UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

____________________

FORM10-Q

____________________

☒

x	Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the quarterly period ended March 31, 2019

~~For the quarterly period ended September 30, 2018~~

☐

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

Commission File Number:1-11859

____________________

PEGASYSTEMS INC.

(Exact name of registrant as specified in its charter)

____________________



Massachusetts		04-2787865
*(State or other jurisdiction of incorporation or organization)*		*(IRS Employer Identification No.)*

One Rogers Street, Cambridge, MA		02142-1209
*(Address of principal executive offices)*		*(Zip Code)*

(617)374-9600

(Registrant’s telephone number, including area code)

____________________

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

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

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



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

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

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

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



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

There were ~~78,700,651~~78,908,093 shares of the Registrant’s common stock, $0.01 par value per share, outstanding on ~~November~~May 1, ~~2018.~~

2019.

PEGASYSTEMS INC.

QUARTERLY REPORT ON FORM10-Q

TABLE OF CONTENTS



		Page
PART I - FINANCIAL INFORMATION


Item 1. Unaudited Condensed Consolidated Financial Statements

Unaudited Condensed Consolidated Balance Sheets as of ~~September 30, 2018~~March 31, 2019 and December 31, ~~2017~~ 2018			3

Unaudited Condensed Consolidated Statements of Operations for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2019 and 2018 ~~and 2017~~			4

Unaudited Condensed Consolidated Statements of Comprehensive (Loss) Income for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2019 and 2018 ~~and 2017~~			5
Unaudited Condensed Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2019 and 2018	6
Unaudited Condensed Consolidated Statements of Cash Flows for the ~~nine~~three months ended ~~September 30,~~March 31, 2019 and 2018 ~~and 2017~~			6	7

Notes to Unaudited Condensed Consolidated Financial Statements			7	8

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			19	16

Item 3. Quantitative and Qualitative Disclosures About Market Risk			26	22

Item 4. Controls and Procedures	22
	27

PART II - OTHER INFORMATION


Item 1A. Risk Factors			28	23

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	23
Item 6. Exhibits	23
28
Signature
~~Item 6. Exhibits~~24			28

~~Signature~~			29

PART I - FINANCIAL INFORMATION

~~ITEM 1.~~

~~UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS~~

ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS⁽¹⁾

(in thousands)

         September 30,
2018      December 31,
2017
Assets

Current assets:

  Cash and cash equivalents
   $ 106,195      $ 162,279
  Marketable securities
   99,782      61,469




   Total cash, cash equivalents, and marketable securities
   205,977      223,748
  Accounts receivable
   150,733      222,735
  Unbilled receivables
   155,964      158,898
  Other current assets
   73,464      41,135




     Total current assets
   586,138      646,516
Long-term unbilled receivables
   168,929      160,708
Goodwill
   72,897      72,952
Other long-term assets
   134,679      131,391




   Total assets
   $ 962,643      $ 1,011,567




Liabilities and stockholders’ equity

Current liabilities:

  Accounts payable
   $ 12,926      $ 17,370
  Accrued expenses
   39,829      45,508
  Accrued compensation and related expenses
   71,318      66,040
  Deferred revenue
   158,178      166,297




Total current liabilities
   282,251      295,215
Deferred income tax liabilities
   36,166      38,463
Other long-term liabilities
   23,371      23,652




       Total liabilities
   341,788      357,330
Stockholders’ equity:

  Preferred stock, 1,000 shares authorized; no shares issued and outstanding
   —      —
  Common stock, 200,000 shares authorized; 78,816 and 78,081 shares issued and outstanding at
  September 30, 2018 and December 31, 2017, respectively
   788      781
  Additionalpaid-in capital
   135,132      152,097
  Retained earnings
   496,815      508,051
  Accumulated other comprehensive loss
   (11,880)    (6,692)




   Total stockholders’ equity
   620,855      654,237




   Total liabilities and stockholders’ equity
   $ 962,643      $ 1,011,567

⁽¹⁾

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



	March 31, 2019			December 31, 2018
Assets
Current assets:
Cash and cash equivalents	$	110,367		$	114,422
Marketable securities	91,804			93,001
Total cash, cash equivalents, and marketable securities	202,171			207,423
Accounts receivable	135,352			180,872
Unbilled receivables	161,480			172,656
Other current assets	63,731			49,684
Total current assets	562,734			610,635
Long-term unbilled receivables	130,494			151,237
Goodwill	72,898			72,858
Other long-term assets	190,433			147,823
Total assets	$	956,559		$	982,553
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	11,559		$	16,487
Accrued expenses	40,947			45,506
Accrued compensation and related expenses	56,349			84,671
Deferred revenue	180,845			185,145
Other current liabilities	12,447			—
Total current liabilities	302,147			331,809
Operating lease liabilities	45,325			—
Deferred income tax liabilities	8,319			6,939
Other long-term liabilities	12,339			22,274
Total liabilities	368,130			361,022
Stockholders’ equity:
Preferred stock, 1,000 shares authorized; none issued	—			—
Common stock, 200,000 shares authorized; 78,896 and 78,526 shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively	789			785
Additional paid-in capital	119,182			123,205
Retained earnings	479,779			510,863
Accumulated other comprehensive loss	(11,321		)	(13,322		)
Total stockholders’ equity	588,429			621,531
Total liabilities and stockholders’ equity	$	956,559		$	982,553

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS⁽¹⁾

(in thousands, except per share amounts)

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

Software license
   $ 52,342    $ 53,234    $ 184,899    $ 231,392
Maintenance
   66,017    61,812    196,448    179,949
Services
   84,904    75,911    253,877    222,521








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








Cost of revenue

Software license
   1,255    1,276    3,772    3,826
Maintenance
   6,079    6,716    18,035    20,945
Services
   67,089    61,739    202,047    180,925








  Total cost of revenue
   74,423    69,731    223,854    205,696








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








Operating expenses

Selling and marketing
   87,490    69,363    269,845    214,244
Research and development
   46,504    41,031    135,261    121,089
General and administrative
   12,104    13,133    38,749    38,174








  Total operating expenses
   146,098    123,527    443,855    373,507








(Loss) income from operations
   (17,258)    (2,301)    (32,485)    54,659
Foreign currency transaction gain (loss)
   399    (5,052)    558    (6,549)
Interest income, net
   683    140    2,076    547
Other income, net
   —    —    363    287








(Loss) income before benefit from income taxes
   (16,176)    (7,213)    (29,488)    48,944
Benefit from income taxes
   (8,589)    (8,501)    (23,692)    (9,009)








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








(Loss) earnings per share

Basic
   $ (0.10)    $ 0.01    $ (0.07)    $ 0.75
Diluted
   $ (0.10)    $ 0.01    $ (0.07)    $ 0.70
Weighted-average number of common shares outstanding

Basic
   78,700    77,691    78,525    77,258
Diluted
   78,700    83,323    78,525    82,717
Cash dividends declared per share
   $ 0.03    $ 0.03    $ 0.09    $ 0.09

⁽¹⁾



	Three Months Ended March 31,
	2019			2018
Revenue
Software license	$	63,264		$	87,773
Maintenance	67,706			64,525
Services	81,576			82,884
Total revenue	212,546			235,182
Cost of revenue
Software license	1,378			1,255
Maintenance	6,335			6,082
Services	66,724			68,277
Total cost of revenue	74,437			75,614
Gross profit	138,109			159,568
Operating expenses
Selling and marketing	108,865			88,383
Research and development	50,596			46,785
General and administrative	12,676			16,464
Total operating expenses	172,137			151,632
(Loss) income from operations	(34,028		)	7,936
Foreign currency transaction loss	(3,712		)	(1,085		)
Interest income, net	723			764
Other income, net	—			363
(Loss) income before benefit from income taxes	(37,017		)	7,978
Benefit from income taxes	(8,300		)	(4,222		)
Net (loss) income	$	(28,717	)	$	12,200
(Loss) earnings per share
Basic	$	(0.37	)	$	0.16
Diluted	$	(0.37	)	$	0.15
Weighted-average number of common shares outstanding
Basic	78,584			78,236
Diluted	78,584			83,102

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

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

(in thousands)

   Three Months Ended
September 30,    Nine Months Ended
September 30,
   2018    2017    2018    2017
Net (loss) income
   $ (7,587)    $ 1,288    $ (5,796)    $ 57,953
Other comprehensive (loss) income, net of tax

Unrealized (loss) gain onavailable-for-sale marketable securities, net of tax
   (162)    22    (277)    148
Foreign currency translation adjustments
   (1,934)    2,576    (4,911)    8,848








  Total other comprehensive (loss) income, net of tax
   (2,096)    2,598    (5,188)    8,996








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

⁽¹⁾



	Three Months Ended March 31,
	2019			2018
Net (loss) income	$	(28,717	)	$	12,200
Other comprehensive income, net of tax
Unrealized gain (loss) on available-for-sale marketable securities, net of tax	374			(188		)
Foreign currency translation adjustments	1,627			4,450
Total other comprehensive income, net of tax	2,001			4,262
Comprehensive (loss) income	$	(26,716	)	$	16,462

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF ~~CASH FLOWS~~⁽¹⁾

STOCKHOLDERS’ EQUITY

(in ~~thousands)~~

   Nine Months Ended
September 30,
   2018    2017
Operating activities:

Net (loss) income
   $ (5,796)    $ 57,953
Adjustment to reconcile net (loss) income to cash provided by operating activities:

  Change in operating assets and liabilities, net
   8,698      (15,455)
  Stock-based compensation expense
   47,573      39,929
  Amortization of intangible assets and depreciation
   18,692      18,703
  Othernon-cash
   (2,079)    12,796




     Cash provided by operating activities
   67,088      113,926
Investing activities:

Purchases of investments
   (68,177)    (25,687)
Proceeds from maturities and called investments
   26,456      23,124
Other
   (7,874)    (9,403)




     Cash used in investing activities
   (49,595)    (11,966)
Financing activities:

Dividend payments to shareholders
   (7,067)    (6,941)
Common stock repurchases
   (64,597)    (37,099)




     Cash used in financing activities
   (71,664)    (44,040)
Effect of exchange rates on cash and cash equivalents
   (1,913)    2,054




Net (decrease) increase in cash and cash equivalents
   (56,084)    59,974
Cash and cash equivalents, beginning of period
   162,279      70,594




Cash and cash equivalents, end of period
   $             106,195      $             130,568

⁽¹⁾

thousands, except per share amounts)



	Common Stock					Additional Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive (Loss) Income			Total Stockholders’ Equity
	Number of Shares		Amount			Additional Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive (Loss) Income			Total Stockholders’ Equity
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

December 31, 2018	78,526		785			123,205			510,863			(13,322		)	621,531
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		)
Stock-based compensation	—		—			18,406			—			—			18,406
Cash dividends declared ($0.12 per share)	—		—			—			(2,367		)	—			(2,367		)
Other comprehensive income	—		—			—			—			2,001			2,001
Net loss	—		—			—			(28,717		)				(28,717		)
March 31, 2019	78,896		$	789		$	119,182		$	479,779		$	(11,321	)	$	588,429

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

Three Months Ended
March 31,
2019 2018
Operating activities:
Net (loss) income $ (28,717 ) $ 12,200
Adjustments to reconcile net (loss) income to cash provided by operating activities:
Stock-based compensation 18,350
15,109
Amortization and depreciation 18,774
10,322
Foreign currency transaction loss 3,712
1,085
Other non-cash 1,471
1,137
Change in operating assets and liabilities, net 9,113
15,802
Cash provided by operating activities 22,703
55,655
Investing activities:

Purchases of investments (7,224 ) (35,204 )
Proceeds from maturities and called investments 8,548
5,995
Other (2,790 ) (2,069 )
Cash used in investing activities (1,466 ) (31,278 )
Financing activities:
Dividend payments to shareholders (2,363 ) (2,344 )
Common stock repurchases (23,224 ) (20,708 )
Cash used in financing activities (25,587 ) (23,052 )
Effect of exchange rate changes on cash and cash equivalents 295
2,186
Net (decrease) increase in cash and cash equivalents (4,055 ) 3,511
Cash and cash equivalents, beginning of period 114,422
162,279
Cash and cash equivalents, end of period $ 110,367
$ 165,790

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 of the information and footnotes required by accounting principles generally accepted in the United States of America (“U.S.”) for complete financial statements and should be read in conjunction with the Company’s audited financial statements included in the Annual Report on Form10-K for the year ended December 31, ~~2017.~~

2018.

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

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

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

2019.

2. NEW ACCOUNTING PRONOUNCEMENTS

Financial instruments

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ~~ASU~~Accounting Standards Update No. 2016-13, “Financial ~~Instruments—~~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 toavailable-for-sale debt securities should be recorded through an allowance for credit losses when the fair value is below the amortized cost of the asset, removing the concept of “other-than-temporary” impairments. The effective date for the Company will be January 1, 2020, with early adoption permitted. The Company is currently evaluating the effect this ASU will have on its consolidated financial statements and related disclosures.

Leases

~~In February 2016, the FASB issued ASUNo. 2016-02,~~ ~~“Leases (Topic 842),” which requires lessees to record most leases on their balance sheets, recognizing a lease liability for the obligation to make lease payments and aright-of-use~~ ~~asset for the right to use the underlying asset for the lease term. The effective date for the Company will be~~

On January 1, 2019, ~~with early adoption permitted. The Company expects that most of its operating lease commitments will be subject to this ASU and recognized as operating lease liabilities andright-of-use~~ assets upon adoption with a material impact to the Company’s balance sheet but an immaterial impact to its results of operations and cash flows. The Company expects to elect the optional transition method to apply the new lease standard prospectively at the adoption date, as opposed to recasting prior reporting periods. As a result, the Company expects to recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption.

~~ASC 606 and ASC340-40~~

~~On January 1, 2018,~~ the Company adopted Accounting Standards Codifications 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 ~~606 revenue recognition standard~~842, while prior period amounts were not adjusted and ~~has adjusted prior periods~~continue to ~~conform.~~

~~The most significant adoption impacts were as follows:~~

•

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

•

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

~~PEGASYSTEMS INC.~~

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

•

~~Deferred contract costs~~ ~~- Sales incentive programs and other incremental costs to obtain a contract were previously expensed when incurred. ASC340-40~~ requires these costs be recognized as an asset when incurred and expensed over the period of expected benefit, which is on average five years. This change primarily impacts the Company’s contracts related to multi-year cloud offerings, maintenance on term and perpetual licenses, and long-term term and perpetual licenses with client usage rights that increase over time.

•

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

~~For additional information on~~ the Company’s historic accounting ~~policies as a result~~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 ~~adoption~~right of ~~ASC 606~~use assets and ~~ASC340-40~~ ~~see Note 4. “Receivables, Contract Assets,~~lease liabilities is due to the reclassification of existing deferred rent, prepaid rent, and ~~Deferred Revenue”, Note 5. “Deferred Contract Costs”, and~~unamortized lease incentives as of January 1, 2019.

See Note 9. ~~“Revenue”.~~

~~The impact of the adoption of ASC 606 and ASC340-40~~ ~~on the Company’s unaudited condensed consolidated balance sheet and unaudited condensed consolidated statement of operations is:~~

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

Accounts receivable, unbilled receivables, and contract assets
   $ 248,331    $ 134,216    $ 382,547
Long-term unbilled receivables
   —    160,708    160,708
Deferred income taxes
   57,127    (42,887)    14,240
Deferred contract costs
   —    37,924    37,924
Other assets⁽¹⁾
   416,148    —    416,148






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






Liabilities and stockholders’ equity

Deferred revenue
   $ 195,073    $ (28,776)    $ 166,297
Long-term deferred revenue
   6,591    (2,885)    3,706
Deferred income tax liabilities
   —    38,463    38,463
Other liabilities⁽²⁾
   148,864    —    148,864






Total liabilities
   350,528    6,802    357,330
Foreign currency translation adjustments
   (3,494)    (2,966)    (6,460)
Retained earnings
   221,926    286,125    508,051
Other equity⁽³⁾
   152,646    —    152,646






Total stockholders’ equity
   371,078    283,159    654,237






Total liabilities and stockholders’ equity
   $         721,606    $         289,961    $         1,011,567

⁽¹⁾

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

⁽²⁾

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

⁽³⁾

~~Includes common stock, additionalpaid-in~~ ~~capital, and net unrealized loss onavailable-for-sale~~ ~~marketable securities (as reflected in the consolidated balance sheets in the Annual Report on Form10-K~~ ~~for the year ended December 31, 2017).~~

~~PEGASYSTEMS INC.~~

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

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

Software license
   $ 41,793    $ 11,441    $ 53,234    $ 195,220    $ 36,172    $ 231,392
Maintenance
   62,204    (392)    61,812    180,759    (810)    179,949
Services
   75,818    93    75,911    225,063    (2,542)    222,521












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












Cost of revenue:

Software license
   1,276    —      1,276    3,826    —      3,826
Maintenance
   6,716    —      6,716    20,945    —      20,945
Services
   61,739    —      61,739    180,925    —      180,925












  Total cost of revenue
   69,731    —      69,731    205,696    —      205,696












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












Operating expenses:

Selling and marketing
   70,209    (846)    69,363    217,384    (3,140)    214,244
Research and development
   41,031    —      41,031    121,089    —      121,089
General and administrative
   13,133    —      13,133    38,174    —      38,174












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












(Loss) income from operations
   (14,289)    11,988    (2,301)    18,699    35,960    54,659
Foreign currency transaction loss
   (552)    (4,500)    (5,052)    (793)    (5,756)    (6,549)
Interest income, net
   144    (4)    140    470    77    547
Other income, net
   —      —      —      287    —      287












(Loss) income before benefit from income taxes
   (14,697)    7,484    (7,213)    18,663    30,281    48,944
Benefit from income taxes
   (12,885)    4,384    (8,501)    (17,952)    8,943    (9,009)












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












(Loss) earnings per share:

Basic
   $ (0.03)       $ 0.01    $ 0.47       $ 0.75








Diluted
   $ (0.03)       $ 0.01    $ 0.44       $ 0.70








Weighted-average number of common shares outstanding:

Basic
   77,691       77,691    77,258       77,258
Diluted
   77,691       83,323    82,717       82,717

~~Adoption of ASC 606 and ASC340-40~~ ~~did not change the Company’s total cash provided by or used in operating, financing, or investing activities in the Company’s unaudited condensed consolidated statements of cash flows~~“Leases” for ~~the nine months ended September 30, 2017.~~

additional information.

3. MARKETABLE SECURITIES

   September 30, 2018
(in thousands)        Amortized Cost            Unrealized Gains            Unrealized Losses                Fair Value
Municipal bonds
   $ 46,633    $ —    $ (267)    $ 46,366
Corporate bonds
   53,738    1    (323)    53,416








   $ 100,371    $ 1    $ (590)    $ 99,782

   December 31, 2017
(in thousands)        Amortized Cost            Unrealized Gains            Unrealized Losses                Fair Value
Municipal bonds
   $ 32,996    $ —    $ (148)    $ 32,848
Corporate bonds
   28,757    1    (137)    28,621








   $ 61,753    $ 1    $ (285)    $ 61,469



	March 31, 2019
(in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
Municipal bonds	$	42,693	$	86	$	(20	)	$	42,759
Corporate bonds	48,966		142		(63		)	49,045
	$	91,659	$	228	$	(83	)	$	91,804



	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 ~~September 30, 2018,~~March 31, 2019, the Company did not hold any investments with unrealized losses that are considered to be other-than-temporary.

As of March 31, 2019, maturities of marketable securities ranged from April 2019 to August 2022, with a weighted-average remaining maturity of approximately 1.4 years.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

4. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE

Receivables

(in thousands)            September 30,
2018            December 31,
2017
Accounts receivable
   $ 150,733    $ 222,735
Unbilled receivables
   155,964    158,898
Long-term unbilled receivables
   168,929    160,708




   $                         475,626    $                         542,341



(in thousands)	March 31, 2019		December 31, 2018
Accounts receivable	$	135,352	$	180,872
Unbilled receivables	161,480		172,656
Long-term unbilled receivables	130,494		151,237
	$	427,326	$	504,765

Unbilled receivables are ~~the~~client committed amounts ~~due from clients where the only condition~~for which revenue recognition precedes billing, and billing is solely subject to ~~the right of payment is~~ the passage of time.

As of ~~September 30, 2018~~March 31, 2019 and December 31, ~~2017,~~2018, the allowance for doubtful accounts was not material.

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

(Dollars in thousands)            September 30,
2018
1 Year or Less
   $         155,964                48%
1-2 Years
   89,177    27%
2-5 Years
   79,752    25%




   $ 324,893    100%

(Dollars in thousands) March 31, 2019
1 year or less $ 161,480
55 %
1-2 years 86,496
30 %
2-5 years 43,998
15 %
$ 291,974
100 %

Contract assets and deferred revenue

(in thousands)            September 30,
2018            December 31,
2017
Contract assets⁽¹⁾
   $ 2,888    $ 914
Long-term contract assets⁽²⁾
   1,581    —




   $ 4,469    $ 914




Deferred revenue
   $ 158,178    $ 166,297
Long-term deferred revenue⁽³⁾
   5,840    3,706




   $ 164,018    $ 170,003



(in thousands)	March 31, 2019		December 31, 2018
Contract assets ⁽¹⁾	$	3,380	$	3,711
Long-term contract assets ⁽²⁾	1,818		2,543
	$	5,198	$	6,254
Deferred revenue	$	180,845	$	185,145
Long-term deferred revenue ⁽³⁾	5,866		5,344
	$	186,711	$	190,489

⁽¹⁾Included in other current assets.

⁽²⁾ Included in other long-term assets.

⁽³⁾Included in other long-term liabilities.

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

The change in deferred revenue in the ~~nine~~three months ended ~~September 30, 2018~~March 31, 2019 was primarily due to ~~$225.1~~$89.4 million of revenue recognized, excluding the impact of netting contract assets and deferred revenue at the contract level, during the period that was included in deferred revenue at December 31, ~~2017,~~2018, partially offset by new billings in advance of revenue recognition.

~~Major clients~~

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

5. DEFERRED CONTRACT COSTS

The Company recognizes an asset for the incremental costs of obtaining a client contract, ~~with a client~~which primarily relate to sales commissions, if the Company expects ~~the~~to benefit offrom those costs ~~to be longer~~for more than one year. Deferred costs are amortized on a straight-line basis over the benefit period, which is on average ~~five~~5 years.

(in thousands)        September 30,
2018        December 31,
2017
Deferred contract costs⁽¹⁾
   $                         50,799      $                         37,924



(in thousands)	March 31, 2019		December 31, 2018
Deferred contract costs ⁽¹⁾	$	64,869	$	64,367

⁽¹⁾ Included in other long-term assets.



	Three Months Ended March 31,
(in thousands)	2019		2018
Amortization of deferred contract costs ⁽¹⁾	$	8,301	$	3,789

⁽¹⁾Included in selling and marketing expenses.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

~~Amortization of deferred contract costs was as follows:~~

               Three Months Ended
September 30,            Nine Months Ended
September 30,
(in thousands)          2018                2017                2018                2017
Amortization of deferred contract costs⁽¹⁾
   $             4,208    $             3,034    $             11,806    $             8,529

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

6. GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill

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


~~(in thousands)~~	~~Nine Months Ended~~ ~~September 30,~~
~~(in thousands)~~	~~2018~~
~~Balance as of January 1,~~	$	~~72,952~~
~~Currency translation adjustments~~		~~(55)~~

~~Balance as of September 30,~~	$	~~72,897~~

was:

(in thousands) Three Months Ended
March 31,
2019
Balance as of January 1, $ 72,858
Currency translation adjustments 40
Balance as of March 31, $ 72,898

Intangibles

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

September 30, 2018
(in thousands)         Useful Lives         Cost Accumulated
Amortization Net Book Value⁽¹⁾
Client-related intangibles
4-10 years $                 63,136 $                 (49,633) $                 13,503
Technology
3-10 years 58,942 (49,067) 9,875
Other
1-5 years 5,361 (5,361) —

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



		March 31, 2019
(in thousands)	Useful Lives	Cost		Accumulated Amortization			Net Book Value ⁽¹⁾
Client-related intangibles	4-10 years	$	63,136	$	(52,839	)	$	10,297
Technology	2-10 years	59,742		(51,730		)	8,012
Other	1 - 5 years	5,361		(5,361		)	—
		$	128,239	$	(109,930	)	$	18,309

⁽¹⁾Included in other long-term assets.

December 31, 2017
(in thousands)         Useful Lives         Cost Accumulated
Amortization Net Book Value⁽¹⁾
Client-related intangibles
4-10 years $                 63,164 $                 (44,835) $                 18,329
Technology
3-10 years 58,942 (45,372) 13,570
Other
1-5 years 5,361 (5,361) —

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



		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.

Amortization of intangible assets ~~was as follows:~~

               Three Months Ended
September 30,                Nine Months Ended
September 30,
(in thousands)    2018    2017    2018    2017
Cost of revenue
   $                 1,232    $                 1,232    $                 3,695    $                 3,871
Selling and marketing
   1,603    1,873    4,813    5,608








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








was:

~~PEGASYSTEMS INC.~~

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

(in thousands) Three Months Ended
March 31,
2019 2018
Cost of revenue $ 1,332
$ 1,232
Selling and marketing 1,603
1,605
$ 2,935
$ 2,837

7. ACCRUED EXPENSES

(in thousands)    September 30,
2018    December 31,
2017
Outside professional services
   $ 11,638    $ 14,468
Income and other taxes
   3,971    7,420
Marketing and sales program expenses
   4,623    6,444
Dividends payable
   2,365    2,344
Employee-related expenses
   5,212    4,065
Other
   12,020    10,767




   $                     39,829    $                     45,508



(in thousands)	March 31, 2019		December 31, 2018
Outside professional services expenses	$	8,815	$	10,367
Income and other taxes	7,954		10,387
Marketing and sales program expenses	8,318		5,860
Dividends payable	2,367		2,363
Employee-related expenses	5,432		3,536
Other	8,061		12,993
	$	40,947	$	45,506

8. FAIR VALUE MEASUREMENTS

Assets and liabilities measured at fair value on a recurring basis

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

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

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

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

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

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

hierarchy.

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

March 31, 2019.

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

   September 30, 2018
(in thousands)            Level 1                    Level 2                    Level 3                    Total
Cash equivalents
   $                     10,212      $                     15,212      $                     —      $                     25,424
Marketable securities:

Municipal bonds
   $ —      $ 46,366      $ —      $ 46,366
Corporate bonds
   —      53,416      —      53,416








Total marketable securities
   $ —      $ 99,782      $ —      $ 99,782
Investments in privately-held companies⁽¹⁾
   $ —      $ —      $ 2,890      $ 2,890

were:



	March 31, 2019
(in thousands)	Level 1		Level 2		Level 3		Total
Cash equivalents	$	12,401	$	10,062	$	—	$	22,463
Marketable securities:
Municipal bonds	$	—	$	42,759	$	—	$	42,759
Corporate bonds	—		49,045		—		49,045
Total marketable securities	$	—	$	91,804	$	—	$	91,804
Investments in privately-held companies ⁽¹⁾	$	—	$	—	$	3,390	$	3,390

⁽¹⁾ Included in other long-term assets.

~~PEGASYSTEMS INC.~~

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

   December 31, 2017
(in thousands)            Level 1                    Level 2                    Level 3                    Total
Cash equivalents
   $             2,720      $             40,051      $             —      $             42,771
Marketable securities:

Municipal bonds
   $ —      $ 32,848      $ —      $ 32,848
Corporate bonds
   —      28,621      —      28,621








Total marketable securities
   $ —      $ 61,469      $ —      $ 61,469
Investments in privately-held companies⁽¹⁾
   $ —      $ —      $ 1,030      $ 1,030



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

~~Assets measured at fair value on a nonrecurring basis~~

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

9. ~~REVENUE~~

~~Revenue policy~~

LEASES

The Company’s ~~revenue is~~leases are primarily ~~derived from:~~

for office space used in the ordinary course of business.

~~Software license revenue is primarily derived from sales of~~Accounting policy

All the Company’s ~~Pega Platform and software applications.~~

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

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

~~Contracts with multiple performance obligations~~

leases are operating leases. The ~~Company’s license and cloud arrangements often contain multiple performance obligations. For contracts with multiple performance obligations, the~~ Company accounts for ~~individual performance obligations separately~~a contract as a lease when it has the right to control the asset for a period of time while obtaining substantially all 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 ~~they~~modified. Fixed lease costs are ~~distinct. The transaction price is allocated to the separate performance obligations~~recognized on a ~~relative stand-alone selling price basis. If~~straight-line basis over the ~~transaction price contains discounts~~term of the lease. Variable lease costs are recognized in the period in which the obligation for those payments is incurred. The Company combines lease and non-lease components in the determination of lease costs for its office space leases. The lease liability includes lease payments related to options to extend or renew the lease term, if the Company expects to provide a future price concession, these elements are considered when determining the transaction price prior to allocation. Variable fees within the transaction price are estimated and recognized in revenue as the Company satisfies each performance obligation to the extentis reasonably certain it ~~is probable that a significant reversal of cumulative revenue recognized~~ will exercise those options. The Company’s leases do not ~~occur when the uncertainty associated with the variable fee is resolved. If the contract grants the client the option to acquire additional products~~contain any material residual value guarantees or services, the Company assesses whether any discount on the included products and services is in excess of levels normally available to similar clients and, if so, accounts for that discount as an additional performance obligation.

~~Software licenses~~

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

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

restrictive covenants.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

~~Term license fees~~

Expense



	Three Months Ended March 31,
(in thousands)	2019
Operating lease costs	$	4,300
Variable lease costs ⁽¹⁾	1,321
	$	5,621

⁽¹⁾ Lease costs that are ~~usually payable~~not fixed at lease commencement.

Right of use assets and lease liabilities



(in thousands)	March 31, 2019
Right of use assets ⁽¹⁾	$	46,464
Lease liabilities ⁽²⁾	$	12,447
Long-term lease liabilities	$	45,325

⁽¹⁾An asset that represents the Company’s right to use the leased asset during the lease term. Included in ~~advance~~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:



	March 31, 2019
Weighted-average remaining lease term	4.3 years
Weighted-average discount rate ⁽¹⁾	5.7	%

⁽¹⁾The rate implicit in the lease is not readily determinable in most of the Company’s leases, 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 at lease commencement to borrow an amount equal to the lease payments on a ~~monthly, quarterly, or annual~~collateralized basis over the term of the ~~license agreement, which is typically three to five years and may be renewed for additional terms~~lease.

Maturities of lease liabilities were:



(in thousands)	March 31, 2019
Remainder of 2019	$	11,324
2020	15,784
2021	13,764
2022	12,761
2023	11,604
Total lease payments	65,237
Less: imputed interest ⁽¹⁾	(7,465		)
	$	57,772

⁽¹⁾Lease liabilities are measured at the ~~client’s option. Perpetual license fees are usually payable when the contract is executed.~~

~~Maintenance~~

~~Maintenance contracts entitle clients to receive technical support and software updates, on a when and if available basis, during the term~~present value of the ~~maintenance contract. Technical support and software updates are considered distinct services but accounted for~~remaining lease payments using a discount rate determined at lease commencement unless the discount rate is updated as a ~~single performance obligation,~~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 ~~they each constitute a series of distinct services that are substantially the same and have the same pattern of transfer~~determined prior to the ~~client. Maintenance revenue is recognized over time on a straight-line basis over~~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 ~~contract period.~~

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

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

~~Services~~

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

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

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

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

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

~~Contract modifications~~

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

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

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

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

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

~~a cumulativecatch-up~~ ~~basis.~~

its restructuring activities.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Cash flow information



	Three Months Ended March 31,
(in thousands)	2019
Cash paid for leases	5,197
Right of use assets recognized for new leases (non-cash)	8,034

10. REVENUE

Geographic revenue

   Three Months Ended
September 30,    Nine Months Ended
September 30,
(Dollars in thousands)    2018    2017    2018    2017
U.S.
   $ 103,075    51%    $ 105,059    55%    $ 327,409    51%    $ 376,819    59%
Other Americas
   10,424    5%    9,307    5%    37,766    6%    32,890    5%
United Kingdom (“U.K.”)
   19,277    9%    18,537    10%    68,450    11%    67,403    11%
Europe (excluding U.K.), Middle East, and Africa
   42,254    21%    31,109    16%    101,150    16%    81,557    13%
Asia-Pacific
   28,233    14%    26,945    14%    100,449    16%    75,193    12%








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

Three Months Ended
March 31,
(Dollars in thousands) 2019 2018
U.S. $ 103,991
48 % $ 113,985
48 %
Other Americas 28,829
14 % 17,715
8 %
United Kingdom (“U.K.”) 24,549
12 % 26,094
11 %
Europe (excluding U.K.), Middle East, and Africa 34,186
16 % 31,826
14 %
Asia-Pacific 20,991
10 % 45,562
19 %
$ 212,546
100 % $ 235,182
100 %

Revenue streams

   Three Months Ended
September 30,    Nine Months Ended
September 30,
(in thousands)                2018                            2017                            2018                            2017
Perpetual license
   $         20,276    $         12,623    $         56,829    $         81,819
Term license
   32,066    40,611    128,070    149,573








Revenue recognized at a point in time
   52,342    53,234    184,899    231,392
Maintenance
   66,017    61,812    196,448    179,949
Cloud
   22,184    13,280    57,967    36,207
Consulting
   62,720    62,631    195,910    186,314








Revenue recognized over time
   150,921    137,723    450,325    402,470








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








   Three Months Ended
September 30,    Nine Months Ended
September 30,
(in thousands)                2018                            2017                            2018                            2017
Term license
   $         32,066    $         40,611    $         128,070    $         149,573
Cloud
   22,184    13,280    57,967    36,207
Maintenance
   66,017    61,812    196,448    179,949








Subscription⁽¹⁾
   120,267    115,703    382,485    365,729
Perpetual license
   20,276    12,623    56,829    81,819
Consulting
   62,720    62,631    195,910    186,314








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



	Three Months Ended March 31,
(in thousands)	2019		2018
Perpetual license	$	14,950	$	23,078
Term license	48,314		64,695
Revenue recognized at a point in time	63,264		87,773
Maintenance	67,706		64,525
Cloud	27,758		15,582
Consulting	53,818		67,302
Revenue recognized over time	149,282		147,409
	$	212,546	$	235,182



(in thousands)	Three Months Ended March 31,
(in thousands)	2019		2018
Term license	$	48,314	$	64,695
Cloud	27,758		15,582
Maintenance	67,706		64,525
Subscription ⁽¹⁾	143,778		144,802
Perpetual license	14,950		23,078
Consulting	53,818		67,302
	$	212,546	$	235,182

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

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

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

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

   September 30, 2018
(Dollars in thousands)    Perpetual license    Term license    Maintenance    Cloud    Consulting    Total
1 year or less
   $ 25,343    $ 44,283    $ 140,591    $ 88,529    $ 14,107    $ 312,853                60%
1-2 years
   6,490    10,063    8,877    70,815    1,830    98,075    19%
2-3 years
   360    1,598    2,586    54,646    449    59,639    11%
Greater than 3 years
   1,306    218    1,079    49,110    50    51,763    10%
��













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

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

~~Major clients~~

~~Clients accounting for 10%~~

Remaining performance obligations

Revenue recognition timing on existing contracts:



	March 31, 2019
(Dollars in thousands)	Perpetual license		Term License		Maintenance		Cloud		Consulting		Total
1 year or less	$	10,263	$	44,404	$	187,324	$	115,548	$	13,251	$	370,790	58	%
1-2 years	998		4,274		9,350		91,539		1,363		107,524		17	%
2-3 years	2,180		756		4,438		71,509		473		79,356		13	%
Greater than 3 years	—		135		2,008		72,742		27		74,912		12	%
	$	13,441	$	49,569	$	203,120	$	351,338	$	15,114	$	632,582	100	%



	March 31, 2018
(Dollars in thousands)	Perpetual license		Term License		Maintenance		Cloud		Consulting		Total
1 year or less	$	33,859	$	21,087	$	156,702	$	47,764	$	9,403	$	268,815	59	%
1-2 years	14,106		7,877		21,381		52,849		1,098		97,311		21	%
2-3 years	1,204		5,634		4,924		37,844		—		49,606		11	%
Greater than 3 years	382		853		1,825		40,478		—		43,538		9	%
	$	49,551	$	35,451	$	184,832	$	178,935	$	10,501	$	459,270	100	%

The above amounts include contracts that have an original expected duration of one year or ~~more of the Company’s total revenue were as follows:~~

               Three Months Ended
September 30,                Nine Months Ended
September 30,
(in thousands)    2018    2017    2018    2017
Total revenue
   $           203,263       $           190,957       $ 635,224    $ 633,862
Client A
   10%    10%    *    *

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

~~10.~~less.

11. STOCK-BASED COMPENSATION

Expense

                   Three Months Ended
September 30,                    Nine Months Ended
September 30,
(in thousands)    2018    2017    2018    2017
Cost of revenues
   $ 4,319      $ 3,613      $ 12,277      $ 10,913
Selling and marketing
   6,198      3,976      16,895      11,482
Research and development
   3,917      3,420      11,356      10,306
General and administrative
   1,974      2,480      7,045      7,228








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








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



	Three Months Ended March 31,
(in thousands)	2019			2018
Cost of revenues	$	4,519		$	3,701
Selling and marketing	7,374			4,658
Research and development	4,560			3,637
General and administrative	1,897			3,113
	$	18,350		$	15,109
Income tax benefit	$	(3,740	)	$	(3,141	)

The Company recognizes stock-based compensation using the accelerated recognition method, treating each vesting tranche as if it were an individual grant. As of ~~September 30, 2018,~~March 31, 2019, the Company had ~~net of estimated forfeitures, $74.2~~$114.1 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to all unvested restricted stock units (“RSUs”) and stock ~~options, which was~~options. These amounts are expected to be recognized over a weighted-average period of ~~2.2~~2.3 years.

Grants

The Company granted the following stock-based compensation awards:

               Nine Months Ended
September 30,
(in thousands)            Shares                 Total Fair Value
RSUs⁽¹⁾
   1,117 $ 65,569
Non-qualified stock options
   1,623 $ 29,372

⁽¹⁾

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

Three Months Ended
March 31,
2019
(in thousands) Shares Total Fair Value
RSUs 839
$ 53,184
Non-qualified stock options 1,770
$ 33,344

RSU vestings and stock option exercises

During the ~~nine~~three months ended ~~September 30, 2018, 1.2~~March 31, 2019, 0.5 million shares of common stock were issued due to stock option exercises and RSU vestings under the Company’s stock-based compensation plans.

~~11. INCOME TAXES~~

~~Effective income tax rate~~

   Nine Months Ended
September 30,
(Dollars in thousands)            2018                 2017
Benefit from income taxes
   $ (23,692 ) $ (9,009 )
Effective income tax rate
   80 % (18 )%

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

12. INCOME TAXES

Effective income tax rate



	Three Months Ended March 31,
(Dollars in thousands)	2019			2018
Benefit from income taxes	$	(8,300	)	$	(4,222	)
Effective income tax rate	22		%	(53		)%

During the ~~nine~~three months ended ~~September 30, 2018,~~March 31, 2019, the Company’s effective income tax rate changed primarily due to the ~~following factors:~~

Global Intangible Low-Taxed Income (“GILTI”) and Base Erosion and Anti-Abuse Tax (“BEAT”) provisions of the Tax Reform Act. The Company’s effective income tax rate was also affected by excess tax benefits from stock-based compensation, ~~were disproportionately greater than the (loss) income before benefit from income taxes;~~

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

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

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

~~Tax reform act~~

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

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

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

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

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

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

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

~~12.~~13. EARNINGS PER SHARE

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

~~PEGASYSTEMS INC.~~

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

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

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

Net (loss) income
   $             (7,587)    $             1,288    $             (5,796)    $             57,953
Weighted-average common shares outstanding
               78,700                77,691                78,525    77,258








(Loss) earnings per share, basic
   $ (0.10)    $ 0.01    $ (0.07)    $ 0.75









Diluted

Net (loss) income
   $ (7,587)    $ 1,288    $ (5,796)    $ 57,953
Weighted-average effect of dilutive securities:

Stock options
   —    3,681    —    3,519
RSUs
   —    1,951    —    1,940








Effect of dilutive securities
   —    5,632    —    5,459








Weighted-average common shares outstanding, assuming dilution
   78,700    83,323    78,525    82,717








(Loss) earnings per share, diluted
   $ (0.10)    $ 0.01    $ (0.07)    $ 0.70









Outstanding anti-dilutive stock options and RSUs⁽¹⁾
   6,119    105    6,380    219

⁽¹⁾	Certain outstanding stock options and RSUs were excluded from the computation of diluted earnings per share because they were anti-dilutive in the period presented. These awards may be dilutive in the future.

was:



	Three Months Ended March 31,
(in thousands, except per share amounts)	2019			2018
Basic
Net (loss) income	$	(28,717	)	$	12,200
Weighted-average common shares outstanding	78,584			78,236
(Loss) earnings per share, basic	$	(0.37	)	$	0.16

Diluted
Net (loss) income	$	(28,717	)	$	12,200
Weighted-average effect of dilutive securities:
Stock options	—			3,119
RSUs	—			1,747
Effect of dilutive securities	—			4,866
Weighted-average common shares outstanding, assuming dilution	78,584			83,102
(Loss) earnings per share, diluted	$	(0.37	)	$	0.15

Outstanding anti-dilutive stock options and RSUs ⁽¹⁾	5,563			397

⁽¹⁾ Certain outstanding stock options and RSUs were excluded from the computation of diluted earnings per share because they were anti-dilutive in the period presented. These awards may be dilutive in the future.

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

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form10-Q contains or incorporates forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, statements about our future financial performance and business plans, the adequacy of our liquidity and capital resources, the continued payment of quarterly dividends, ~~and~~ the timing of revenue recognition, and are described more completely in Part I of our Annual Report on Form10-K for the year ended December 31, ~~2017.~~

2018.

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

~~These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict.~~

Important factors that could cause actual future activities and results to differ materially from those expressed in such forward-looking statements include, among others, variation in demand for our products and ~~services;~~services, reliance on third party ~~relationships; our beliefs and the timing of the completion of our analysis regarding the impact of the Tax Cuts and Jobs Act of 2017, including its impact~~relationships, reliance on ~~income tax expense and deferred tax assets;~~key personnel, the inherent risks associated with international operations and the continued uncertainties in the global ~~economy;~~economy, our continued effort to market and sell both domestically and ~~internationally;~~internationally, foreign currency exchange ~~rates; the financial impact of any future acquisitions;~~rates, the potential legal and financial liabilities and reputation damage due to cyber-attacks and security ~~breaches;~~breaches, and management of our growth. These risks and other factors that could cause actual results to differ materially from those expressed in such forward-looking statements are described more completely in Part I of our Annual Report on Form10-K for the year ended December 31, ~~2017~~2018 as well as other filings we make with the U.S. Securities and Exchange Commission (“SEC”).

Investors are cautioned not to place undue reliance on such forward-looking statements and there are no assurances that the results contained in such statements will be achieved. Although ~~subsequent~~new information, future events, or risks may cause ~~our view~~actual results to ~~change,~~differ materially from future results expressed or implied by such forward-looking statements, except as required by applicable law, we do not undertake and specifically disclaim any obligation to publicly update or revise these forward-looking statements whether as the result of new information, future events, or otherwise.

BUSINESS OVERVIEW

We develop, market, license, and support enterprise software applications that help organizations transform the way they engage with their customers and process and complete work across their enterprise. We license our no-code Pega Platform™ for ~~customer engagement and digital process automation, in addition to licensing our Pega Platform~~rapid application development ~~product for~~to clients that wish to build and extend their own business applications. ~~The~~Our cloud-architected portfolio of customer engagement and digital process automation applications leverages artificial intelligence (“AI”), case management, and robotic automation technology, built on our unified no-code Pega Platform, empowering businesses to quickly design, extend, and ~~applications help connect enterprises to~~scale their ~~customers in real-time across channels, streamline business operations, and adapt~~enterprise applications to meet ~~changing requirements.~~

strategic business needs.

Our target clients ~~include~~are Global 3000 ~~companies~~organizations and government agencies that ~~seek~~require applications to ~~manage complex enterprise systems~~differentiate themselves in the markets they serve. Our applications achieve and ~~customer service issues with greater~~facilitate differentiation by increasing business agility, driving growth, improving productivity, attracting and ~~cost-effectiveness. Our strategy is~~retaining customers, and reducing risk. We deliver applications tailored to ~~sell a client a series of licenses, each focused on a~~our clients’ specific ~~purpose or area of operations in support of longer term enterprise-wide digital transformation initiatives.~~

industry needs.

Performance metrics

(Dollars in thousands, except per share amounts)    Three Months Ended
September 30,          Nine Months Ended
September 30,
   2018    2017    Change    2018    2017    Change
Total revenue
   $     203,263    $     190,957    $     12,306    6%    $     635,224    $     633,862    $ 1,362    —%
Subscription⁽¹⁾
   $ 120,267    $ 115,703    $ 4,564    4%    $ 382,485    $ 365,729    $ 16,756    5%
Net (loss) income
   $ (7,587)    $ 1,288    $ (8,875)    *    $ (5,796)    $ 57,953    $     (63,749)    *
Diluted (loss) earnings per share
   $ (0.10)    $ 0.01    $ (0.11)    *    $ (0.07)    $ 0.70    $ (0.77)    *

We utilize a number of different performance measures in analyzing and assessing our overall performance, making operating decisions, and forecasting and planning for future periods.



(Dollars in thousands, except per share amounts)	Three Months Ended March 31,					Change
(Dollars in thousands, except per share amounts)	2019			2018		Change
Total revenue	$	212,546		$	235,182	$	(22,636	)	(10	)%
Subscription revenue ⁽¹⁾	$	143,778		$	144,802	$	(1,024	)	(1	)%
Net (loss) income	$	(28,717	)	$	12,200	$	(40,917	)	*
(Loss) earnings per share, diluted	$	(0.37	)	$	0.15	$	(0.52	)	*

* not meaningful

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

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

Annual Contract Value (“ACV”)⁽¹⁾

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

   September 30,
(Dollars in thousands)    2018    2017    Change
Term and cloud ACV
   $         272,693    $         200,180    $         72,513            36%
Maintenance ACV
   264,068    247,248    16,820    7%





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

⁽¹⁾



	March 31,				Change
(Dollars in thousands)	2019		2018		Change
Pega Cloud ACV	$	128,636	$	72,966	$	55,670	76	%
Client Cloud ACV	462,130		421,159		40,971		10	%
Total ACV	$	590,766	$	494,125	$	96,641	20	%

⁽¹⁾ACV, as of a given date, is ~~the sum of the following two components:~~

the sum of the following two components:

Client Cloud: the sum of (1) the annual value of each term ~~and cloud~~license contract in effect on such date, ~~with the annual value of a term or cloud contract being~~which is equal to ~~the~~its total value ~~of the contract~~ divided by the total number of years ~~of the contract.~~

and (2) maintenance revenue reported for the quarter ended on such date, multiplied by four.

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.

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

Revenue ~~for the remaining performance obligations~~recognition timing on existing contracts:



	March 31, 2019
(Dollars in thousands)	Perpetual license		Term license		Maintenance		Cloud		Consulting		Total
1 year or less	$	10,263	$	44,404	$	187,324	$	115,548	$	13,251	$	370,790	58	%
1-2 years	998		4,274		9,350		91,539		1,363		107,524		17	%
2-3 years	2,180		756		4,438		71,509		473		79,356		13	%
Greater than 3 years	—		135		2,008		72,742		27		74,912		12	%
	$	13,441	$	49,569	$	203,120	$	351,338	$	15,114	$	632,582	100	%



	March 31, 2018
(Dollars in thousands)	Perpetual license		Term license		Maintenance		Cloud		Consulting		Total
1 year or less	$	33,859	$	21,087	$	156,702	$	47,764	$	9,403	$	268,815	59	%
1-2 years	14,106		7,877		21,381		52,849		1,098		97,311		21	%
2-3 years	1,204		5,634		4,924		37,844		—		49,606		11	%
Greater than 3 years	382		853		1,825		40,478		—		43,538		9	%
	$	49,551	$	35,451	$	184,832	$	178,935	$	10,501	$	459,270	100	%

The above amounts include contracts isthat have an original expected ~~to be recognized as follows:~~

   September 30, 2018
(Dollars in thousands)    Perpetual license    Term license    Maintenance    Cloud    Consulting    Total
1 year or less
   $         25,343    $ 44,283    $ 140,591    $ 88,529    $ 14,107    $ 312,853                60%
1-2 years
   6,490    10,063    8,877    70,815    1,830    98,075    19%
2-3 years
   360    1,598    2,586    54,646    449    59,639    11%
Greater than 3 years
   1,306    218    1,079    49,110    50    51,763    10%














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

duration of one year or less.

CRITICAL ACCOUNTING POLICES

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

(“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 available information.

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

locations in our Annual Report on Form 10-K for the year ended December 31, 2018:

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

Note 2. “Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary Data” ~~both of which are contained in our Annual Report on Form10-K~~ ~~for the year ended December 31, 2017.~~

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

~~Except as described below, there~~There have been no significant changes to our critical accounting policies as disclosed in our Annual Report on Form10-K for the year ended December 31, ~~2017.~~

~~Revenue~~

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

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

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

2018.

RESULTS OF OPERATIONS

   Three Months Ended
September 30,          Nine Months Ended
September 30,
(Dollars in thousands)    2018    2017    Change    2018    2017    Change
Total revenue
   $     203,263    $     190,957    $ 12,306    6 %    $ 635,224    $     633,862    $ 1,362    — %
Gross profit
   $ 128,840    $ 121,226    $ 7,614    6 %    $ 411,370    $ 428,166    $ (16,796)    (4)%
(Loss) income from operations
   $ (17,258)    $ (2,301)    $     (14,957)    650 %    $     (32,485)    $ 54,659    $ (87,144)    *
Net (loss) income
   $ (7,587)    $ 1,288    $ (8,875)    *    $ (5,796)    $ 57,953    $     (63,749)    *

* not meaningful

Revenue

Three Months Ended
September 30, Nine Months Ended
September 30,
(Dollars in thousands) 2018 2017 Change 2018 2017 Change
Term license
$ 32,066 16% $ 40,611 21% $ (8,545) (21)% $ 128,070 20% $ 149,573 24% $ (21,503) (14)%
Cloud
22,184 11% 13,280 7% 8,904 67 % 57,967 9% 36,207 6% 21,760 60 %
Maintenance
66,017 32% 61,812 33% 4,205 7 % 196,448 31% 179,949 28% 16,499 9 %

Subscription⁽¹⁾
120,267 59% 115,703 61% 4,564 4 % 382,485 60% 365,729 58% 16,756 5 %
Perpetual license
20,276 10% 12,623 7% 7,653 61 % 56,829 9% 81,819 13% (24,990) (31)%
Consulting
62,720 31% 62,631 32% 89 — % 195,910 31% 186,314 29% 9,596 5 %

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

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



(Dollars in thousands)	Three Months Ended March 31,								Change
(Dollars in thousands)	2019				2018				Change
Term license	$	48,314	23	%	$	64,695	28	%	$	(16,381	)	(25	)%
Cloud	27,758		13	%	15,582		7	%	12,176			78	%
Maintenance	67,706		32	%	64,525		27	%	3,181			5	%
Subscription revenue ⁽¹⁾	143,778		68	%	144,802		62	%	(1,024		)	(1	)%
Perpetual license	14,950		7	%	23,078		10	%	(8,128		)	(35	)%
Consulting	53,818		25	%	67,302		28	%	(13,484		)	(20	)%
	$	212,546	100	%	$	235,182	100	%	$	(22,636	)	(10	)%

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

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

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

Subscription revenue

The decrease in term license revenue in the three months ended ~~September 30, 2018~~March 31, 2019 was primarily due to ~~$17 million of~~lower average revenue ~~recognized~~per arrangement. The increase in ~~the three months ended September 30, 2017 from a large term license renewal. The decrease in term license~~cloud revenue ~~in the nine months ended September 30, 2018 was primarily due to $35.3 million of revenue recognized~~ in the three months ended March 31, ~~2017 from a large term license renewal.~~

~~The increases in cloud revenue in the three and nine months ended September 30, 2018 reflect~~2019 reflects the shift in client preferences to cloud arrangements from other types of arrangements.

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

Perpetual license

The ~~increase~~decrease in perpetual license revenue in the three months ended September 30, 2018 was primarily due to revenue recognized from license rights which became effective in the current period from perpetual arrangements executed in prior periods, primarily the three months ended June 30, 2018. The decrease in perpetual license revenue in the nine months ended September 30, 2018March 31, 2019 reflects the shift in client preferences in favor of our cloud offerings and away from perpetual license arrangements.

Consulting

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

The ~~increase~~decrease in consulting revenue in the ~~nine~~three months ended ~~September 30, 2018~~March 31, 2019 was primarily due to ~~higher~~a decrease in billable ~~hours driven by an increase~~hours.

Gross profit



	Three Months Ended March 31,								Change
(Dollars in thousands)	2019				2018				Change
Software license	$	61,886	98	%	$	86,518	99	%	$	(24,632	)	(28	)%
Maintenance	61,371		91	%	58,443		91	%	2,928			5	%
Cloud	14,460		52	%	7,861		50	%	6,599			84	%
Consulting	392		1	%	6,746		10	%	(6,354		)	(94	)%
	$	138,109	65	%	$	159,568	68	%	$	(21,459	)	(13	)%

The recent shift in our revenue mix toward cloud arrangements has resulted in slower total gross profit growth as our cloud business continues to grow and scale. Revenue from cloud arrangements is generally recognized over the ~~number of projects performed.~~

~~Gross profit~~

Three Months Ended
September 30, Nine Months Ended
September 30,
(Dollars in thousands) 2018 2017 Change 2018 2017 Change
Software license
$ 51,087 98% $ 51,958 98% $ (871 ) (2)% $   181,127 98% $   227,566 98% $   (46,439) (20)%
Maintenance
59,938 91% 55,096 89% 4,842 9 % 178,413 91% 159,004 88% 19,409 12 %
Cloud
12,569 57% 7,269 55% 5,300 73 % 31,853 55% 18,938 52% 12,915 68 %
Consulting
5,246 8% 6,903 11%   (1,657 ) (24)% 19,977 10% 22,658 12% (2,681) (12)%

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

service period, while revenue from term and perpetual license arrangements is generally recognized upfront when the license rights become effective.

The ~~increase~~decrease in total gross profit in the three months ended ~~September 30, 2018~~March 31, 2019 was primarily due to ~~an increase in maintenance revenue, due to growth in~~ the ~~aggregate value of the installed base of our software, and an increase in cloud revenue, due to a shift in client preferences to cloud arrangements from other types of arrangements.~~

~~The~~ decrease in ~~total gross profit in the nine months ended September 30, 2018 was primarily due to $35.3 million of revenue recognized in the three months ended March 31, 2017 from a large~~ term ~~license renewal~~ and ~~the decrease in~~ perpetual license revenue reflecting the shift in client preferences toward our cloud ~~offerings, partially offset~~offerings.

The decrease in total gross profit percent in the three months ended March 31, 2019 was driven by ~~the~~a shift in favor of cloud arrangements, which are lower margin ~~growth in~~than our ~~maintenance~~term and ~~cloud~~perpetual license revenue streams. The ~~current shift~~increase in ~~our revenue mix toward~~ cloud ~~arrangements may result in slower total~~ gross profit ~~growth in the near term~~percent was driven by cost efficiency gains as our cloud business continues to grow and scale.

~~Maintenance and cloud gross profit percent~~

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

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

~~Consulting gross profit percent~~

~~The decreases~~ in consulting gross profit percent was driven by a decrease in billable hours as consulting resources were transitioning to new projects after completing a large project which began in the ~~three~~second half of 2016 and ~~nine months ended September 30, 2018 were driven primarily by increases~~an increase in ~~compensation~~consulting resource availability in Europe as we continue growing and ~~benefits, lower utilization rates, and the impact of~~leveraging our ~~policy introduced late in the three months ended June 30, 2017 to offer ourweb-based~~ ~~training free of charge to users which reduced training revenue for the three and nine months ended September 30, 2018.~~

partner network.

Operating expenses

Selling and marketing

   Three Months Ended
September 30,          Nine Months Ended
September 30,
(Dollars in thousands)            2018                    2017                    Change                    2018                    2017                    Change
Selling and marketing
   $     87,490       $     69,363       $     18,127    26%    $     269,845       $     214,244       $     55,601    26%
As a percent of total revenue
   43%    36%          42%    34%
Selling and marketing headcount, end of period
               1,194       934       260    28%



	Three Months Ended March 31,						Change
(Dollars in thousands)	2019			2018			Change
Selling and marketing ⁽¹⁾	$	108,865		$	88,383		$	20,482	23	%
As a percent of total revenue	51		%	38		%
Selling and marketing headcount, end of period	1,282			1,082			200		18	%

⁽¹⁾Includes compensation, benefits, and other headcount-related expenses ~~associated with our selling and marketing personnel~~ as well as advertising, promotions, trade shows, seminars, and the amortization of client-related intangibles.

The ~~increases~~increase in the three ~~and nine~~ months ended ~~September 30, 2018 were~~March 31, 2019 was primarily due to ~~increases~~an increase in compensation and benefits of ~~$15.2~~$17.7 million, ~~and $40.6 million, as a result of~~attributable to increased headcount, ~~increased~~and an increase of $4.5 million in deferred contract commission ~~costs amortization of $1.2 million and $3.3 million, and an increase in marketing programs in the nine months ended September 30, 2018 of $3.1 million.~~amortization. The increase in headcount reflects our efforts to increase our sales capacity to deepen relationships with existing clients and target new accounts.

Research and development

   Three Months Ended
September 30,          Nine Months Ended
September 30,
(Dollars in thousands)            2018                    2017                    Change                    2018                    2017                    Change
Research and development
   $     46,504       $     41,031       $     5,473    13%    $     135,261       $     121,089       $     14,172    12%
As a percent of total revenue
   23%    21%          21%    19%
Research and development headcount, end of period
               1,595       1,474       121    8%



	Three Months Ended March 31,						Change
(Dollars in thousands)	2019			2018			Change
Research and development ⁽¹⁾	$	50,596		$	46,785		$	3,811	8	%
As a percent of total revenue	24		%	20		%
Research and development headcount, end of period	1,638			1,602			36		2	%

⁽¹⁾Includes compensation, benefits, contracted services, and other headcount-related expenses associated with the ~~creation and~~ development of our products, as well as enhancements and design changes to existing products and the integration of acquired technologies.

The ~~increases~~increase in the three ~~and nine~~ months ended ~~September 30, 2018 were~~March 31, 2019 was primarily due to ~~increases~~an increase in compensation and benefits of ~~$4 million and $9.5~~$2.1 million, attributable to ~~increased~~an increase in headcount, and ~~the expansion~~an increase of $1.6 million in cloud hosting expenses as we expand our ~~application~~cloud-focused research and development ~~team to support the continued development of our expanding suite of software.~~

activities.

General and administrative

   Three Months Ended
September 30,          Nine Months Ended
September 30,
(Dollars in thousands)            2018                    2017                    Change                    2018                    2017                    Change
General and administrative
   $ 12,104       $ 13,133       $ (1,029)    (8)%    $ 38,749       $ 38,174       $ 575    2 %
As a percent of total revenue
   6%    7%          6%    6%
General and administrative headcount,
end of period
               326        407       (81)    (20)%



	Three Months Ended March 31,						Change
(Dollars in thousands)	2019			2018			Change
General and administrative ⁽¹⁾	$	12,676		$	16,464		$	(3,788	)	(23	)%
As a percent of total revenue	6		%	7		%
General and administrative headcount, end of period ⁽²⁾	373			299			74			25	%

⁽¹⁾Includes compensation, benefits, and other headcount-related expenses associated with finance, legal, corporate governance, and other administrative headcount. ~~They also include~~Also includes accounting, legal, and other professional consulting and administrative fees. ⁽²⁾The ~~general and administrative~~ headcount includes employees in information technology and corporate services departments, whose costs are partially allocated to other operating expense areas.

The decrease in the three months ended ~~September 30, 2018~~March 31, 2019 was primarily due to a decrease in compensation and benefits of $1.2 million, due to ~~decreased headcount, reflecting the realignment~~a decrease in equity compensation, and a decrease of ~~contract negotiation and product development resources to augment our selling and marketing and research and development functions.~~

~~The increase in the nine months ended September 30, 2018 was primarily due to an increase of $2.1~~$1.9 million in legal and ~~tax fees partially offset by a decrease of $1.7 million in~~other professional services fees. Despite the headcount increase, associated compensation and benefits ~~due~~did not increase because these costs are primarily allocated to ~~decreased headcount reflecting the realignment of contract negotiation and product development resources to augment our selling and marketing and research and development functions.~~

other operating expense areas.

Stock-based compensation

   Three Months Ended
September 30,          Nine Months Ended
September 30,
(Dollars in thousands)    2018    2017    Change    2018    2017    Change
Cost of revenues
   $ 4,319    $ 3,613    $ 706            20 %    $ 12,277    $ 10,913    $         1,364            12 %
Selling and marketing
   6,198    3,976    2,222    56 %    16,895    11,482    5,413    47 %
Research and development
   3,917    3,420    497    15 %    11,356    10,306    1,050    10 %
General and administrative
   1,974    2,480    (506)    (20)%    7,045    7,228    (183)    (3)%









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









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



	Three Months Ended March 31,						Change
(Dollars in thousands)	2019			2018			Change
Cost of revenues	$	4,519		$	3,701		$	818		22	%
Selling and marketing	7,374			4,658			2,716			58	%
Research and development	4,560			3,637			923			25	%
General and administrative	1,897			3,113			(1,216		)	(39	)%
	$	18,350		$	15,109		$	3,241		21	%
Income tax benefit	$	(3,740	)	$	(3,141	)	$	(599	)	19	%

The increase in the three ~~and nine~~ months ended ~~September 30, 2018~~March 31, 2019 was primarily due to the increased value of our annual periodic equity awards granted in March ~~2018~~2019 and ~~2017.~~2018. These awards generally have a five-year vesting schedule.

Non-operating (expense) income, ~~(expense),~~ net

   Three Months Ended
September 30,          Nine Months Ended
September 30,
(Dollars in thousands)    2018    2017    Change    2018    2017    Change
Foreign currency transaction gain (loss)
   $ 399    $         (5,052)    $         5,451    *    $ 558    $ (6,549)    $         7,107    *
Interest income, net
   683    140    543        388 %    2,076    547    1,529        280 %
Other income, net
   —    —    —    — %    363    287    76    26 %









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



	Three Months Ended March 31,						Change
(Dollars in thousands)	2019			2018			Change
Foreign currency transaction loss	$	(3,712	)	$	(1,085	)	$	(2,627	)	242	%
Interest income, net	723			764			(41		)	(5	)%
Other income, net	—			363			(363		)	(100	)%
	$	(2,989	)	$	42		$	(3,031	)	*

* not meaningful

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

~~The change in interest income, net was primarily~~receivables of our U.K subsidiary due to ~~an increase~~fluctuations in ~~prevailing interest~~foreign currency exchange rates as the British Pound strengthened against the Euro and ~~an increase in the size of our holdings in marketable securities.~~

U.S. dollar.

Benefit from income taxes

   Three Months Ended
September 30,          Nine Months Ended
September 30,
(Dollars in thousands)    2018    2017    Change    2018    2017    Change
Benefit from income taxes
   $          (8,589)    $         (8,501)    $         (88)    1%    $         (23,692)        $         (9,009)        $         (14,683)            163%
Effective income tax rate
               80%    (18)%

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

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

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



	Three Months Ended March 31,						Change
(Dollars in thousands)	2019			2018			Change
Benefit from income taxes	$	(8,300	)	$	(4,222	)	$	(4,078	)	97	%
Effective income tax rate	22		%	(53		)%

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

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

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

During the three months ended March 31, 2019, the Company’s effective income tax rate changed primarily due to the Global Intangible Low-Taxed Income (“GILTI”) and Base Erosion and Anti-Abuse Tax (“BEAT”) provisions of the Tax Reform Act. The Company’s effective income tax rate was also affected by excess tax benefits from stock-based compensation, an increase in U.S. research and development tax credits, and a decrease in uncertain tax positions as a result of the lapse of the statute of limitations on certain foreign reserves.

LIQUIDITY AND CAPITAL RESOURCES

   Nine Months Ended
September 30,
(in thousands)    2018    2017
Cash provided by (used in):

Operating activities
   $                 67,088    $                 113,926
Investing activities
   (49,595)    (11,966)
Financing activities
   (71,664)    (44,040)
Effect of exchange rates on cash and cash equivalents
   (1,913)    2,054




Net (decrease) increase in cash and cash equivalents
   $ (56,084)    $ 59,974




(in thousands)    September 30,
2018    December 31,
2017
Held by U.S. entities
   $ 134,634    $ 136,444
Held by foreign entities
   71,343    87,304




Total cash, cash equivalents, and marketable securities
   $ 205,977    $ 223,748



	Three Months Ended March 31,
(in thousands)	2019			2018
Cash provided by (used in):
Operating activities	$	22,703		$	55,655
Investing activities	(1,466		)	(31,278		)
Financing activities	(25,587		)	(23,052		)
Effect of exchange rates on cash and cash equivalents	295			2,186
Net (decrease) increase in cash and cash equivalents	$	(4,055	)	$	3,511



(in thousands)	March 31, 2019		December 31, 2018
Held by U.S. entities	$	141,051	$	143,533
Held by foreign entities	61,120		63,890
Total cash, cash equivalents, and marketable securities	$	202,171	$	207,423

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

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

Cash provided by operating activities

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

The primary driver during the ~~nine~~three months ended ~~September 30, 2018~~March 31, 2019 was ~~$57.6~~$78.1 million in cash generated from client receivables, ~~and contract assets,~~ largely due to cash collections and the timing of billings.

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

Cash used in investing activities

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

Cash used in financing activities

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

Stock repurchase program⁽¹⁾

~~Remaining~~

The changes in the remaining stock repurchase authority was:



	Three Months Ended March 31,
(in thousands)	2019
January 1	$	6,620
Authorizations ⁽²⁾	60,000
Repurchases	(7,586		)
March 31,	$	59,034

⁽¹⁾ Purchases under ~~existing~~these programs ~~is as follows:~~

   Nine Months Ended
September 30,
(in thousands)    2018
January 1
   $ 34,892
Authorizations
   27,003
Repurchases
   (30,149 )


September 30,
   $                 31,746

⁽¹⁾

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

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

Common stock repurchases

   Nine Months Ended
September 30,
   2018    2017
    (in thousands)    Shares    Amount    Shares    Amount
Tax withholdings for net settlement of equity awards
   591      $ 35,530      682      $ 34,791
    Stock repurchase program⁽¹⁾

    Repurchases paid
   512      29,949      68      2,986
    Repurchases unsettled at period end
   3      200      —      —








    Activity in period⁽²⁾
   1,106      $ 65,679      750      $ 37,777

⁽¹⁾

~~Represents activity under our publicly announced stock repurchase programs.~~

⁽²⁾

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

Three Months Ended
March 31,
2019 2018
(in thousands) Shares Amount Shares Amount
Tax withholdings for net settlement of equity awards 232
$ 14,838
270
$ 15,575
Stock repurchase program ⁽¹⁾

Repurchases paid 141
7,387
89
4,998
Repurchases unsettled at period end 3
199
12
690
Activity in period ⁽²⁾
376
$ 22,424
371
$ 21,263

⁽¹⁾ Represents activity under our publicly announced stock repurchase programs. ⁽²⁾ During the three months ended March 31, 2019 and 2018, instead of receiving cash from the equity holders, we withheld shares with a value of $12.2 million and $11.2 million, respectively, for the exercise price of options. These amounts have been excluded from the table above.

Dividends

Nine Months Ended
September 30,
(in thousands)
            2018

                2017
Dividend payments to shareholders
$            7,067 $            6,941



	Three Months Ended March 31,
(in thousands)	2019		2018
Dividend payments to shareholders	$	2,363	$	2,344

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

~~ITEM 3.~~

~~QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK~~

~~Market risk represents~~

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes during the ~~risk of loss from adverse changes in financial market prices and rates. Our~~three months ended March 31, 2019 to the market risk exposure ~~is primarily related to fluctuations in foreign exchange rates.~~

See Item 7A. “Quantitative and Qualitative Disclosures about Market Risk” and Item 1A. “Risk Factors—We are exposed to fluctuations in currency exchange rates that could negatively impact our financial results and cash flows” includeddisclosed in our Annual Report on Form10-K for the year ended December 31, ~~2017 for a more complete discussion of our market risk exposure.~~

~~Foreign currency exposure~~

~~Translation risk~~

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

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

Nine Months Ended
September 30,
Increase (decrease)
2018

2017
Total revenue
(4)% (4)%
Net (loss) income
12% (1)%

~~Remeasurement risk~~

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

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

2018.

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

~~ITEM 4.~~

~~CONTROLS AND PROCEDURES~~

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of ~~Disclosure Controls~~disclosure controls and ~~Procedures~~

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 Rules13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)) as of ~~September 30, 2018.~~March 31, 2019. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of ~~September 30, 2018.~~

March 31, 2019.

(b) Changes in ~~Internal Control~~internal control over ~~Financial Reporting~~

financial reporting

There have been no changes in our internal control over financial reporting (as defined in Rules13a-15(f) and15d-15(f) under the Exchange Act) during the quarter ended ~~September 30, 2018~~March 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

~~ITEM 1A.~~

~~RISK FACTORS~~

ITEM 1A. RISK FACTORS

We encourage you to carefully consider the risk factors identified in Item 1A. “Risk Factors” of our Annual Report onForm 10-K for the year ended December 31, ~~2017.~~2018. These risk factors could materially affect our business, financial condition, and future results and could cause our actual business and financial results to differ materially from those contained in forward-looking statements made in this Quarterly Report on Form10-Q or elsewhere by management from time to time.

There have been no material changes during the ~~nine~~three months ended ~~September 30, 2018~~March 31, 2019 to the risk factors disclosed in our Annual Report on Form10-K for the year ended December 31, ~~2017.~~

2018.

~~ITEM 2.~~

~~UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS~~

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

The following table sets forth information regarding our repurchases of our common stock during the three months ended ~~September~~March 31, 2019.



(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⁾
January 1, 2019 - January 31, 2019	153	$	51.30	129	$	18
February 1, 2019 - February 28, 2019	129	$	63.81	—	$	18
March 1, 2019 - March 31, 2019	285	$	64.97	15	$	59,034
	567	$	61.03

⁽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 15, 2019, we announced that our Board of Directors extended the expiration date of the current stock repurchase program to June 30, ~~2018.~~

(in thousands, except per share

amounts)

Total Number
of Shares
Purchased⁽¹⁾

Average
Price Paid
per
Share⁽¹⁾

Total Number
of Shares Purchased as Part
of Publicly Announced
Share Repurchase
Program
Approximate Dollar
Value of Shares That
May Yet Be Purchased at Period End
Under Publicly Announced Share
Repurchase Programs⁽²⁾
July 1, 2018 - July 31, 2018
138      $     57.34      119   $                                                    39,189
August 1, 2018 - August 31, 2018
172      $     59.89      93   $                                                    33,645
September 1, 2018 - September 30, 2018
182      $     63.96      30   $                                                    31,746


Total
492      $     60.68

2020 and increased the amount of common stock we are authorized to repurchase by $60 million between March 15, 2019 and June 30, 2020 (the “Current Program”). Under the Current Program, purchases may be made from time to time on the open market or in privately negotiated transactions. Shares may be repurchased in such amounts as market conditions warrant, subject to regulatory and other considerations. We have established a pre-arranged stock repurchase plan, intended to comply with the requirements of Rule 10b5-1 under the Exchange Act, and Rule 10b-18 under the Exchange Act (the “10b5-1 Plan”). All stock repurchases under the Current Program during closed trading window periods will be made pursuant to the 10b5-1 Plan.

ITEM 6. EXHIBITS

⁽¹⁾

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

⁽²⁾

Since 2004, our Board of Directors has approved stock repurchase programs that have authorized the repurchase, in the aggregate, of up to $221.8 million of our common stock. On June 21, 2018, we announced that our Board of Directors extended the expiration date of the current stock repurchase program to June 30, 2019 and increased the amount of common stock we are authorized to repurchase to $50 million between June 15, 2018 and June 30, 2019 (the “Current Program”). Under the Current Program, purchases may be made from time to time on the open market or in privately negotiated transactions. Shares may be repurchased in such amounts as market conditions warrant, subject to regulatory and other considerations. We have established a~~pre-arranged~~ ~~stock repurchase plan, intended to comply with the requirements of Rule10b5-1~~ ~~under the Exchange Act, and Rule10b-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 the10b5-1~~ ~~Plan.~~

~~ITEM 6.~~

~~EXHIBITS~~


Exhibit No.		Description

31.1		Certification pursuant to Exchange Act Rules13a-14 and15d-14 of the Chief Executive Officer.

31.2		Certification pursuant to Exchange Act Rules13a-14 and15d-14 of the Chief Financial Officer.

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

101.INS		XBRL Instance document.

101.SCH		XBRL Taxonomy Extension Schema Document.

101.CAL		XBRL Taxonomy Calculation Linkbase Document.

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document.

101.LAB		XBRL Taxonomy Label Linkbase Document.

101.PRE		XBRL Taxonomy Presentation Linkbase Document.

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

++~~Management contracts and compensatory plan or arrangements~~

SIGNATURE

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


				~~Pegasystems Inc.~~

~~Dated: November 7, 2018~~		Pegasystems Inc.
			~~By:~~
Dated:	May 7, 2019	By:	/s/ KENNETH STILLWELL
					Kenneth Stillwell
					Chief Financial Officer and Chief Administrative Officer
					(Principal Financial Officer)


	September 30, 2018		December 31, 2017
Assets
Current assets:
Cash and cash equivalents	$	106,195	$	162,279
Marketable securities		99,782		61,469

Total cash, cash equivalents, and marketable securities		205,977		223,748
Accounts receivable		150,733		222,735
Unbilled receivables		155,964		158,898
Other current assets		73,464		41,135

Total current assets		586,138		646,516
Long-term unbilled receivables		168,929		160,708
Goodwill		72,897		72,952
Other long-term assets		134,679		131,391

Total assets	$	962,643	$	1,011,567

Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	12,926	$	17,370
Accrued expenses		39,829		45,508
Accrued compensation and related expenses		71,318		66,040
Deferred revenue		158,178		166,297

Total current liabilities		282,251		295,215
Deferred income tax liabilities		36,166		38,463
Other long-term liabilities		23,371		23,652

Total liabilities		341,788		357,330
Stockholders’ equity:
Preferred stock, 1,000 shares authorized; no shares issued and outstanding		—		—
Common stock, 200,000 shares authorized; 78,816 and 78,081 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively		788		781
Additionalpaid-in capital		135,132		152,097
Retained earnings		496,815		508,051
Accumulated other comprehensive loss		(11,880)		(6,692)

Total stockholders’ equity		620,855		654,237

Total liabilities and stockholders’ equity	$	962,643	$	1,011,567


	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
Revenue
Software license	$	52,342	$	53,234	$	184,899	$	231,392
Maintenance		66,017		61,812		196,448		179,949
Services		84,904		75,911		253,877		222,521

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

Cost of revenue
Software license		1,255		1,276		3,772		3,826
Maintenance		6,079		6,716		18,035		20,945
Services		67,089		61,739		202,047		180,925

Total cost of revenue		74,423		69,731		223,854		205,696

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

Operating expenses
Selling and marketing		87,490		69,363		269,845		214,244
Research and development		46,504		41,031		135,261		121,089
General and administrative		12,104		13,133		38,749		38,174

Total operating expenses		146,098		123,527		443,855		373,507

(Loss) income from operations		(17,258)		(2,301)		(32,485)		54,659
Foreign currency transaction gain (loss)		399		(5,052)		558		(6,549)
Interest income, net		683		140		2,076		547
Other income, net		—		—		363		287

(Loss) income before benefit from income taxes		(16,176)		(7,213)		(29,488)		48,944
Benefit from income taxes		(8,589)		(8,501)		(23,692)		(9,009)

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

(Loss) earnings per share
Basic	$	(0.10)	$	0.01	$	(0.07)	$	0.75
Diluted	$	(0.10)	$	0.01	$	(0.07)	$	0.70
Weighted-average number of common shares outstanding
Basic		78,700		77,691		78,525		77,258
Diluted		78,700		83,323		78,525		82,717
Cash dividends declared per share	$	0.03	$	0.03	$	0.09	$	0.09


	December 31, 2017
(in thousands)	Previously reported		Adjustments		As adjusted
Assets
Accounts receivable, unbilled receivables, and contract assets	$	248,331	$	134,216	$	382,547
Long-term unbilled receivables		—		160,708		160,708
Deferred income taxes		57,127		(42,887)		14,240
Deferred contract costs		—		37,924		37,924
Other assets⁽¹⁾		416,148		—		416,148

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

Liabilities and stockholders’ equity
Deferred revenue	$	195,073	$	(28,776)	$	166,297
Long-term deferred revenue		6,591		(2,885)		3,706
Deferred income tax liabilities		—		38,463		38,463
Other liabilities⁽²⁾		148,864		—		148,864

Total liabilities		350,528		6,802		357,330
Foreign currency translation adjustments		(3,494)		(2,966)		(6,460)
Retained earnings		221,926		286,125		508,051
Other equity⁽³⁾		152,646		—		152,646

Total stockholders’ equity		371,078		283,159		654,237

Total liabilities and stockholders’ equity	$	721,606	$	289,961	$	1,011,567


	September 30, 2017
	Three Months Ended						Nine Months Ended
(in thousands, except per share amounts)	Previously Reported		Adjustments		As Adjusted		Previously Reported		Adjustments		As Adjusted
Revenue:
Software license	$	41,793	$	11,441	$	53,234	$	195,220	$	36,172	$	231,392
Maintenance		62,204		(392)		61,812		180,759		(810)		179,949
Services		75,818		93		75,911		225,063		(2,542)		222,521

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

Cost of revenue:
Software license		1,276		—		1,276		3,826		—		3,826
Maintenance		6,716		—		6,716		20,945		—		20,945
Services		61,739		—		61,739		180,925		—		180,925

Total cost of revenue		69,731		—		69,731		205,696		—		205,696

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

Operating expenses:
Selling and marketing		70,209		(846)		69,363		217,384		(3,140)		214,244
Research and development		41,031		—		41,031		121,089		—		121,089
General and administrative		13,133		—		13,133		38,174		—		38,174

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

(Loss) income from operations		(14,289)		11,988		(2,301)		18,699		35,960		54,659
Foreign currency transaction loss		(552)		(4,500)		(5,052)		(793)		(5,756)		(6,549)
Interest income, net		144		(4)		140		470		77		547
Other income, net		—		—		—		287		—		287

(Loss) income before benefit from income taxes		(14,697)		7,484		(7,213)		18,663		30,281		48,944
Benefit from income taxes		(12,885)		4,384		(8,501)		(17,952)		8,943		(9,009)

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

(Loss) earnings per share:
Basic	$	(0.03)			$	0.01	$	0.47			$	0.75

Diluted	$	(0.03)			$	0.01	$	0.44			$	0.70

Weighted-average number of common shares outstanding:
Basic		77,691				77,691		77,258				77,258
Diluted		77,691				83,323		82,717				82,717


	September 30, 2018
(in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
Municipal bonds	$	46,633	$	—	$	(267)	$	46,366
Corporate bonds		53,738		1		(323)		53,416

	$	100,371	$	1	$	(590)	$	99,782


(Dollars in thousands)	September 30, 2018
1 Year or Less	$	155,964	48%
1-2 Years		89,177	27%
2-5 Years		79,752	25%

	$	324,893	100%


(in thousands)	September 30, 2018		December 31, 2017
Outside professional services	$	11,638	$	14,468
Income and other taxes		3,971		7,420
Marketing and sales program expenses		4,623		6,444
Dividends payable		2,365		2,344
Employee-related expenses		5,212		4,065
Other		12,020		10,767

	$	39,829	$	45,508


	Nine Months Ended September 30,
(in thousands)	Shares		Total Fair Value
RSUs⁽¹⁾		1,117	$	65,569
Non-qualified stock options		1,623	$	29,372


	Three Months Ended September 30,				Nine Months Ended September 30,
(in thousands, except per share amounts)	2018		2017		2018		2017
Basic
Net (loss) income	$	(7,587)	$	1,288	$	(5,796)	$	57,953
Weighted-average common shares outstanding		78,700		77,691		78,525		77,258

(Loss) earnings per share, basic	$	(0.10)	$	0.01	$	(0.07)	$	0.75


Diluted
Net (loss) income	$	(7,587)	$	1,288	$	(5,796)	$	57,953
Weighted-average effect of dilutive securities:
Stock options		—		3,681		—		3,519
RSUs		—		1,951		—		1,940

Effect of dilutive securities		—		5,632		—		5,459

Weighted-average common shares outstanding, assuming dilution		78,700		83,323		78,525		82,717

(Loss) earnings per share, diluted	$	(0.10)	$	0.01	$	(0.07)	$	0.70


Outstanding anti-dilutive stock options and RSUs⁽¹⁾		6,119		105		6,380		219


	September 30,
(Dollars in thousands)	2018		2017		Change
Term and cloud ACV	$	272,693	$	200,180	$	72,513	36%
Maintenance ACV		264,068		247,248		16,820	7%

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


	Nine Months Ended September 30,
Increase (decrease)	2018	2017
Total revenue	(4)%	(4)%
Net (loss) income	12%	(1)%


(in thousands, except per share amounts)	Total Number of Shares Purchased⁽¹⁾	Average Price Paid per Share⁽¹⁾	Total Number of Shares Purchased as Part of Publicly Announced Share Repurchase Program	Approximate Dollar Value of Shares That May Yet Be Purchased at Period End Under Publicly Announced Share Repurchase Programs⁽²⁾
July 1, 2018 - July 31, 2018	138	$ 57.34	119	$	39,189
August 1, 2018 - August 31, 2018	172	$ 59.89	93	$	33,645
September 1, 2018 - September 30, 2018	182	$ 63.96	30	$	31,746

Total	492	$ 60.68