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PEGA Pegasystems


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________
FORM 10-Q
_____________________________________
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2020
OR
Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 1-11859 
____________________________

PEGASYSTEMS INC.
(Exact name of Registrant as specified in its charter) 
____________________________
Massachusetts04-2787865
(State or other jurisdiction of incorporation or organization)(IRS Employer Identification No.)
One Rogers Street, Cambridge, MA 02142-1209
(Address of principal executive offices, including zip code)
(617) 374-9600
(Registrant’s telephone number, including area code)
____________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading symbol(s)Name of each exchange on which registered
Common Stock, $.01 par value per sharePEGANASDAQ Global Select Market
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files). Yes x No ¨   
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filerxAccelerated filerNon-accelerated filerSmaller reporting companyEmerging growth company
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No
There were 80,089,203 shares of the Registrant’s common stock, $0.01 par value per share, outstanding on April 13, 2020.



PEGASYSTEMS INC.

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

Page
PART I - FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019
Unaudited Condensed Consolidated Statements of Operations for the three months ended March 31, 2020 and 2019
Unaudited Condensed Consolidated Statements of Comprehensive (Loss) for the three months ended March 31, 2020 and 2019
Unaudited Condensed Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2020 and 2019
Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2020 and 2019
Notes to Unaudited Condensed Consolidated Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II - OTHER INFORMATION
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 6. Exhibits
Signature
 
2

PART I - FINANCIAL INFORMATION
ITEM 1.  UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)

March 31, 2020December 31, 2019
Assets
Current assets:
Cash and cash equivalents$538,142  $68,363  
Accounts receivable191,533  199,720  
Unbilled receivables182,399  180,219  
Other current assets72,000  57,308  
Total current assets984,074  505,610  
Unbilled receivables110,393  121,736  
Goodwill78,498  79,039  
Other long-term assets301,428  278,427  
Total assets$1,474,393  $984,812  
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable$27,770  $17,475  
Accrued expenses36,985  48,001  
Accrued compensation and related expenses59,928  104,126  
Deferred revenue197,018  190,080  
Other current liabilities17,790  18,273  
Total current liabilities339,491  377,955  
Convertible senior notes, net505,108  —  
Operating lease liabilities47,919  52,610  
Other long-term liabilities15,264  15,237  
Total liabilities907,782  445,802  
Stockholders’ equity:
Preferred stock,1,000 shares authorized; NaN issued—  —  
Common stock, 200,000 shares authorized; 80,076 and 79,599 shares issued and outstanding at
March 31, 2020 and December 31, 2019, respectively
801  796  
Additional paid-in capital196,310  140,523  
Retained earnings383,142  410,919  
Accumulated other comprehensive (loss) (13,642) (13,228) 
Total stockholders’ equity566,611  539,010  
Total liabilities and stockholders’ equity$1,474,393  $984,812  

See notes to unaudited condensed consolidated financial statements.
3


PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)

Three Months Ended
March 31,
20202019
Revenue
Software license$93,916  $63,264  
Maintenance73,695  67,706  
Services97,980  81,576  
Total revenue265,591  212,546  
Cost of revenue
Software license684  1,378  
Maintenance5,576  6,335  
Services73,268  66,724  
Total cost of revenue79,528  74,437  
Gross profit  186,063  138,109  
Operating expenses
Selling and marketing136,024  108,865  
Research and development58,727  50,596  
General and administrative15,630  12,676  
Total operating expenses210,381  172,137  
(Loss) from operations (24,318) (34,028) 
Foreign currency transaction (loss) (5,947) (3,712) 
Interest income  607  723  
Interest expense  (2,306) —  
Loss on capped call transactions  (18,592) —  
Other income, net  1,374  —  
(Loss) before (benefit from) income taxes (49,182) (37,017) 
(Benefit from) income taxes (23,810) (8,300) 
Net (loss) $(25,372) $(28,717) 
(Loss) per share 
Basic$(0.32) $(0.37) 
Diluted$(0.32) $(0.37) 
Weighted-average number of common shares outstanding
Basic79,808  78,584  
Diluted79,808  78,584  

See notes to unaudited condensed consolidated financial statements.
4


PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS)
(in thousands)

Three Months Ended
March 31,
20202019
Net (loss)$(25,372) $(28,717) 
Other comprehensive (loss) income, net of tax 
Unrealized gain on available-for-sale securities  100  374  
Foreign currency translation adjustments(514) 1,627  
Total other comprehensive (loss) income, net of tax (414) 2,001  
Comprehensive (loss) $(25,786) $(26,716) 

See notes to unaudited condensed consolidated financial statements.
5



PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except per share amounts)
Common StockAdditional
Paid-In Capital
Retained Earnings
Accumulated Other Comprehensive (Loss)
Total
Stockholders’ Equity
Number
of Shares
Amount
December 31, 201878,526  $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 plans514   (14,843) —  —  (14,838) 
Stock-based compensation—  —  18,406  —  —  18,406  
Cash dividends declared ($0.03 per share)—  —  —  (2,367) —  (2,367) 
Other comprehensive income—  —  —  —  2,001  2,001  
Net (loss)—  —  —  (28,717) —  (28,717) 
March 31, 201978,896  $789  $119,182  $479,779  $(11,321) $588,429  
December 31, 201979,599  $796  $140,523  $410,919  $(13,228) $539,010  
Equity component of convertible senior notes, net—  —  61,604  —  —  61,604  
Repurchase of common stock(87) (1) (5,999) —  —  (6,000) 
Issuance of common stock for share-based compensation plans564   (23,017) —  —  (23,011) 
Stock-based compensation—  —  23,199  —  —  23,199  
Cash dividends declared ($0.03 per share)—  —  —  (2,405) —  (2,405) 
Other comprehensive (loss)—  —  —  —  (414) (414) 
Net (loss)—  —  —  (25,372) —  (25,372) 
March 31, 202080,076  $801  $196,310  $383,142  $(13,642) $566,611  

See notes to unaudited condensed consolidated financial statements.
6


PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

Three Months Ended
March 31,
20202019
Operating activities
Net (loss) $(25,372) $(28,717) 
Adjustments to reconcile net (loss) to cash (used in) provided by operating activities 
Stock-based compensation23,175  18,350  
Loss on capped call transactions18,592  —  
Deferred income taxes(9,231) 1,455  
Amortization of deferred contract costs8,497  8,301  
Lease expense3,852  3,403  
Amortization of debt discount and issuance costs1,719  —  
Amortization of intangible assets and depreciation4,919  6,755  
Amortization of investments—  315  
Foreign currency transaction loss  5,947  3,712  
Other non-cash(1,374) 16  
Change in operating assets and liabilities, net(49,047) 9,113  
Cash (used in) provided by operating activities (18,323) 22,703  
Investing activities
Purchases of investments(1,490) (7,224) 
Proceeds from maturities and called investments—  8,548  
Sales of investments1,424  —  
Investment in property and equipment(12,496) (2,790) 
Cash (used in) investing activities (12,562) (1,466) 
Financing activities
Proceeds from issuance of convertible senior notes600,000  —  
Payment of debt issuance costs(14,527) —  
Purchase of capped calls related to convertible senior notes(51,900) —  
Dividend payments to shareholders(2,388) (2,363) 
Common stock repurchases(29,011) (23,224) 
Cash provided by (used in) financing activities 502,174  (25,587) 
Effect of exchange rate changes on cash and cash equivalents(1,510) 295  
Net increase (decrease) in cash and cash equivalents 469,779  (4,055) 
Cash and cash equivalents, beginning of period68,363  114,422  
Cash and cash equivalents, end of period$538,142  $110,367  

See notes to unaudited condensed consolidated financial statements.
7

PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION
Pegasystems Inc. (together with its subsidiaries, “the Company”) has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all the information required by accounting principles generally accepted in the United States of America (“U.S.”) for complete financial statements and should be read in conjunction with the Company’s audited financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2019.
In the opinion of management, the Company has prepared the accompanying unaudited condensed consolidated financial statements on the same basis as its audited financial statements, and these financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented.
The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year 2020.
2. NEW ACCOUNTING PRONOUNCEMENTS
Financial instruments
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which requires measurement and recognition of expected credit losses for financial assets measured at amortized cost, including accounts receivable, upon initial recognition of that financial asset using a forward-looking expected loss model, rather than an incurred loss model. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses when the fair value is below the amortized cost of the asset, removing the concept of “other-than-temporary” impairments. The Company adopted this standard effective January 1, 2020. The adoption of this standard did not have a material effect on the Company’s financial position or results of operations.
3. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE
Receivables
(in thousands)March 31, 2020December 31, 2019
Accounts receivable$191,533  $199,720  
Unbilled receivables182,399  180,219  
Long-term unbilled receivables110,393  121,736  
$484,325  $501,675  
Unbilled receivables are client committed amounts for which revenue recognition precedes billing, and billing is solely subject to the passage of time. They are expected to be billed in the future as follows:
(Dollars in thousands)March 31, 2020
1 year or less$182,399  62 %
1-2 years88,928  31 %
2-5 years21,465  %
$292,792  100 %
Unbilled receivables based upon contract effective date:
(Dollars in thousands)March 31, 2020
2020$40,533  14 %
2019102,154  35 %
201855,484  19 %
201744,691  15 %
2016 and prior49,930  17 %
$292,792  100 %
8

PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



Contract assets and deferred revenue
(in thousands)March 31, 2020December 31, 2019
Contract assets (1)
$6,195  $5,558  
Long-term contract assets (2)
5,664  5,420  
$11,859  $10,978  
Deferred revenue$197,018  $190,080  
Long-term deferred revenue (3)
5,630  5,407  
$202,648  $195,487  
(1) Included in other current assets. (2) Included in other long-term assets. (3) Included in other long-term liabilities.
Contract assets are client committed amounts for which revenue recognized exceeds the amount billed to the client and the right to payment is subject to conditions other than the passage of time, such as the completion of a related performance obligation. Deferred revenue consists of billings and payments received in advance of revenue recognition. Contract assets and deferred revenue are netted at the contract level for each reporting period.
The change in deferred revenue in the three months ended March 31, 2020 was primarily due to new billings in advance of revenue recognition, partially offset by revenue recognized during the period that was included in deferred revenue at December 31, 2019.
4. DEFERRED CONTRACT COSTS
(in thousands)March 31, 2020December 31, 2019
Deferred contract costs (1)
$81,452  $85,314  
(1) Included in other long-term assets.
Three Months Ended
March 31,
(in thousands)20202019
Amortization of deferred contract costs (1)
$8,497  $8,301  
(1) Included in selling and marketing expenses.
5. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
Change in the carrying amount of goodwill:
(in thousands)Three Months Ended
March 31, 2020
Balance as of January 1,$79,039  
Currency translation adjustments(541) 
Balance as of March 31,$78,498  
Intangibles
Intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives:
March 31, 2020
(in thousands)Useful LivesCostAccumulated
Amortization
Net Book Value (1)
Client-related4 - 10 years$63,096  $(54,703) $8,393  
Technology2 - 10 years64,842  (54,546) 10,296  
Other1 - 5 years5,361  (5,361) —  
$133,299  $(114,610) $18,689  
(1) Included in other long-term assets.
December 31, 2019
(in thousands)Useful LivesCostAccumulated Amortization
Net Book Value (1)
Client-related4 - 10 years$63,140  $(54,368) $8,772  
Technology2 - 10 years64,843  (53,898) 10,945  
Other1 - 5 years5,361  (5,361) —  
$133,344  $(113,627) $19,717  
(1) Included in other long-term assets.
9

PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



Amortization of intangible assets:
(in thousands)Three Months Ended
March 31,
20202019
Cost of revenue$647  $1,332  
Selling and marketing371  1,603  
$1,018  $2,935  

6. DEBT
Convertible senior notes and capped calls
Convertible senior notes
In February 2020, the Company issued Convertible Senior Notes (the "Notes") with an aggregate principal amount of $600 million, due March 1, 2025, in a private placement to certain initial purchasers in reliance upon the exemption from registration provided by Section 4(a)(2) of the Securities Act in transactions not involving any public offering, for resale by the initial purchasers to persons whom the initial purchasers believe are qualified institutional buyers pursuant to Rule144A under the Securities Act. This included $75 million in aggregate principal amount of the Notes that the Company issued resulting from initial purchasers fully exercising their option to purchase additional Notes. There are no required principal payments prior to the maturity of the Notes. The Notes will accrue interest at an annual rate of 0.75%, payable semi-annually in arrears on March 1 and September 1 of each year, beginning on September 1, 2020. The proceeds of the issuance were used for the Capped Call Transactions (described below), working capital, and other general corporate purposes.
Total net proceeds from the Notes and Capped Call Transactions:

(in thousands)Amount
Principal$600,000  
Less: issuance costs(14,527) 
Less: Capped Call Transactions(51,900) 
$533,573  
Beginning on September 1, 2024, noteholders may convert their Notes at any time at their election. Before September 1, 2024, noteholders may convert their Notes in the following circumstances:
During any calendar quarter commencing after the calendar quarter ending on June 30, 2020 (and only during such calendar quarter), if the last reported sale price per share of common stock exceeds one hundred and thirty percent (130%) of the conversion price for each of at least twenty (20) trading days (whether or not consecutive) during the thirty (30) consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter.
During the five (5) consecutive business days immediately after any five (5) consecutive trading day period, (the “Measurement Period”) if the trading price per $1,000 principal amount of Notes for each trading day of the Measurement Period was less than ninety eight percent (98%) of the product of the last reported sale price per share of common stock on such trading day and the conversion rate on such trading day.
Upon the occurrence of certain corporate events or distributions, or if the Company calls all or any Notes for redemption, then the noteholder of any Note may convert such Note at any time before the close of business on the business day immediately before the related redemption date (or, if the Company fails to pay the redemption price due on such redemption date in full, at any time until the Company pays such redemption price in full).
As of March 31, 2020, no Notes were eligible for conversion at the election of the noteholder.
The initial conversion rate is 7.4045 shares of common stock per $1,000 principal amount of the Notes, which represents an initial conversion price of approximately $135.05 per share of common stock. The Company will settle conversions by paying or delivering, as applicable, cash, shares of its common stock, or a combination of cash and shares of its common stock, at the Company’s election, based on the applicable conversion rate. The conversion rate will be adjusted upon the occurrence of certain events including spin offs, tender offers, exchange offers and certain stockholder distributions.
On or after March 1, 2023 and on or before the 40th scheduled trading day immediately before the maturity date, the Company may redeem for cash all or part of the Notes, at a repurchase price equal to 100% of the principal amount, plus accrued and unpaid interest, if the last reported sale price of the Company’s common stock exceeded 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period ending on, and including, the trading day immediately preceding the date on which the Company provides a redemption notice.
10

PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



If certain corporate events that constitute a “Fundamental Change” (as described below) occur at any time, each noteholder will have the right, at such noteholder’s option, to require the Company to repurchase for cash all of such noteholder’s Notes, or any portion of the principal thereof that is equal to $1,000 or an integral multiple of $1,000, at a repurchase price equal to 100% of the principal amount thereof, plus accrued and unpaid interest. A fundamental change relates to events such as mergers, changes in control of the Company, liquidation/dissolution of the Company, or the delisting of the Company’s common stock.
In accounting for the transaction, the Notes have been separated into liability and equity components.
The initial carrying amount of the liability component was calculated by measuring the fair value of a similar debt instrument that does not have an associated conversion feature.
The equity component was recorded as an increase to additional paid-in capital and is not remeasured as long as it continues to meet the conditions for equity classification.
The excess of the principal amount of the Notes over the initial carrying amount of the liability component, the debt discount, is amortized as interest expense over the contractual term of the Notes.
The Company incurred issuance costs of $14.5 million related to the Notes, which were allocated between liability and equity components of the Notes proportionate to the initial carry amount of the liability and equity components.
Issuance costs attributable to the liability component are netted against the principal balance of the Notes and are amortized as interest expense using the effective interest method over the contractual term of the Notes.
Issuance costs attributable to the equity component are netted with the equity component in additional paid-in capital and are not amortized.
Net carrying amount of the liability component:
(in thousands)March 31, 2020
Principal$600,000  
Unamortized debt discount(82,624) 
Unamortized issuance costs(12,268) 
$505,108  
Net carrying amount of the equity component, included in additional paid in capital:
(in thousands)March 31, 2020
Conversion options (1)
$61,604  
(1) Net of issuance costs and taxes.
Interest expense related to the Notes:
Three Months Ended
March 31,
(in thousands)2020
Contractual interest expense (0.75% coupon)$450  
Amortization of debt discount (1)
1,497  
Amortization of issuance cost (1)
222  
$2,169  
(1) Amortized based upon an effective interest rate of 4.31%.
Future payments of principal and contractual interest:
March 31, 2020
(in thousands)PrincipalInterestTotal
2020$—  $2,338  $2,338  
2021—  4,500  4,500  
2022—  4,500  4,500  
2023—  4,500  4,500  
2024—  4,500  4,500  
2025600,000  1,488  601,488  
$600,000  $21,826  $621,826  


PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



Capped call transactions
In February 2020, the Company entered into privately negotiated capped call transactions (“Capped Call Transactions”) with certain financial institutions. The Capped Call Transactions cover approximately 4.4 million shares (representing the number of shares for which the Notes are initially convertible) of the Company’s common stock and are generally expected to reduce potential dilution to the common stock upon any conversion of Notes and/or offset any potential cash payments the Company is required to make in excess of the principal amount of converted Notes, as the case may be, with such reduction and/or offset subject to a cap. The cap price of the Capped Call Transactions is initially $196.44. The Capped Call Transactions are classified as “other long-term assets” and re-measured to fair value at the end of each reporting period, resulting in a non-operating gain or loss.
Change in value of Capped Call Transactions:
(in thousands)Three Months Ended
March 31, 2020
Value at issuance$51,900  
Fair value adjustment(18,592) 
Balance as of March 31,$33,308  
Credit Facility
In November 2019, and as amended in February 2020, the Company entered into a five-year $100 million senior secured revolving credit agreement (the “Credit Facility”) with PNC Bank, National Association (“PNC”). The Company may use borrowings to finance working capital needs and for general corporate purposes. Subject to specific circumstances, the Credit Facility allows the Company to increase the aggregate commitment up to $200 million.
The Credit Facility contains customary covenants, including, but not limited to, those relating to additional indebtedness, liens, asset divestitures, and affiliate transactions. The Company is also required to comply with financial covenants that consist of a maximum net consolidated leverage ratio of 3.5 (with a step-up in the event of certain acquisitions) and a minimum consolidated interest coverage ratio of 3.5. The commitments expire on November 4, 2024, and any outstanding loans will be payable on such date.
As of March 31, 2020 and December 31, 2019, the Company had 0 outstanding borrowings under the Credit Facility.
7. FAIR VALUE MEASUREMENTS
Assets and liabilities measured at fair value on a recurring basis
The Company records its cash equivalents, Capped Call Transactions, 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.
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 which are classified within Level 1 in the fair value hierarchy. The Company’s investments in privately-held companies are classified within Level 3 in the fair value hierarchy. The fair value of the Capped Call Transactions at the end of each reporting period is determined using a Black-Scholes option-pricing model. These valuation models use various market-based inputs, including stock price, remaining contractual term, expected volatility, risk-free interest rate, and expected dividend yield, as applicable. The Company applies significant judgment in its determination of expected volatility. The Company considers both historical and implied volatility levels of the underlying equity security and apply limited consideration of historical peer group volatility levels.
The Company’s assets and liabilities measured at fair value on a recurring basis were:
March 31, 2020December 31, 2019
(in thousands)Level 1Level 2Level 3TotalLevel 1Level 2Level 3Total
Cash equivalents (1)
$460,475  $—  $—  $460,475  $—  $—  $—  $—  
Investments in privately-held companies (2)
$—  $—  $6,338  $6,338  $—  $—  $4,871  $4,871  
Capped Call Transactions (2) (3)
$—  $33,308  $—  $33,308  $—  $—  $—  $—  
(1) Composed of investments in money market funds. (2) Included in other long-term assets. (3) See "6. Debt" for additional information.


PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)




Change in investments in privately-held companies:
(in thousands)Three Months Ended
March 31, 2020
Balance as of January 1,$4,871  
New investments1,490  
Sales of investments(1,424) 
Currency translation adjustments(73) 
Fair value adjustment1,474  
Balance as of end of period$6,338  

For certain other financial instruments, including cash equivalents, accounts receivable, and accounts payable, the carrying value approximates fair value due to the relatively short maturity of these items.
The fair value of the Company’s Notes was recorded at $515.9 million upon issuance, which reflected the principal amount of the Notes less the fair value of the conversion feature. The fair value of the debt component was determined based on a discounted cash flow model. The discount rate used reflected both the time value of money and credit risk inherent in the Notes. The carrying value of the Notes will be accreted, over the remaining term to maturity, to their principal value of $600 million.
The fair value of the Notes (inclusive of the conversion feature which is embedded in the Notes) was approximately $533 million as of March 31, 2020. The fair value was determined based on the quoted price of the Notes in an over-the-counter market on the last trading day of the reporting period and has been classified within Level 2 in the fair value hierarchy. See "6. Debt" for additional information.
8. LEASES
Expense
Three Months Ended
March 31,
(in thousands)20202019
Fixed lease costs$4,818  $4,300  
Short-term lease costs455  285  
Variable lease costs1,278  1,321  
$6,551  $5,906  
Right of use assets and lease liabilities
(in thousands)March 31, 2020December 31, 2019
Right of use assets (1)
$54,624  $58,273  
Lease liabilities (2)
$15,385  $15,885  
Long-term lease liabilities$47,919  $52,610  
(1) Represents the Company’s right to use the leased asset during the lease term. Included in other long-term assets. (2) Included in other current liabilities.
The weighted-average remaining lease term and discount rate for the Company’s leases were:
March 31, 2020December 31, 2019
Weighted-average remaining lease term3.8 years4 years
Weighted-average discount rate (1)
5.8 %  5.8 %
(1) The rates implicit in most of the Company’s leases are not readily determinable. Therefore, the Company uses its incremental borrowing rate as the discount rate when measuring operating lease liabilities. The incremental borrowing rate represents an estimate of the interest rate the Company would incur to borrow an amount equal to the lease payments on a collateralized basis over the term of the lease.
Maturities of lease liabilities are:
(in thousands)March 31, 2020December 31, 2019
2020$13,838  $19,373  
202118,640  18,702  
202217,383  17,671  
202316,350  16,615  
2024 and thereafter4,619  4,734  
Total lease payments70,830  77,095  
Less: imputed interest (1)
(7,526) (8,600) 
Total short and long-term lease liabilities$63,304  $68,495  
13

PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



(1) Lease liabilities are measured at the present value of the remaining lease payments using a discount rate determined at lease commencement unless the discount rate is updated as a result of a lease reassessment event.
Cash flow information
Three Months Ended
March 31,
(in thousands)20202019
Cash paid for leases$5,520  $5,197  
Right of use assets recognized for new leases and amendments (non-cash)$551  $8,034  

9. REVENUE
Geographic revenue
Three Months Ended
March 31,
(Dollars in thousands)20202019
U.S.$172,417  65 %$103,991  48 %
Other Americas15,342  %28,829  14 %
United Kingdom (“U.K.”)21,837  %24,549  12 %
Europe (excluding U.K.), Middle East, and Africa31,938  12 %34,186  16 %
Asia-Pacific24,057  %20,991  10 %
$265,591  100 %$212,546  100 %
Revenue streams
Three Months Ended
March 31,
(in thousands)20202019
Perpetual license$3,659  $14,950  
Term license90,257  48,314  
Revenue recognized at a point in time93,916  63,264  
Maintenance73,695  67,706  
Cloud43,466  27,758  
Consulting54,514  53,818  
Revenue recognized over time171,675  149,282  
$265,591  $212,546  

(in thousands)Three Months Ended
March 31,
20202019
Term license$90,257  $48,314  
Cloud43,466  27,758  
Maintenance73,695  67,706  
Subscription (1)
207,418  143,778  
Perpetual license3,659  14,950  
Consulting54,514  53,818  
$265,591  $212,546  
(1) Reflects client arrangements (term license, cloud, and maintenance) that are subject to renewal.
14

PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



Remaining performance obligations ("Backlog")
Expected future revenue on existing contracts:
March 31, 2020
(Dollars in thousands)Perpetual licenseTerm licenseMaintenanceCloudConsultingTotal
1 year or less$3,995  $30,962  $205,083  $174,277  $18,945  $433,262  58 %
1-2 years2,168  5,088  34,633  125,473  1,215  168,577  22 %
2-3 years—  6,504  19,411  81,187  107  107,209  14 %
Greater than 3 years—  635  10,596  33,537  10  44,778  %
$6,163  $43,189  $269,723  $414,474  $20,277  $753,826  100 %

March 31, 2019
(Dollars in thousands)Perpetual licenseTerm LicenseMaintenanceCloudConsultingTotal
1 year or less$10,263  $44,404  $187,324  $115,548  $13,251  $370,790  58 %
1-2 years998  4,274  9,350  91,539  1,363  107,524  17 %
2-3 years2,180  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 %

10. STOCK-BASED COMPENSATION
Expense
Three Months Ended
March 31,
(in thousands)20202019
Cost of revenues$5,152  $4,519  
Selling and marketing9,718  7,374  
Research and development5,496  4,560  
General and administrative2,809  1,897  
$23,175  $18,350  
Income tax benefit$(4,582) $(3,740) 
As of March 31, 2020, the Company had $146.3 million of unrecognized stock-based compensation expense, net of estimated forfeitures, which is expected to be recognized over a weighted-average period of 2.3 years.
Grants
The Company granted the following stock-based compensation awards:
Three Months Ended
March 31, 2020
(in thousands)SharesTotal Fair Value
RSUs813  $72,733  
Non-qualified stock options1,540  $34,988  
Common stock issued
During the three months ended March 31, 2020, the Company issued 0.6 million shares of common stock to settle obligations of the Company’s stock-based compensation plans.
15

PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



11. INCOME TAXES
Effective income tax rate
Three Months Ended
March 31,
(Dollars in thousands)20202019
(Benefit from) income taxes $(23,810) $(8,300) 
Effective income tax rate48 %22 %
During the three months ended March 31, 2020, the Company’s effective income tax rate benefit increased primarily due to the excess tax benefits from stock-based compensation and a carry back claim benefit as a result of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), partially offset by Global Intangible Low-Taxed Income (“GILTI”).
12. (LOSS) PER SHARE
Basic (loss) per share is computed using the weighted-average number of common shares outstanding during the applicable period. Diluted (loss) per share is computed using the weighted-average number of common shares outstanding during the applicable period, plus the dilutive effect of outstanding stock options, RSUs, and the impact of the conversion spread of the Company’s convertible senior notes.
Calculation of the basic and diluted earnings per share:
Three Months Ended
March 31,
(in thousands, except per share amounts)20202019
Net (loss)$(25,372) $(28,717) 
Weighted-average common shares outstanding79,808  78,584  
(Loss) per share, basic $(0.32) $(0.37) 
Net (loss)$(25,372) $(28,717) 
Weighted-average common shares outstanding, assuming dilution (1) (2)
79,808  78,584  
(Loss) per share, diluted $(0.32) $(0.37) 
Outstanding anti-dilutive stock options and RSUs (3)
5,948  5,563  

(1) The Company expects to settle the principal amount of the Notes in cash. As a result, only the amount by which the conversion value exceeds the aggregated principal amount of the Notes is included in the diluted earnings per share computation under the treasury stock method. The conversion spread has a dilutive impact on diluted net income per share when the average market price of the Company’s common stock for a given period of time exceeds the initial conversion price of $135.05 per share for the Notes. In connection with the issuance of the Notes, the Company entered into Capped Call Transactions, which were not included in calculating the number of diluted shares outstanding, as their effect would have been anti-dilutive.
(2) In periods of loss, all dilutive securities are excluded as their inclusion would be anti-dilutive.
(3) 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.

16


ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains or incorporates forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.
Words such as expects, anticipates, intends, plans, believes, will, could, should, estimates, may, targets, strategies, intends to, projects, forecasts, guidance, likely, and usually, or variations of such words and other similar expressions are intended to identify forward-looking statements, which speak only as of the date the statement was made and are based on current expectations and assumptions.
These forward-looking statements deal with future events, and are subject to various risks and uncertainties that are difficult to predict, including, 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, management of our transition to a more subscription-based business model, variation in demand for our products and services, including among clients in the public sector, the impact of actual or threatened public health emergencies, such as the Coronavirus (COVID-19), reliance on third-party service providers, compliance with our debt obligations and debt covenants, the potential impact of our convertible senior notes and related capped call transactions, reliance on key personnel, and the continued uncertainties in the global economy, foreign currency exchange rates, the potential legal and financial liabilities and reputation damage due to cyber-attacks, security breaches and security flaws, our ability to protect our intellectual property rights and costs associated with defending such rights, maintenance of our client retention rate, 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 further in Part I of our Annual Report on Form 10-K for the year ended December 31, 2019, and other filings we make with the U.S. Securities and Exchange Commission (“SEC”).
Except as required by applicable law, we do not undertake and expressly disclaim any obligation to 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, host, and support enterprise software applications that help organizations transform the way they engage with their customers and process work across their enterprise. We also license our low-code Pega Platform™ for rapid application development to clients that wish to build and extend their business applications. 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 low-code Pega Platform, empowering businesses to quickly design, extend, and scale their enterprise applications to meet strategic business needs.
Our target clients are Global 3000 organizations and government agencies that require applications to differentiate themselves in the markets they serve. Our applications achieve and facilitate differentiation by increasing business agility, driving growth, improving productivity, attracting and retaining customers, and reducing risk. We deliver applications tailored to our clients’ specific industry needs.
COVID-19
The impact of COVID-19 on our operational and financial performance will depend on future developments, including the duration and spread of the outbreak, impact on our clients and our sales cycles, and impact on our partners or employees, all of which are uncertain and cannot be predicted. As of March 31, 2020, COVID-19 has not had a material impact on our results of operations or financial condition.
Our shift towards subscription-based revenue streams, the industry mix of our clients, our product mix, the fact that many of our clients are well-known and of large size, and the critical nature of our products to our clients may reduce the impact of COVID-19 on our business compared to other businesses or may delay the effect, if any, of COVID-19 on our results of operations until future periods. However, it is not possible to estimate the ultimate impact that COVID-19 will have on our business, and such an impact will depend on future developments, which are highly uncertain and cannot be predicted. For example, in response to the COVID-19 pandemic, we have shifted certain of our client events to virtual-only experiences, and we may deem it advisable to similarly alter, postpone or cancel entirely additional client, employee, or industry events in the future. See “Coronavirus (“COVID-19”)” under Item 1A. Risk Factors for additional information.
17


Performance metrics
We utilize several performance metrics in analyzing and assessing our overall performance, making operating decisions, and forecasting and planning for future periods including:
Annual contract value (“ACV”) | +21% since March 31, 2019
ACV represents the annualized value of our active contracts as of the measurement date. ACV for term license and cloud contracts is calculated by dividing the total value of the contract by the duration of the contract in years. ACV for maintenance is calculated as maintenance revenue for the quarter then ended multiplied by four. Client cloud ACV is composed of maintenance ACV and ACV from term license contracts. We believe the presentation of ACV on a constant currency basis enhances the understanding of our results and evaluation of our performance in comparison to prior periods, as it provides visibility into the impact of changes in foreign currency exchange rates, which are outside of our control. All periods shown reflect foreign currency exchange rates as of March 31, 2020.
Remaining performance obligations (“Backlog”) | +19% since March 31, 2019
Backlog represents contracted revenue that has not yet been recognized, and includes deferred revenue and non-cancellable amounts that will be invoiced and recognized as revenue in future periods.
Cloud revenue | +57% since March 31, 2019
Cloud revenue is revenue as reported under US GAAP for cloud contracts.
pega-20200331_g1.jpg
18


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CRITICAL ACCOUNTING POLICIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our unaudited condensed consolidated financial statements, which have been prepared 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 in our Annual Report on Form 10-K for the year ended December 31, 2019:
“Critical Accounting Estimates and Significant Judgments” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations”; and
Note 2. “Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary Data.”
There have been no significant changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2019 other than those listed below.
Capped Call Transactions
In February 2020, we entered into privately negotiated capped call transactions (“Capped Call Transactions”) with certain financial institutions. The Capped Call Transactions cover approximately 4.4 million shares (representing the number of shares for which the Notes are initially convertible) of our common stock and are generally expected to reduce potential dilution of our common stock upon any conversion of Notes. The fair value of the Capped Call Transactions at the end of each reporting period is determined using a Black-Scholes option-pricing model. These valuation models use various market-based inputs, including stock price, remaining contractual term, expected volatility, risk-free interest rate, and expected dividend yield, as applicable. Management applies significant judgment in its determination of expected volatility. We consider both historical and implied volatility levels of the underlying equity security and apply limited consideration of historical peer group volatility levels.
The Capped Call Transactions are classified as “other long-term assets” and re-measured to fair value at the end of each reporting period, resulting in a non-operating gain or loss.
See "6. Debt" and “7. Fair Value Measurements” in Item 1 of this Quarterly Report for additional information.
19


RESULTS OF OPERATIONS
Revenue
Our license revenue is derived from sales of our applications and Pega Platform. Our cloud revenue is derived from our hosted Pega Platform and software applications. We expect our revenue mix to continue to shift in favor of our subscription offerings, particularly cloud arrangements, which could result in slower total revenue growth in the near term. Revenue from cloud arrangements is generally recognized over the service period, while revenue from term and perpetual license arrangements is generally recognized upfront when the license rights become effective.
(Dollars in thousands)Three Months Ended
March 31,
Change
20202019
Cloud$43,466  16 %$27,758  13 %$15,708  57 %
Maintenance73,695  28 %67,706  32 %5,989  %
Term license90,257  34 %48,314  23 %41,943  87 %
Subscription (1)
207,418  78 %143,778  68 %63,640  44 %
Perpetual license3,659  %14,950  %(11,291) (76)%
Consulting54,514  21 %53,818  25 %696  %
Total revenue$265,591  100 %$212,546  100 %$53,045  25 %
(1) Reflects client arrangements (term license, cloud, and maintenance) that are subject to renewal.
The increase in total revenue was primarily due to the increase in subscription revenue, partially offset by a decrease in perpetual revenue, which reflects the shift in client preferences to subscription arrangements from other types of arrangements.
Gross profit
Three Months Ended
March 31,
Change
(Dollars in thousands)20202019
Software license$93,232  99 %$61,886  98 %$31,346  51 %
Maintenance68,119  92 %61,371  91 %6,748  11 %
Cloud25,933  60 %14,460  52 %11,473  79 %
Consulting(1,221) (2)%392  %(1,613)  
$186,063  70 %$138,109  65 %$47,954  35 %
* not meaningful
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 service period, while revenue from term and perpetual license arrangements is generally recognized upfront when the license rights become effective.
The increase in gross profit was primarily due to the increases in term and cloud revenue, which reflects the shift in client preferences to cloud arrangements from other types of arrangements.
The increase in gross profit percent was primarily due to the:
increase in cloud gross profit percent, driven by cost efficiency gains as our cloud business continues to grow and scale, and
decrease in consulting gross profit percent, driven by an increase in consulting resource availability as we leverage our partner network.
Operating expenses
(Dollars in thousands)Three Months Ended
March 31,
Change
20202019
Selling and marketing$136,024  51 %$108,865  51 %$27,159  25 %
Research and development$58,727  22 %$50,596  24 %$8,131  16 %
General and administrative$15,630  %$12,676  %$2,954  23 %
The increase in sales and marketing was primarily due to an increase in compensation and benefits of $22.5 million, attributable to increased headcount and equity compensation, and $5.3 million of costs incurred in 2020 as a result of the cancellation of the live event portion of PegaWorld. The increase in headcount reflects our efforts to increase our sales capacity to deepen relationships with existing clients and target new accounts.
The increase in research and development was primarily due to an increase in compensation and benefits of $7.2 million, attributable to increased headcount and equity compensation.
20


The increase in general and administrative was primarily due to an increase of $1.5 million in compensation and benefits due to increased headcount.
Other income (expense), net
(Dollars in thousands)Three Months Ended
March 31,
Change
20202019
Foreign currency transaction (loss) $(5,947) $(3,712) $(2,235) (60)%
Interest income  607  723  (116) (16)%
Interest expense  (2,306) —  (2,306)  
Other (loss), net (17,218) —  (17,218)  

$(24,864) $(2,989) $(21,875) (732)%
* not meaningful
The change in other (loss), net is due to a fair value adjustment of $18.6 million on the Capped Call Transactions, entered into in connection with our issuance of the Notes. See "6. Debt" in Item 1 of this Quarterly Report for additional information.
The change in foreign currency transaction (loss) were primarily due to the impact of fluctuations in foreign currency exchange rates associated with our foreign currency-denominated cash, accounts receivable, and intercompany receivables and payables held by our United Kingdom (“U.K.”) subsidiary.
The increase in interest expense is due to our issuance of $600 million in aggregate principal amount of our convertible senior notes (“Notes”) on February 24, 2020. See "6. Debt" in Item 1 of this Quarterly Report for additional information.
(Benefit from) income taxes
Three Months Ended
March 31,
(Dollars in thousands)20202019
(Benefit from) income taxes$(23,810) $(8,300) 
Effective income tax rate48 %22 %
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, depending on our future stock price in relation to the fair value of awards, the timing of the vestings of RSU awards, 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, 2020, our effective income tax rate benefit increased primarily due to the excess tax benefits from stock-based compensation and a carry back claim benefit as a result of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), partially offset by Global Intangible Low-Taxed Income (“GILTI”).
21


LIQUIDITY AND CAPITAL RESOURCES
Three Months Ended
March 31,
 (in thousands)20202019
Cash provided by (used in):
Operating activities$(18,323) $22,703  
Investing activities(12,562) (1,466) 
Financing activities502,174  (25,587) 
Effect of exchange rates on cash and cash equivalents(1,510) 295  
Net increase (decrease) in cash and cash equivalents$469,779  $(4,055) 

(in thousands)March 31, 2020December 31, 2019
Held by U.S. entities$493,629  $23,437  
Held by foreign entities44,513  44,926  
Total cash and cash equivalents$538,142  $68,363  
We believe that our current cash, cash flow from operations, and borrowing capacity will be sufficient to fund our operations and quarterly cash dividends for at least the next 12 months. Whether these resources are adequate to meet our liquidity needs beyond that period will depend on our growth, operating results, and the investments required to meet the possible increased demand for our services. If we require additional capital resources to grow our business, we may seek to finance our operations from available funds or additional external financing.
If it became necessary to repatriate foreign funds, we may be required to pay U.S. and foreign taxes upon repatriation. Due to the complexity of income tax laws and regulations, and the effects of the Tax Reform Act, it is impracticable to estimate the amount of taxes we would have to pay.
Cash (used in) provided by operating activities
As client preferences continue to shift in favor of cloud arrangements, we could continue to experience slower operating cash flow growth, or negative cash flow, in the near term. Cash from cloud and term arrangements is generally collected over an average service period of three years, while cash from perpetual license arrangements is generally collected upfront, shortly after the license rights become effective.
The primary driver of the decrease in the three months ended March 31, 2020 was the recent shift in our revenue mix toward cloud arrangements and increased costs as we accelerated investments in our cloud offerings and selling and marketing activities to support future growth.
In the three months ended March 31, 2020, COVID-19 did not have a material impact on our cash flows from operations. See “Coronavirus (“COVID-19”)” under Item 1A. Risk Factors for additional information.
Cash (used in) investing activities
The change in cash (used in) investing activities was primarily driven by investments in property and equipment at several of our office locations.
Cash provided by (used in) financing activities
In February 2020, we issued $600 million in aggregate principal amount of our convertible senior notes (“Notes”) due March 1, 2025, which provided net proceeds as follows:
(in thousands)Amount
Principal$600,000  
Less: issuance costs(14,527) 
Less: Capped Call Transactions(51,900) 
$533,573  
A portion of the proceeds of the Notes was used to fund the Capped Call Transactions with the remainder to be used for working capital and other general corporate purposes. See "6. Debt" in Item 1 of this Quarterly Report for additional information.
In November 2019, and as amended in February 2020, we entered into a five-year $100 million senior secured revolving credit agreement (the “Credit Facility”) with PNC Bank, National Association (“PNC”). As of March 31, 2020 and December 31, 2019, we had 0 outstanding borrowings under the Credit Facility.
22


Stock repurchase program (1)
Changes in the remaining stock repurchase authority:
(in thousands)Three Months Ended
March 31, 2020
January 1,$45,484  
Repurchases(6,000) 
March 31,$39,484  
(1) Purchases under these programs have been made on the open market.
Common stock repurchases
Three Months Ended
March 31,
20202019
(in thousands)SharesAmountSharesAmount
Tax withholdings for net settlement of equity awards257  $23,011  232  $14,838  
Stock repurchase program (1)
876,000  144  7,586  
Activity in period (2)
344  $29,011  376  $22,424  
(1) Represents activity under our publicly announced stock repurchase programs. (2) During the three months ended March 31, 2020 and 2019, instead of receiving cash from the equity holders, we withheld shares with a value of $15.3 million and $12.2 million, respectively, for the exercise price of options. These amounts have been excluded from the table above.
Dividends
Three Months Ended
March 31,
(in thousands)20202019
Dividend payments to shareholders$2,388  $2,363  
We currently intend to pay a quarterly cash dividend of $0.03 per share, however, the Board of Directors may terminate or modify the dividend program at any time without prior notice.
Contractual obligations
As of March 31, 2020, our contractual obligations were:
Payments due by period
(in thousands)202020212022-20232024-20252026 and thereafterOtherTotal
Purchase obligations (1)
$49,237  $56,689  $57,498  $—  $—  $—  $163,424  
Investment commitments (2)
995  703  —  —  —  —  1,698  
Liability for uncertain tax positions (3)
—  —  —  —  —  5,210  5,210  
Operating lease obligations (4)
13,837  18,640  33,733  3,925  695  —  70,830  
Total$64,069  $76,032  $91,231  $3,925  $695  $5,210  $241,162  
(1) Represents the fixed or minimum amounts due under purchase obligations for hosting services and sales and marketing programs.
(2) Represents the maximum funding that would be expected under existing investment agreements with privately-held companies. Our investment agreements generally allow us to withhold unpaid committed funds at our discretion.
(3) We are unable to reasonably estimate the timing of the cash outflow due to uncertainties in the timing of the effective settlement of tax positions.
(4) See "8. Leases" in Item 1 of this Quarterly Report for additional information.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may affect us due to adverse changes in financial market prices and rates.
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 offsets our foreign currency exposure.
23


A hypothetical 10% strengthening in the U.S. dollar against other currencies would result in the following impact:
Three Months Ended
March 31,
20202019
(Decrease) increase in revenue (3)%(4)%
(Decrease) increase in net income (14)%(6)%
Remeasurement risk
We experience fluctuations in transaction gains or losses from remeasurement of monetary assets and liabilities that are denominated in currencies other than the functional currency of the entities in which they are recorded.
We are primarily exposed to changes in foreign currency exchange rates associated with the Australian dollar, Euro, and U.S. dollar-denominated cash and cash equivalents, accounts receivable, unbilled receivables, and intercompany receivables and payables held by our U.K. subsidiary, a British pound functional entity.
A hypothetical 10% strengthening in the British pound exchange rate in comparison to the Australian dollar, Euro, and U.S. dollar would result in the following impact:
Three Months Ended
March 31,
(in millions)20202019
Foreign currency gain (loss) $ $(4) 

ITEM 4.  CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures
Our management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)) as of March 31, 2020. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of March 31, 2020.
(b) Changes in internal control over financial reporting
There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 31, 2020 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
COVID-19
In response to COVID-19, we have undertaken measures to protect our employees, partners, and clients, including encouraging employees to work remotely. These changes have compelled us to modify some of our control procedures. However, those changes have so far not been material.
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PART II - OTHER INFORMATION
ITEM 1A.  RISK FACTORS
We encourage you to carefully consider the risk factors identified below and in Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2019, which was filed with the Securities and Exchange Commission on February 12, 2020. These risk factors could materially affect our business, financial condition, and future results, and they could cause our actual business and financial results to differ materially from those contained in forward-looking statements made in this Quarterly Report on Form 10-Q or elsewhere by management from time to time.
Coronavirus (“COVID-19”)
Epidemic diseases, such as the recent global COVID-19 outbreak, could harm our business and results of operations.
The recent outbreak of a novel coronavirus disease (“COVID-19”), which has been declared by the World Health Organization to be a pandemic, has spread across the globe and is impacting worldwide economic activity. A pandemic, including COVID-19, or other public health epidemic poses the risk that we or our employees and other partners may be prevented from conducting business activities at full capacity for an indefinite period of time, including due to spread of the disease within these groups or due to shutdowns that are requested or mandated by governmental authorities. Moreover, these conditions can affect the rate of IT spending and may adversely affect our clients’ willingness to purchase our solutions, delay prospective clients’ purchasing decisions, reduce the value or duration of their contracts, request concessions including extended payment terms or better pricing, or affect attrition rates, all of which could adversely affect our future sales and operating results. The global spread of COVID-19 has created significant volatility, uncertainty, and economic disruption.
We have undertaken measures to protect our employees, partners, and clients, including by adopting a virtual-only meeting format for our annual PegaWorld conference and by encouraging employees to work remotely. There can be no assurance that these measures will be sufficient, however, or that we can implement them without adversely affecting our business operations.
We continue to monitor the situation and may adjust our current policies as more information and public health guidance become available. Precautionary measures that have been adopted, or may be adopted in the future, could negatively affect our client success efforts, sales, and marketing efforts, delay and lengthen our sales cycles, or create operational or other challenges, any of which could harm our business and results of operations. In addition, COVID-19 may disrupt the operations of our clients, vendors, and partners for an indefinite period, including as a result of travel restrictions and/or business shutdowns, all of which could negatively impact our business and results of operations, including cash flows.
It is not possible at this time to estimate the ultimate impact that COVID-19 could have on our business, as the impact will depend on future developments, which are highly uncertain and cannot be predicted. Furthermore, due to our shift to a renewable model, the effect of COVID-19 may not be fully reflected in our results of operations until future periods, if at all. The extent to which COVID-19 impacts our business, operations, and financial results will depend on numerous evolving factors that we may not be able to predict accurately, including:
the duration and scope of the pandemic;
governmental, business and individual actions taken in response to the pandemic and the impact of those actions on global economic activity;
the actions taken in response to economic disruption;
the impact of business disruptions and reductions in our clients’ business and the resulting impact on their demand for our services and solutions; and
our ability to provide our services and solutions, including as a result of our employees or our clients’ employees working remotely and/or closures of offices and facilities.
Risks related to our Convertible Senior Notes
We have a significant amount of debt that may decrease our business flexibility, access to capital, and/or increase our borrowing costs, and we may still incur additional debt in the future, which may adversely affect our operations and financial results.
As of March 31, 2020, we had $600 million aggregate principal amount of indebtedness under our Convertible Senior Notes due 2025 (the “Notes”).
Our indebtedness may:
limit our ability to borrow additional funds for working capital, capital expenditures, acquisitions or other general business purposes;
limit our ability to use our cash flow or obtain additional financing for future working capital, capital expenditures, acquisitions or other general business purposes;
require us to use a substantial portion of our cash flow from operations to make debt service payments;
limit our flexibility to plan for, or react to, changes in our business and industry;
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place us at a competitive disadvantage compared to our less leveraged competitors;
dilute the interests of our existing stockholders as a result of issuing shares of our common stock upon the conversion of the Notes; and
increase our vulnerability to the impact of adverse economic and industry conditions.
Our ability to pay our debt when due or to refinance our indebtedness, including the Notes, depends on our future performance, which is subject to economic, financial, competitive, and other factors beyond our control. Our business may not generate cash flow from operations in the future sufficient to service our debt and make necessary capital expenditures. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations which could, in turn, result in that and our other indebtedness becoming immediately payable in full.
In addition, we and our subsidiaries may incur additional debt to meet future financing needs. We will not be restricted under the terms of the indenture governing the Notes from incurring additional debt, securing existing or future debt, recapitalizing our debt or taking a number of other actions that are not limited by the terms of the indenture governing the Notes that could have the effect of diminishing our ability to make payments on the Notes when due. If we incur additional indebtedness, the risks related to our business and our ability to service or repay our indebtedness would increase.
The conditional conversion feature of the Notes, if triggered, may adversely affect our financial condition and operating results.
Pursuant to their terms, holders of the Notes may convert their Notes at their option prior to the scheduled maturities of Notes under certain circumstances. Upon conversion of the Notes, unless we elect to deliver solely shares of our common stock to settle such conversion, we will be obligated to make cash payments. In addition, holders of our Notes will have the right to require us to repurchase their Notes upon the occurrence of a fundamental change (as defined in the indenture, dated as of February 24, 2020, between us and U.S. Bank National Association, as trustee (the “Trustee”) (the “Indenture”)), at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest, if any, to, but not including, the fundamental change repurchase date. Although it is our intention and we currently expect to settle the conversion value of the Notes in cash up to the principal amount and any excess in shares, there is a risk that we may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of Notes surrendered therefor or Notes being converted. In addition, our ability to make payments may be limited by law, by regulatory authority, or by agreements governing our future indebtedness. Our failure to repurchase Notes at a time when the Indenture requires the repurchase or to pay any cash payable on future conversions of the Notes as required by the Indenture would constitute a default under the Indenture. A default under the Indenture or the fundamental change itself could also lead to a default under agreements governing our future indebtedness. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase the Notes or make cash payments upon conversions thereof. In addition, even if holders of Notes do not elect to convert their Notes, we could be required under applicable accounting rules to reclassify all or a portion of the outstanding principal of the Notes as a current rather than long-term liability, which would result in a material reduction of our net working capital.
The accounting method for convertible debt securities that may be settled in cash, such as the Notes, could have a material effect on our reported financial results.
Under Accounting Standards Codification 470-20, Debt with Conversion and Other Options (ASC 470-20), an entity must separately account for the liability and equity components of the convertible debt instruments (such as the Notes) that may be settled entirely or partially in cash upon conversion in a manner that reflects the issuer’s economic interest cost. The effect of ASC 470-20 on the accounting for the Notes is that the equity component is required to be included in the additional paid-in capital section of stockholders’ equity on our consolidated balance sheet at the issuance date and the value of the equity component is treated as debt discount for purposes of accounting for the debt component of the Notes. As a result, we will be required to record noncash interest expense through the amortization of the excess of the face amount over the carrying amount of the expected life of the Notes. We will report larger net losses (or lower net income) in our financial results because ASC 470-20 requires interest to include both the amortization of the debt discount and the instrument’s cash coupon interest rate, which could adversely affect our reported or future financial results, the trading price of our common stock, and the trading price of the Notes.
In addition, under certain circumstances, convertible debt instruments (such as the Notes) that may be settled entirely or partially in cash may be accounted for utilizing the treasury stock method, the effect of which is that the shares issuable upon conversion of such Notes are not included in the calculation of diluted earnings per share except to the extent that the conversion value of such Notes exceeds their principal amount. Under the treasury stock method, the number of shares of common stock that would be necessary to settle such excess, if we elected to settle such excess in shares, is included in the denominator for purposes of calculating diluted earnings per share. We cannot be sure that the accounting standards in the future will continue to permit the use of the treasury stock method. If we are unable or otherwise elect not to use the treasury stock method in accounting for the shares issuable upon conversion of the Notes, then our diluted earnings per share could be adversely affected.
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The capped call transactions may affect the value of the Notes and our common stock.
In connection with the issuance of the Notes, we entered into capped call transactions with certain financial institutions (“option counterparties”). The capped call transactions are generally expected to reduce the potential dilution to our common stock upon any conversion of the Notes and/or offset any cash payments we are required to make in excess of the principal amount of converted Notes, as the case may be, with such reduction and/or offset subject to a cap. From time to time, the option counterparties that are parties to the capped call transactions or their respective affiliates may modify their hedge positions by entering into or unwinding various derivative transactions with respect to our common stock and/or purchasing or selling our common stock or other securities of ours in secondary market transactions prior to the maturity of the Notes. This activity could cause a decrease in the market price of our common stock.
We are subject to counterparty risk with respect to the capped call transactions.
The option counterparties are financial institutions, and we will be subject to the risk that one or more of the option counterparties may default or otherwise fail to perform, or may exercise certain rights to terminate, their obligations under the Capped Calls. Our exposure to the credit risk of the option counterparties will not be secured by any collateral. Recent global economic conditions have resulted in the actual or perceived failure or financial difficulties of many financial institutions. If an option counterparty becomes subject to insolvency proceedings, we will become an unsecured creditor in those proceedings with a claim equal to our exposure at the time under such transaction. Our exposure will depend on many factors but, generally, our exposure will increase if the market price or the volatility of our common stock increases. In addition, upon a default or other failure to perform, or a termination of obligations, by an option counterparty, we may suffer more dilution than we currently anticipate with respect to our common stock. We can provide no assurances as to the financial stability or viability of the option counterparties.
Provisions in the indenture for the Notes may deter or prevent a business combination that may be favorable to our stockholders.
If a fundamental change occurs prior to the maturity date of the Notes, holders of the Notes will have the right, at their option, to require us to repurchase all or a portion of their Notes. In addition, if a “make-whole fundamental change” (as defined in the Indenture) occurs prior the maturity date, we will in some cases be required to increase the conversion rate of the Notes for a holder that elects to convert its Notes in connection with such make-whole fundamental change.
Furthermore, the Indenture will prohibit us from engaging in certain mergers or acquisitions unless, among other things, the surviving entity assumes our obligations under the Notes. These and other provisions in the Indenture could deter or prevent a third party from acquiring us even when the acquisition may be favorable to our stockholders.
Conversion of the Notes may dilute the ownership interest of existing stockholders.
The conversion of some or all of the Notes will dilute the ownership interests of existing stockholders to the extent we deliver shares of our common stock upon conversion of any of the Notes. Any sales in the public market of the common stock issuable upon such conversion could adversely affect prevailing market prices of our common stock. In addition, the existence of the Notes may encourage short selling by market participants because the conversion of the Notes could be used to satisfy short positions, or anticipated conversion of the Notes into shares of our common stock could depress the price of our common stock.
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ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
Common stock repurchased in the three months ended March 31, 2020 was:
(in thousands, except per share amounts)
Total Number of Shares Purchased (1) (2)
Average 
Price Paid
per Share (1) (2)
Total Number of Shares Purchased as Part of Publicly Announced Share Repurchase Program (2)
Approximate Dollar Value of Shares That May Yet Be Purchased at Period End Under Publicly Announced Share Repurchase Programs (2)
January 1, 2020 - January 31, 202033  $82.11  —  $45,484  
February 1, 2020 - February 29, 2020181  $97.83  —  $45,484  
March 1, 2020 - March 31, 2020299  $79.88  87  $39,484  
513  $86.35  87
(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, 2020 and increased the amount of common stock we are authorized to repurchase by $60 million. See "Liquidity and Capital Resources" in Item 2 of this Quarterly Report for additional information.
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ITEM 6.  EXHIBITS
Exhibit No.Description
3.1
3.2
4.1
4.2
4.3
10.1
10.2
10.3
31.1
31.2
32+
101.INSInline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCHInline XBRL Taxonomy Extension Schema Document.
101.CALInline XBRL Taxonomy Calculation Linkbase Document.
101.DEFInline XBRL Taxonomy Extension Definition Linkbase Document.
101.LABInline XBRL Taxonomy Label Linkbase Document.
101.PREInline XBRL Taxonomy Presentation Linkbase Document.
104Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
+ Indicates that the exhibit is being furnished with this report and is not filed as a part of it.
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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
Pegasystems Inc.
Dated:April 29, 2020By:/s/ KENNETH STILLWELL
Kenneth Stillwell
Chief Financial Officer and Chief Administrative Officer
(Principal Financial Officer)

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