~

~~By:~~

/s/ KENNETH STILLWELL

Kenneth Stillwell

Chief Financial Officer and Chief Administrative Officer

(Principal Financial Officer)



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



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



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



	June 30, 2019
(in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
Municipal bonds	$	29,495	$	156	$	(5	)	$	29,646
Corporate bonds	29,620		291		(8		)	29,903
	$	59,115	$	447	$	(13	)	$	59,549



(in thousands)	Six Months Ended June 30, 2019
Balance as of January 1,	$	72,858
Acquisition ⁽¹⁾	6,179
Currency translation adjustments	—
Balance as of June 30,	$	79,037



		June 30, 2019
(in thousands)	Useful Lives	Cost		Accumulated Amortization			Net Book Value ⁽¹⁾
Client-related intangibles	4-10 years	$	63,115	$	(53,608	)	$	9,507
Technology	2-10 years	64,843		(52,605		)	12,238
Other	1 - 5 years	5,361		(5,361		)	—
		$	133,319	$	(111,574	)	$	21,745



(in thousands)	Three Months Ended June 30, 2019		Six Months Ended June 30, 2019
Operating lease costs ⁽¹⁾	$	4,281	$	8,581
Variable lease costs	1,362		2,683
	$	5,643	$	11,264



(in thousands)	June 30, 2019
Right of use assets ⁽¹⁾	$	57,772
Lease liabilities ⁽²⁾	$	14,576
Long-term lease liabilities	$	54,292



(in thousands)	June 30, 2019
Remainder of 2019	$	8,290
2020	18,976
2021	17,099
2022	16,166
2023 and thereafter	17,393
Total lease payments	77,924
Less: imputed interest ⁽¹⁾	(9,056		)
	$	68,868



(in thousands)	Operating Leases ⁽¹⁾
2019	$	15,993
2020	14,807
2021	13,262
2022	12,279
2023	11,084
	$	67,425



(Dollars in thousands, except per share amounts)	Three Months Ended June 30,						Change					Six Months Ended June 30,					Change
(Dollars in thousands, except per share amounts)	2019			2018			Change					2019			2018		Change
Total revenue	$	205,592		$	196,779		$	8,813		4	%	$	418,138		$	431,961	$	(13,823	)	(3	)%
Subscription revenue ⁽¹⁾	$	125,982		$	117,416		$	8,566		7	%	$	269,760		$	262,218	$	7,542		3	%
Net (loss) income	$	(32,296	)	$	(10,409	)	$	(21,887	)	(210	)%	$	(61,013	)	$	1,791	$	(62,804	)	*
(Loss) earnings per share, diluted	$	(0.41	)	$	(0.13	)	$	(0.28	)	(215	)%	$	(0.77	)	$	0.02	$	(0.79	)	*



	June 30,				Change				Constant Currency Change
(Dollars in thousands)	2019		2018		Change				Constant Currency Change
Maintenance ACV	$	277,316	$	263,624	$	13,692	5	%	7	%
Term ACV	199,299		168,528		$	30,771	18	%	19	%
Client Cloud ACV	476,615		432,152		$	44,463	10	%	12	%
Pega Cloud ACV	136,074		82,376		53,698		65	%	67	%
Total ACV	$	612,689	$	514,528	$	98,161	19	%	21	%


•	Client Cloud: the sum of (1) the annual value of each term license contract in effect on such date, which is equal to its total license value divided by the total number of years and (2) maintenance revenue reported for the quarter ended on such date, multiplied by four.maintenance ACV and ACV from term license contracts. We ~~do not provide hosting for Client Cloud arrangements.~~


•	~~Pega Cloud: the total of the annual value of each cloud contract in effect on such date, which is equal to its total value divided by the total number of years.~~



(in thousands, except per share amounts)	Total Number of Shares Purchased ⁽¹⁾	Average Price Paid per Share ⁽¹⁾		Total Number of Shares Purchased as Part of Publicly Announced Share Repurchase Program	Approximate Dollar Value of Shares That May Yet Be Purchased at Period End Under Publicly Announced Share Repurchase Programs ⁽²⁾
April 1, 2019 - April 30, 2019	39	$	70.05	30	$	56,930
May 1, 2019 - May 31, 2019	189	$	71.57	30	$	54,731
June 1, 2019 - June 30, 2019	170	$	71.19	28	$	52,731
	398	$	71.26