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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended September 30, 2017

OR

 

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

For the transition period from                      to                     

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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes  ☒    No  ☐

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

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer   ☐  (Do not check if smaller reporting company)    Smaller reporting company  
     Emerging growth company  

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

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

There were 77,859,958 shares of the Registrant’s common stock, $.01 par value per share, outstanding on October 27, 2017.

 

 

 


Table of Contents

PEGASYSTEMS INC.

Index to Form 10-Q

 

     Page  

PART I—FINANCIAL INFORMATION

 

Item 1. Unaudited Condensed Consolidated Financial Statements

  

Unaudited Condensed Consolidated Balance Sheets as of September  30, 2017 and December 31, 2016

     2  

Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2017 and 2016

     3  

Unaudited Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2017 and 2016

     4  

Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2017 and 2016

     5  

Notes to Unaudited Condensed Consolidated Financial Statements

     6  

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

     15  

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     25  

Item 4. Controls and Procedures

     25  

PART II—OTHER INFORMATION

 

Item 1A. Risk Factors

     25  

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     25  

Item 6. Exhibits

     26  

Signature

     27  

 

1


Table of Contents

PART I—FINANCIAL INFORMATION

 

ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

     September 30,
2017
    December 31,
2016
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 130,568     $ 70,594  

Marketable securities

     63,812       63,167  
  

 

 

   

 

 

 

Total cash, cash equivalents, and marketable securities

     194,380       133,761  

Trade accounts receivable, net of allowance of $6,189 and $4,126

     191,161       265,028  

Income taxes receivable

     34,864       14,155  

Other current assets

     17,679       12,188  
  

 

 

   

 

 

 

Total current assets

     438,084       425,132  

Property and equipment, net

     39,849       38,281  

Deferred income taxes

     73,459       69,898  

Long-term other assets

     5,982       3,990  

Intangible assets, net

     34,755       44,191  

Goodwill

     72,941       73,164  
  

 

 

   

 

 

 

Total assets

   $ 665,070     $ 654,656  
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Current liabilities:

    

Accounts payable

   $ 12,535     $ 14,414  

Accrued expenses

     39,681       36,751  

Accrued compensation and related expenses

     53,869       60,660  

Deferred revenue

     160,931       175,647  
  

 

 

   

 

 

 

Total current liabilities

     267,016       287,472  

Income taxes payable

     4,774       4,263  

Long-term deferred revenue

     6,130       10,989  

Other long-term liabilities

     15,449       16,043  
  

 

 

   

 

 

 

Total liabilities

     293,369       318,767  
  

 

 

   

 

 

 

Stockholders’ equity:

    

Preferred stock, 1,000 shares authorized; no shares issued and outstanding

     —         —    

Common stock, 200,000 shares authorized; 77,839 shares and 76,591 shares issued and outstanding

     778       766  

Additional paid-in capital

     146,728       143,903  

Retained earnings

     227,953       198,315  

Accumulated other comprehensive loss

     (3,758     (7,095
  

 

 

   

 

 

 

Total stockholders’ equity

     371,701       335,889  
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 665,070     $ 654,656  
  

 

 

   

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

2


Table of Contents

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2017     2016     2017     2016  

Revenue:

        

Software license

   $ 41,793     $ 68,833     $ 195,220     $ 207,849  

Maintenance

     62,204       55,038       180,759       163,174  

Services

     75,818       58,931       225,063       179,633  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     179,815       182,802       601,042       550,656  
  

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenue:

        

Software license

     1,276       1,313       3,826       3,646  

Maintenance

     6,716       6,659       20,945       18,889  

Services

     61,739       52,465       180,925       154,512  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue

     69,731       60,437       205,696       177,047  
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     110,084       122,365       395,346       373,609  
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Selling and marketing

     70,209       67,032       217,384       202,126  

Research and development

     41,031       38,036       121,089       108,530  

General and administrative

     13,133       11,725       38,174       34,067  

Acquisition-related

     —         74       —         2,903  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     124,373       116,867       376,647       347,626  
  

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/income from operations

     (14,289     5,498       18,699       25,983  

Foreign currency transaction (loss)/gain

     (552     1,082       (793     2,764  

Interest income, net

     144       172       470       650  

Other income/(expense), net

     —         (1,237     287       (4,891
  

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/income before (benefit)/provision for income taxes

     (14,697     5,515       18,663       24,506  

(Benefit)/provision for income taxes

     (12,885     2,214       (17,952     6,269  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income

   $ (1,812   $ 3,301     $ 36,615     $ 18,237  
  

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/earnings per share:

        

Basic

     (0.03     0.04       0.47       0.24  

Diluted

     (0.03     0.04       0.44       0.23  

Weighted-average number of common shares outstanding:

        

Basic

     77,691       76,278       77,258       76,323  

Diluted

     77,691       79,548       82,717       79,401  

Cash dividends declared per share

   $ 0.03     $ 0.03     $ 0.09     $ 0.09  

See notes to unaudited condensed consolidated financial statements.

 

3


Table of Contents

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2017     2016     2017      2016  

Net (loss)/income

   $ (1,812   $ 3,301     $ 36,615      $ 18,237  

Other comprehensive income/(loss), net of tax

         

Unrealized gain/(loss) on available-for-sale marketable securities, net of tax

     22       (174     148        168  

Foreign currency translation adjustments

     549       (169     3,189        (1,400
  

 

 

   

 

 

   

 

 

    

 

 

 

Total other comprehensive income/(loss), net of tax

     571       (343     3,337        (1,232
  

 

 

   

 

 

   

 

 

    

 

 

 

Comprehensive (loss)/income

   $ (1,241   $ 2,958     $ 39,952      $ 17,005  
  

 

 

   

 

 

   

 

 

    

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

4


Table of Contents

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

     Nine Months Ended
September 30,
 
     2017     2016  

Operating activities:

    

Net income

   $ 36,615     $ 18,237  

Adjustments to reconcile net income to cash provided by operating activities:

    

Deferred income taxes

     (2,607     (2,841

Depreciation and amortization

     18,703       17,896  

Stock-based compensation expense

     39,929       30,634  

Foreign currency transaction loss/(gain)

     793       (2,764

Other non-cash

     (89     153  

Change in operating assets and liabilities:

    

Trade accounts receivable

     80,580       3,940  

Income taxes receivable and other current assets

     (25,943     (11,904

Accounts payable and accrued expenses

     (8,546     (16,678

Deferred revenue

     (25,639     (17,698

Other long-term assets and liabilities

     130       1,581  
  

 

 

   

 

 

 

Cash provided by operating activities

     113,926       20,556  

Investing activities:

    

Purchases of marketable securities

     (25,687     (22,614

Proceeds from maturities and called marketable securities

     23,124       21,838  

Sales of marketable securities

     —         62,283  

Payments for acquisitions, net of cash acquired

     (297     (49,113

Investment in property and equipment

     (9,106     (15,253
  

 

 

   

 

 

 

Cash used in investing activities

     (11,966     (2,859

Financing activities:

    

Dividend payments to shareholders

     (6,941     (6,883

Common stock repurchases for tax withholdings for net settlement of equity awards

     (34,113     (10,398

Common stock repurchases under share repurchase programs

     (2,986     (25,750
  

 

 

   

 

 

 

Cash used in financing activities

     (44,040     (43,031

Effect of exchange rates on cash and cash equivalents

     2,054       (1,309
  

 

 

   

 

 

 

Net increase/(decrease) in cash and cash equivalents

     59,974       (26,643

Cash and cash equivalents, beginning of period

     70,594       93,026  
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 130,568     $ 66,383  
  

 

 

   

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

5


Table of Contents

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 Form 10-K for the year ended December 31, 2016.

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 2017.

2. NEW ACCOUNTING PRONOUNCEMENTS

Stock-Based Compensation

In May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2017-09 “Stock Compensation (Topic 718), Scope of Modification Accounting” to clarify when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The effective date for the Company will be January 1, 2018. The Company does not expect the adoption of this standard to have a material effect on its financial position or results of operations.

Financial Instruments

In June 2016, the FASB issued 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 trade accounts receivable, upon initial recognition of that financial asset using a forward-looking expected loss model, rather than an incurred loss model for credit losses. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses when the fair value is below the amortized cost of the asset, removing the concept of “other-than-temporary” impairments. The effective date for the Company will be 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 ASU No. 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 a right-of-use asset for the right to use the underlying asset for the lease term. The effective date for the Company will be 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 and right-of-use assets upon adoption with no material impact to its results of operations and cash flows.

Revenue

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. This ASU amends the guidance for revenue recognition, creating the new Accounting Standards Codification Topic 606 (“ASC 606”). ASC 606 requires entities to apportion consideration from contracts to performance obligations on a relative standalone selling price basis, based on a five-step model. Under ASC 606, revenue is recognized when a customer obtains control of a promised good or service and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for the good or service. In addition, ASC 606 requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

The Company has elected the full retrospective adoption model, effective January 1, 2018. The Company’s quarterly results beginning with the quarter ending March 31, 2018 and comparative prior periods will be compliant with ASC 606. The Company’s Annual Report on Form 10-K for the year ended December 31, 2018 will be the Company’s first Annual Report that will be issued in compliance with ASC 606.

 

6


Table of Contents

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

The Company has made significant progress on quantifying the impact of its adoption and identifying necessary changes to our policies, processes, systems, and controls.

The Company expects the following impacts:

 

    Currently, the Company recognizes revenue from term licenses and perpetual licenses with extended payment terms over the term of the agreement as payments become due or earlier if prepaid, provided all other criteria for revenue recognition have been met, and any corresponding maintenance over the term of the agreement. The adoption of ASC 606 will result in revenue for performance obligations being recognized as they are satisfied. Therefore, revenue from the term and perpetual license performance obligations with extended payment terms is recognized when control is transferred to the customer. Any unrecognized license revenue from these arrangements, included in deferred revenue at December 31, 2015, will not be recognized in revenue in future periods but as a cumulative adjustment to retained earnings. Further, term license revenue from new arrangements executed in 2016 and 2017 will be recognized in full in the year that control of the license is transferred to the customer instead of over the term of the agreement. Revenue from the maintenance performance obligations is expected to be recognized on a straight-line basis over the contractual term. Due to the revenue from term and perpetual licenses with extended payment terms being recognized prior to amounts being billed to the customer, the Company expects to recognize a net contract asset on the balance sheet.

 

    Currently, the Company allocates revenue to licenses under the residual method when it has Vendor Specific Objective Evidence (“VSOE”) for the remaining undelivered elements, which allocates any future credits or significant discounts entirely to the license. The adoption of ASC 606 will result in future credits, significant discounts, and material rights under ASC 606, to be allocated to all performance obligations based upon their relative selling price. Under ASC 606, additional license revenue from the reallocation of such arrangement considerations will be recognized when control is transferred to the customer, which is generally upon delivery of the license.

 

    Currently, the Company does not have VSOE for fixed price services, time and materials services in certain geographical areas, and unspecified future products, which results in revenue being deferred in such instances until such time as VSOE exists for all undelivered elements or recognized ratably over the longest performance period. The adoption of ASC 606 eliminates the requirement for VSOE and replaces it with the concept of a stand-alone selling price. Once the transaction price is allocated to each of the performance obligations, the Company can recognize revenue as the performance obligations are delivered, either at a point in time or over time. Under ASC 606, license revenue will be recognized when control is transferred to the customer, professional services revenue will be recognized over time based on input or output measures that reflect the Company’s performance on the contract. This will result in the acceleration of professional services revenue when compared to the current practice of ratable recognition for professional services when there is a lack of VSOE.

 

    Sales commissions and other third party acquisition costs resulting directly from securing contracts with customers are currently expensed when incurred. ASC 606 will require these costs to be recognized as an asset when incurred and to be expensed over the associated contract term. As a practical expedient, if the term of the contract is one year or less, the Company will expense these costs as incurred. The Company expects this change to impact its multi-year cloud offerings and term and perpetual licenses with additional rights of use that extend beyond one year.

 

    ASC 606 provides additional accounting guidance for contract modifications whereby changes must be accounted for either as a retrospective change (creating either a catch up or deferral of past revenues), prospectively with a reallocation of revenues amongst identified performance obligations, or prospectively as separate contracts which will not require any reallocation. This may result in a difference in the timing of the recognition of revenue as compared to how contract modifications are recognized currently.

 

    There will be a corresponding effect on tax liabilities in relation to all of the above impacts.

 

7


Table of Contents

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

3. MARKETABLE SECURITIES

The Company’s marketable securities are as follows:

 

(in thousands)    Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
     Fair
Value
 

September 30, 2017

           

Municipal bonds

   $ 32,764      $ 12      $ (17    $ 32,759  

Corporate bonds

     31,079        12        (38      31,053  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 63,843      $ 24      $ (55    $ 63,812  
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2016

           

Municipal bonds

   $ 36,746      $ —        $ (139    $ 36,607  

Corporate bonds

     26,610        1        (51      26,560  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 63,356      $ 1      $ (190    $ 63,167  
  

 

 

    

 

 

    

 

 

    

 

 

 

As of September 30, 2017, the Company did not hold any investments with unrealized losses that are considered to be other-than-temporary.

As of September 30, 2017, remaining maturities of marketable debt securities ranged from October 2017 to September 2020, with a weighted-average remaining maturity of approximately 14 months.

4. DERIVATIVE INSTRUMENTS

In May 2017, the Company discontinued its forward contracts program; however, it will continue to evaluate periodically its foreign exchange exposures and may re-initiate this program if it is deemed necessary.

The Company has historically used foreign currency forward contracts (“forward contracts”) to hedge its exposure to fluctuations in foreign currency exchange rates associated with its foreign currency denominated cash, accounts receivable, and intercompany receivables and payables held primarily by the U.S. parent company and its United Kingdom (“U.K.”) subsidiary.

At December 31, 2016, the total notional value of the Company’s outstanding forward contracts was $128.4 million.

The fair value of the Company’s outstanding forward contracts was as follows:

 

     December 31, 2016  
(in thousands)    Recorded In:      Fair Value  

Asset Derivatives

     

Foreign currency forward contracts

     Other current assets      $ 628  

Liability Derivatives

     

Foreign currency forward contracts

     Accrued expenses      $ 883  

As of September 30, 2017, the Company did not have any forward contracts outstanding.

The Company had forward contracts outstanding with total notional values as of September 30, 2016 as follows:

 

(in thousands)       

Euro

   21,810  

British pound

   £ 5,919  

Australian dollar

   A$     19,515  

United States dollar

   $ 59,450  

 

8


Table of Contents

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

The income statement impact of the Company’s outstanding forward contracts and foreign currency transactions was as follows:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
(in thousands)    2017      2016      2017      2016  

Gain (loss) from the change in the fair value of forward contracts included in other income (expense), net

   $ —        $ (1,237    $ 286      $ (4,955

Foreign currency transaction (loss) gain from the remeasurement of foreign currency assets and liabilities

     (552      1,082        (793      2,764  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ (552    $ (155    $ (507    $ (2,191
  

 

 

    

 

 

    

 

 

    

 

 

 

5. FAIR VALUE MEASUREMENTS

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The Company records its money market funds, marketable securities, and forward contracts 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 money market funds are classified within Level 1 of the fair value hierarchy. The Company’s marketable securities 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 foreign currency forward contracts, which were all classified within Level 2 of the fair value hierarchy, are valued based on the notional amounts and rates under the contracts and observable market inputs such as currency exchange rates and credit risk. 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 Level 1 and Level 2 during the nine months ended September 30, 2017.

 

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Table of Contents

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

The Company’s assets and liabilities measured at fair value on a recurring basis consisted of the following:

 

     Fair Value Measurements at Reporting Date Using                    Total  
(in thousands)    Level 1      Level 2           

September 30, 2017

              

Fair Value Assets:

              

Money market funds

   $     655      $ —              $ 655  

Marketable securities:

              

Municipal bonds

   $ —        $ 32,759              32,759  

Corporate bonds

     —          31,053              31,053  
  

 

 

    

 

 

          

 

 

 
   $ —        $ 63,812            $ 63,812  

December 31, 2016

              

Fair Value Assets:

              

Money market funds

   $ 458      $ —              $ 458  

Marketable securities:

              

Municipal bonds

   $ —        $ 36,607            $ 36,607  

Corporate bonds

     —          26,560              26,560  
  

 

 

    

 

 

          

 

 

 
   $ —        $ 63,167            $ 63,167  

Foreign currency forward contracts

     —          628              628  

Fair Value Liabilities:

              

Foreign currency forward contracts

   $ —        $ 883            $ 883  

For certain other financial instruments, including accounts receivable and accounts payable, the carrying value approximates their 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, such as property and equipment and intangible assets, are recognized at fair value when they are impaired. During the nine months ended September 30, 2017 and 2016, the Company did not recognize any impairments of its assets recorded at fair value on a nonrecurring basis.

6. TRADE ACCOUNTS RECEIVABLE, NET OF ALLOWANCE

 

(in thousands)    September 30,
2017
     December 31,
2016
 

Trade accounts receivable

   $ 164,530      $ 234,473  

Unbilled trade accounts receivable

     32,820        34,681  
  

 

 

    

 

 

 

Total trade accounts receivable

     197,350        269,154  

Allowance for sales credit memos

     (6,189      (4,126
  

 

 

    

 

 

 
   $ 191,161      $ 265,028  
  

 

 

    

 

 

 

Unbilled trade accounts receivable primarily relate to services earned under time and materials arrangements and to license, maintenance, and cloud arrangements that have commenced or been delivered in excess of scheduled invoicing.

7. GOODWILL AND OTHER INTANGIBLE ASSETS

The changes in the carrying amount of goodwill for the nine months ended September 30, 2017 as follows:

 

(in thousands)       

Balance as of January 1,

   $ 73,164  

Purchase price adjustments to goodwill

     (354

Currency translation adjustments

     131  
  

 

 

 

Balance as of September 30,

   $ 72,941  
  

 

 

 

 

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

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

 

(in thousands)    Range of
Remaining
Useful Lives
     Cost      Accumulated
Amortization
     Net Book
Value
 

September 30, 2017

           

Customer related intangibles

     4-10 years      $ 63,158      $ (43,205    $ 19,953  

Technology

     7-10 years        58,942        (44,140      14,802  

Other intangibles

     —          5,361        (5,361      —    
     

 

 

    

 

 

    

 

 

 
      $ 127,461      $ (92,706    $ 34,755  
     

 

 

    

 

 

    

 

 

 

December 31, 2016

           

Customer related intangibles

     4-10 years      $ 63,091      $ (37,573    $ 25,518  

Technology

     3-10 years        58,942        (40,269      18,673  

Other intangibles

     —          5,361        (5,361      —    
     

 

 

    

 

 

    

 

 

 
      $ 127,394      $ (83,203    $ 44,191  
     

 

 

    

 

 

    

 

 

 

Amortization expense of intangibles assets is reflected in the Company’s unaudited condensed consolidated statements of operations as follows:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
(in thousands)    2017      2016      2017      2016  

Cost of revenue

   $ 1,232      $ 1,642      $ 3,871      $ 4,626  

Selling and marketing

     1,873        1,867        5,608        5,274  

General and administrative

     —          90        —          268  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 3,105      $ 3,599      $ 9,479      $ 10,168  
  

 

 

    

 

 

    

 

 

    

 

 

 

Future estimated amortization expense related to intangible assets as of September 30, 2017 is as follows:

 

(in thousands)       

Remainder of 2017

   $ 2,846  

2018

     11,347  

2019

     5,555  

2020

     2,659  

2021

     2,637  

2022 and thereafter

     9,711  
  

 

 

 
   $ 34,755  
  

 

 

 

8. ACCRUED EXPENSES

 

(in thousands)    September 30,
2017
     December 31,
2016
 

Outside professional services

   $ 13,447      $ 10,204  

Income and other taxes

     5,947        10,422  

Marketing and sales program expenses

     4,679        3,707  

Dividends payable

     2,336        2,298  

Employee related expenses

     4,715        3,806  

Other

     8,557        6,314  
  

 

 

    

 

 

 
   $ 39,681      $ 36,751  
  

 

 

    

 

 

 

 

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

9. DEFERRED REVENUE

 

(in thousands)    September 30,
2017
     December 31,
2016
 

Term license

   $ 5,636      $ 15,843  

Perpetual license

     20,844        23,189  

Maintenance

     105,588        112,397  

Cloud

     18,805        13,604  

Professional Services

     10,058        10,614  
  

 

 

    

 

 

 

Current deferred revenue

     160,931        175,647  

Perpetual license

     4,085        7,909  

Maintenance

     828        1,802  

Cloud

     1,217        1,278  
  

 

 

    

 

 

 

Long-term deferred revenue

     6,130        10,989  
  

 

 

    

 

 

 
   $ 167,061      $ 186,636  
  

 

 

    

 

 

 

10. STOCK-BASED COMPENSATION

Stock-based compensation expense is reflected in the Company’s unaudited condensed consolidated statements of operations as follows:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
(in thousands)    2017      2016      2017      2016  

Cost of revenues

   $ 3,613      $ 3,117      $ 10,913      $ 8,711  

Selling and marketing

     3,976        3,468        11,482        9,395  

Research and development

     3,420        2,260        10,306        7,480  

General and administrative

     2,480        1,983        7,228        4,706  

Acquisition-related

     —          (10      —          342  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation before tax

   $ 13,489      $ 10,818      $ 39,929      $ 30,634  
  

 

 

    

 

 

    

 

 

    

 

 

 

Income tax benefit

   $ (4,129    $ (3,227    $ (12,231    $ (8,917

During the nine months ended September 30, 2017, the Company issued approximately 1,299,000 shares of common stock to its employees and 18,000 shares of common stock to its non-employee directors under the Company’s stock-based compensation plans.

During the nine months ended September 30, 2017, the Company granted approximately 1,052,000 restricted stock units (“RSUs”) and 1,520,000 non-qualified stock options to its employees with total fair values of approximately $47.5 million and $20.6 million, respectively. This includes approximately 175,000 RSUs which were granted in connection with the election by employees to receive 50% of their 2017 target incentive compensation under the Company’s Corporate Incentive Compensation Plan in the form of RSUs instead of cash. Stock-based compensation of approximately $7.7 million associated with this RSU grant will be recognized over a one-year period beginning on the grant date.

The Company recognizes stock based compensation on the accelerated recognition method, treating each vesting tranche as if it were an individual grant. As of September 30, 2017, the Company had approximately $56.8 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to all unvested RSUs and unvested stock options that is expected to be recognized over a weighted-average period of 2.1 years.

11. 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 options and RSUs, using the treasury stock method. Certain shares related to some of the Company’s outstanding stock options and RSUs were excluded from the computation of diluted earnings per share because they were anti-dilutive in the periods presented, but could be dilutive in the future.

 

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

The calculation of the Company’s 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)    2017      2016      2017      2016  

Basic

           

Net (loss)/income

   $ (1,812    $ 3,301      $ 36,615      $ 18,237  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted-average common shares outstanding

     77,691        76,278        77,258        76,323  
  

 

 

    

 

 

    

 

 

    

 

 

 

(Loss)/earnings per share, basic

   $ (0.03    $ 0.04      $ 0.47      $ 0.24  
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted

           

Net (loss)/income

   $ (1,812    $ 3,301      $ 36,615      $ 18,237  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted-average effect of dilutive securities:

           

Stock options

     —          1,933        3,519        1,851  

RSUs

     —          1,337        1,940        1,227  
  

 

 

    

 

 

    

 

 

    

 

 

 

Effect of assumed exercise of stock options and RSUs

     —          3,270        5,459        3,078  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted-average common shares outstanding, assuming dilution

     77,691        79,548        82,717        79,401  
  

 

 

    

 

 

    

 

 

    

 

 

 

(Loss)/earnings per share, diluted

   $ (0.03    $ 0.04      $ 0.44      $ 0.23  
  

 

 

    

 

 

    

 

 

    

 

 

 

Outstanding stock options and RSUs excluded as impact would be anti-dilutive

     7,232        296        219        368  

In periods of loss, all equity awards are excluded, as the inclusion of any equity awards would be anti-dilutive.

12. GEOGRAPHIC INFORMATION AND MAJOR CLIENTS

Geographic Information

Operating segments are defined as components of an enterprise, about which separate financial information is available that is evaluated regularly by the chief operating decision maker (“CODM”) in deciding how to allocate resources and in assessing performance.

The Company develops and licenses software applications for customer engagement and its Pega® Platform, and provides consulting services, maintenance, and training related to its offerings. The Company derives substantially all of its revenue from the sale and support of one group of similar products and services—software that provides case management, business process management, and real-time decisioning solutions to improve customer engagement and operational excellence in the enterprise applications market. To assess performance, the Company’s CODM, who is the chief executive officer, reviews financial information on a consolidated basis. Therefore, the Company determined it has one reportable segment—Customer Engagement Solutions and one reporting unit.

The Company’s international revenue, based upon the clients’ location, is as follows:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(Dollars in thousands)    2017     2016     2017     2016  

U.S.

   $ 95,087        53   $ 111,274        61   $ 351,330        59   $ 308,049        56

Other Americas

     8,722        5     7,952        4     30,243        5     49,494        9

U.K.

     18,485        10     21,490        12     68,003        11     77,181        14

Other EMEA(1)

     28,100        16     23,656        13     76,958        13     67,314        12

Asia Pacific

     29,421        16     18,430        10     74,508        12     48,618        9
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 179,815        100   $ 182,802        100   $ 601,042        100   $ 550,656        100
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1)  Includes Europe, the Middle East and Africa, but excludes the United Kingdom.

 

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

Major Clients

Clients accounting for 10% or more of the Company’s total revenue were as follows:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
(in thousands)    2017     2016      2017      2016  

Total revenue

   $ 179,815     $ 182,802      $ 601,042      $ 550,656  

Client A

     10.6     *        *        *  

 

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

Clients accounting for 10% or more of the Company’s total trade accounts receivable were as follows:

 

(in thousands)    September 30,
2017
    December 31,
2016
 

Total trade accounts receivable

     197,350       269,154  

Client A

     12.4     *  

 

* Client accounted for less than 10% of total trade account receivable

 

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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. 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 by the Company, and the timing of revenue recognition under license and cloud arrangements and are described more completely in Part I of our Annual Report on Form 10-K for the year ended December 31, 2016.

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 and the difficulty in predicting the completion of product acceptance and other factors affecting the timing of license revenue recognition; reliance on third party relationships; the potential loss of vendor specific objective evidence for our consulting services; the inherent risks associated with international operations and the continued uncertainties in international economies; the Company’s continued effort to market and sell both domestically and internationally; foreign currency exchange rates; the financial impact of any future acquisitions; the potential legal and financial liabilities and reputation damage due to cyber-attacks and security breaches; and management of the Company’s 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 as well as other filings we make with the Securities and Exchange Commission

We have no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or risks. New information, future events or risks may cause the forward-looking events we discuss in this report not to occur or to materially change.

Business overview

We develop, market, license, and support software applications for marketing, sales, service, and operations. In addition, we license our Pega® Platform for clients that wish to build and extend their own applications. The Pega Platform assists our clients in building, deploying, and evolving enterprise applications, creating an environment in which business and IT can collaborate to manage back office operations, front office sales, marketing, and/or customer service needs. We also provide consulting services, maintenance, and training for our software. Our software applications and Pega Platform can be deployed on Pega, partner, or customer-managed cloud architectures.

Our clients include Global 3000 companies and government agencies that seek to manage complex enterprise systems and customer service issues with greater agility and cost-effectiveness. Our strategy is to sell a client a series of licenses, each focused on a specific purpose or area of operations in support of longer term enterprise-wide digital transformation initiatives.

Our license revenue is primarily derived from sales of our applications and our Pega Platform. Our cloud revenue is derived from the licensing of our hosted Pega Platform and software application environments. Our consulting services revenue is primarily related to new license implementations.

Financial and Performance Metrics

Management evaluates our financial performance, based a number of select financial and performance metrics. The performance metrics are periodically reviewed and revised to reflect any changes in our business. Historically, Recurring Revenue and License and Cloud Backlog have been our primary performance metrics. However, due to the change in the revenue recognition patterns of term license arrangements as a result of the expected implementation of the new revenue accounting standard (See Note 2) in the first quarter of 2018, we have started tracking Annual Contract Value (“ACV”), a new performance measure.

 

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Table of Contents

Select Financial Metrics

 

(Dollars in thousands,

except per share amounts)

   Three Months Ended
September 30,
          Nine Months Ended
September 30,
       
   2017     2016     Change     2017     2016     Change  

Total revenue

   $ 179,815     $ 182,802       (2,987     (2 )%    $ 601,042     $ 550,656     $ 50,386        9

Operating margin

     (8 )%      3         3     5     

Diluted (loss)/earnings per share

   $ (0.03   $ 0.04     $ (0.07     (175 )%    $ 0.44     $ 0.23     $ 0.21        91

Cash flow provided by operating activities

             113,926       20,556       93,370        454

Select Performance Metrics

Annual Contract Value (“ACV”)

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

ACV is the sum of the following two components:

 

    Term and Cloud contract value divided by the number of committed contract years

 

    Quarterly Maintenance revenue reported for the current three months ended period multiplied by 4.

 

     September 30,         
(in thousands)    2017      2016      Change  

Term License and Cloud ACV

   $ 200,180      $ 163,408      $ 36,772        23

Maintenance ACV

     248,816        220,152      $ 28,664        13
  

 

 

    

 

 

       

Term License, Cloud and Maintenance ACV

   $ 448,996      $ 383,560      $ 65,436        17
  

 

 

    

 

 

       

 

LOGO

 

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Recurring Revenue

A measure of the predictability and repeatability of our revenue.

 

     Three Months Ended
September 30,
          Nine Months Ended
September 30,
       
(Dollars in thousands)    2017     2016     Change     2017     2016     Change  

Recurring revenue

                 

Term license

   $ 21,678     $ 28,919     $ (7,241     (25 )%    $ 106,170     $ 102,115     $ 4,055        4

Maintenance

     62,204       55,038     $ 7,166       13     180,759       163,174     $ 17,585        11

Cloud

     13,354       10,873     $ 2,481       23     36,914       30,640     $ 6,274        20
  

 

 

   

 

 

       

 

 

   

 

 

      

Total recurring revenue

   $ 97,236     $ 94,830     $ 2,406       3   $ 323,843     $ 295,929     $ 27,914        9
  

 

 

   

 

 

       

 

 

   

 

 

      

Recurring revenue as a percent of total revenue

     54     52         54     54     

License and Cloud Backlog

A measure of the continued growth of our business as a result of future contractual commitments by our clients.

License and Cloud Backlog is the sum of the following two components:

 

    Deferred license and cloud revenue as recorded on the Company’s balance sheet. (See Note 9 “Deferred Revenue”)

 

    License and cloud contractual commitments, which are not recorded on our balance sheet because we have not yet invoiced our clients, nor have we recognized the associated revenue. (See “Future Cash Receipts from Committed License and Cloud Arrangements” which can be found in “Liquidity and Capital Resources” contained elsewhere in this Quarterly Report on Form 10-Q for additional information)

License and cloud backlog may vary in any given period depending on the amount and timing of when the arrangements are executed, as well as the mix between perpetual, term, and cloud license arrangements, which may depend on our clients’ deployment preferences. A change in the mix may cause our revenues to vary materially from period to period. A higher proportion of term and cloud license arrangements executed will generally result in revenue being recognized over longer periods.

 

     September 30,     Change  
(Dollars in thousands)    2017     2016    

Deferred license and cloud revenue on the balance sheet

            

Term license and cloud

   $ 25,658        51   $ 19,627        42     31

Perpetual license

     24,929        49     27,653        58     (10 )% 
  

 

 

      

 

 

      

Total deferred license and cloud revenue

     50,587        100     47,280        100     7
  

 

 

      

 

 

      

License and cloud contractual commitments not on the balance sheet

            

Term license and cloud

     450,535        91     352,804        94     28

Perpetual license

     46,459        9     23,483        6     98
  

 

 

      

 

 

      

Total license and cloud commitments

     496,994        100     376,287        100     32
  

 

 

      

 

 

      

Total license (term and perpetual) and cloud backlog

   $ 547,581        $ 423,567          29
  

 

 

      

 

 

      

Total term license and cloud backlog

     476,193        87     372,431        88     28
  

 

 

      

 

 

      

 

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LOGO

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 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.

There have been no changes in our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016. For more information regarding our critical accounting policies, we encourage you to read the discussion contained in Item 7 under the heading “Critical Accounting Estimates and Significant Judgments” and Note 2 “Significant Accounting Policies” included in the notes to the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2016.

Results of Operations

 

     Three Months Ended
September 30,
          Nine Months Ended
September 30,
       
(Dollars in thousands)    2017     2016     Change     2017     2016     Change  

Total revenue

   $ 179,815     $ 182,802     $ (2,987     (2 )%    $ 601,042     $ 550,656     $ 50,386       9

Gross profit

   $ 110,084     $ 122,365     $ (12,281     (10 )%    $ 395,346     $ 373,609     $ 21,737       6

Total operating expenses

   $ 124,373     $ 116,867     $ 7,506       6   $ 376,647     $ 347,626     $ 29,021       8

(Loss)/income from operations

   $ (14,289   $ 5,498     $ (19,787     (360 )%    $ 18,699     $ 25,983     $ (7,284     (28 )% 

Operating margin

     (8 )%      3         3     5    

(Loss)/income before (benefit)/provision for income taxes

   $ (14,697   $ 5,515     $ (20,212     (366 )%    $ 18,663     $ 24,506     $ (5,843     (24 )% 

Revenue

Software license revenue

 

(Dollars in thousands)    Three Months Ended
September 30,
          Nine Months Ended
September 30,
       
   2017     2016     Change     2017     2016     Change  

Perpetual license

   $ 20,115        48   $ 39,914        58   $ (19,799     (50 )%    $ 89,050        46   $ 105,734        51   ($ 16,684     (16 )% 

Term license

     21,678        52     28,919        42     (7,241     (25 )%      106,170        54     102,115        49     4,055       4
  

 

 

    

 

 

   

 

 

    

 

 

       

 

 

    

 

 

   

 

 

    

 

 

     

Total license revenue

   $ 41,793        100   $ 68,833        100   $ (27,040     (39 )%    $ 195,220        100   $ 207,849        100   ($ 12,629     (6 )% 
  

 

 

    

 

 

   

 

 

    

 

 

       

 

 

    

 

 

   

 

 

    

 

 

     

 

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The mix between perpetual and term license arrangements executed in a particular period varies based on clients’ deployment preferences. A change in the mix may cause our revenues to vary materially from period to period. A higher proportion of term license arrangements executed will generally result in license revenue being recognized over longer periods. Additionally, some of our perpetual license arrangements include extended payment terms or additional rights of use, which may also result in the recognition of revenue over longer periods.

The decrease in perpetual license revenue in the three months ended September 30, 2017 was primarily due to a decrease in the average value of perpetual arrangements executed and a lower percentage of perpetual arrangements executed and recognized in revenue in the current period. The decrease in perpetual license revenue in the nine months ended September 30, 2017 was primarily due to a lower percentage of perpetual arrangements executed and recognized in revenue.

The decrease in term license revenue in the three months ended September 30, 2017 was primarily due to a large term license renewal for which the second year of the term was recognized as revenue in the three months ended September 30, 2016. If the second year of this term license arrangement was not paid in advance in the three months ended September 30, 2016, term license revenue would have decreased 2%. The increase in term license revenue in the nine months ended September 30, 2017 was primarily due to broad based growth amongst new and existing customers offset by a large term license arrangement which was prepaid and recognized in revenue in the three months ended March 31, 2016. If this term license arrangement was not prepaid and recognized in revenue in the three months ended March 31, 2016 term license revenue would have increased 26%.

The aggregate value of future revenue expected to be recognized during the remainder of the year under existing noncancellable perpetual arrangements not reflected in deferred revenue was $13.3 million as of September 30, 2017 compared to $3.9 million as of September 30, 2016.

The aggregate value of future revenue expected to be recognized during the remainder of the year under existing noncancellable term and cloud arrangements not reflected in deferred revenue was $37.7 million as of September 30, 2017 compared to $26.7 million as of September 30, 2016. For additional information see “Future Cash Receipts from Committed License and Cloud Arrangements” which can be found in “Liquidity and Capital Resources.”

Maintenance revenue

 

     Three Months Ended
September 30,
           Nine Months Ended
September 30,
        
(Dollars in thousands)    2017      2016      Change     2017      2016      Change  

Maintenance

   $ 62,204      $ 55,038      $ 7,166        13   $ 180,759      $ 163,174      $ 17,585        11

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

Services revenue

 

     Three Months Ended
September 30,
          Nine Months Ended
September 30,
       
(Dollars in thousands)    2017     2016     Change     2017     2016     Change  

Consulting services

   $ 61,535        81   $ 46,829        80   $ 14,706       31   $ 183,447        82   $ 144,263        80   $ 39,184       27

Cloud

     13,354        18     10,873        18     2,481       23     36,914        16     30,640        17     6,274       20

Training

     929        1     1,229        2     (300     (24 )%      4,702        2     4,730        3     (28     (1 )% 
  

 

 

    

 

 

   

 

 

    

 

 

       

 

 

    

 

 

   

 

 

    

 

 

     

Total services

   $ 75,818        100   $ 58,931        100   $ 16,887       29   $ 225,063        100   $ 179,633        100   $ 45,430       25
  

 

 

    

 

 

   

 

 

    

 

 

       

 

 

    

 

 

   

 

 

    

 

 

     

Consulting services revenue is primarily generated from new license implementations. Our consulting services revenue may fluctuate in future periods depending on the mix of new implementation projects we perform as compared to those performed by our enabled clients or led by our partners.

The increases in consulting services revenue were primarily due to higher billable hours during the three and nine months ended September 30, 2017 driven by a large project which began in the second half of 2016.

Cloud revenue represents revenue from our Pega Cloud offerings. The increases in cloud revenue were primarily due to continued growth of our cloud client base.

 

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Gross profit

 

     Three Months Ended
September 30,
          Nine Months Ended
September 30,
       
(Dollars in thousands)    2017     2016     Change     2017     2016     Change  

Software license

   $ 40,517     $ 67,520     $ (27,003     (40 )%    $ 191,394     $ 204,203     $ (12,809     (6 )% 

Maintenance

     55,488       48,379       7,109       15     159,814       144,285       15,529       11

Services

     14,079       6,466       7,613       118     44,138       25,121       19,017       76
  

 

 

   

 

 

       

 

 

   

 

 

     

Total gross profit

   $ 110,084     $ 122,365     $ (12,281     (10 )%    $ 395,346     $ 373,609     $ 21,737       6

Software license gross profit %

     97     98         98     98    

Maintenance gross profit %

     89     88         88     88    

Services gross profit %

     19     11         20     14    
  

 

 

   

 

 

       

 

 

   

 

 

     

Total gross profit %

     61     67         66     68    

The decrease in total gross profit in the three months ended September 30, 2017 was primarily due to a shift in the mix of license arrangements executed from perpetual to term licenses and an increase in lower margin services revenue.

The increase in total gross profit in the nine months ended September 30, 2017 was primarily due to increased total revenue.

The increases in service gross profit percent in the three and nine months ended September 30, 2017 was driven by a large project which began in the second half of 2016 and several additional large projects for which costs were recognized in 2016 but whose associated revenue was not recognized until after September 30, 2016.

Operating expenses

Selling and marketing

 

     Three Months Ended
September 30,
          Nine Months Ended
September 30,
       
(Dollars in thousands)    2017     2016     Change     2017     2016     Change  

Selling and marketing

   $ 70,209     $ 67,032     $ 3,177        5   $ 217,384     $ 202,126     $ 15,258        8

As a percent of total revenue

     39     37          36     37     

Selling and marketing headcount, end of period

              934       875       59        7

Selling and marketing expenses include compensation, benefits, and other headcount-related expenses associated with our selling and marketing personnel as well as advertising, promotions, trade shows, seminars, and other programs. Selling and marketing expenses also include the amortization of customer related intangibles.

The increase in the three months ended September 30, 2017 was primarily due to an increase in compensation and benefits of $1.8 million, driven by increased headcount and equity compensation, partially offset by a decrease in sales commissions associated with the lower value of new license arrangements executed during the three months ended September 30, 2017.

The increase in the nine months ended September 30, 2017 was primarily due to an increase in compensation and benefits of $12.7 million, respectively, driven by increased headcount and equity compensation, and an increase in employee travel and entertainment, partially offset by a decrease in brand marketing program expenses of $2.2 million.

The increase in headcount reflects our efforts to increase our sales capacity to target new accounts in existing industries, as well as to expand coverage in new industries and geographies and to increase the number of sales opportunities.

Research and development

 

     Three Months Ended
September 30,
          Nine Months Ended
September 30,
       
(Dollars in thousands)    2017     2016     Change     2017     2016     Change  

Research and development

   $ 41,031     $ 38,036     $ 2,995        8   $ 121,089     $ 108,530     $ 12,559        12

As a percent of total revenue

     23     21          20     20     

Research and Development headcount, end of period

              1,474       1,437       37        3

 

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Research and development expenses include 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 integration of acquired technologies.

The increases in the three and nine months ended September 30, 2017 were primarily due to increases in compensation and benefits of $2.9 million and $12.6 million, respectively, attributable to increased headcount and equity compensation.

General and administrative

 

     Three Months Ended
September 30,
          Nine Months Ended
September 30,
       
(Dollars in thousands)    2017     2016     Change     2017     2016     Change  

General and administrative

   $ 13,133     $ 11,725     $ 1,408        12   $ 38,174     $ 34,067     $ 4,107        12

As a percent of total revenue

     7     6          6     6     

General and administrative headcount, end of period

              407       371       36        10

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

The increases in the three and nine months ended September 30, 2017 were primarily due to increases in compensation and benefits of $0.4 million and $4 million, respectively, attributable to increased headcount and equity compensation. The increase in the nine months ended September 30, 2017 was partially offset by a decrease of $1.5 million in legal fees.

Stock-based compensation

 

     Three Months Ended
September 30,
          Nine Months Ended
September 30,
       
(in thousands)    2017     2016     Change     2017     2016     Change  

Cost of revenues

   $ 3,613     $ 3,117     $ 496       16   $ 10,913     $ 8,711     $ 2,202       25

Selling and marketing

     3,976       3,468       508       15     11,482       9,395       2,087       22

Research and development

     3,420       2,260       1,160       51     10,306       7,480       2,826       38

General and administrative

     2,480       1,983       497       25     7,228       4,706       2,522       54

Acquisition-related

     —         (10     10       (100 )%      —         342       (342     (100 )% 
  

 

 

   

 

 

       

 

 

   

 

 

     

Total stock-based compensation before tax

   $ 13,489     $ 10,818     $ 2,671       25   $ 39,929     $ 30,634     $ 9,295       30
  

 

 

   

 

 

       

 

 

   

 

 

     

Income tax benefit

   $ (4,129   $ (3,227   $ (902     28   $ (12,231   $ (8,917   $ (3,314     37

The increases were primarily due to the increased value of our annual periodic equity awards granted in March 2016 and 2017. These awards generally have a five-year vesting schedule.

Amortization of intangibles

 

     Three Months Ended
September 30,
           Nine Months Ended
September 30,
        
(Dollars in thousands)    2017      2016      Change     2017      2016      Change  

Cost of revenue

   $ 1,232      $ 1,642      $ (410     (25 )%    $ 3,871      $ 4,626      $ (755     (16 )% 

Selling and marketing

     1,873        1,867        6       —    %      5,608        5,274        334       6

General and administrative

     —          90        (90     (100 )%      —          268        (268     (100 )% 
  

 

 

    

 

 

        

 

 

    

 

 

      
   $ 3,105      $ 3,599      $ (494     (14 )%    $ 9,479      $ 10,168      $ (689     (7 )% 
  

 

 

    

 

 

        

 

 

    

 

 

      

The decreases in amortization of intangibles in the three and nine months ended September 30, 2017 were due to the amortization in full of certain intangibles acquired through past acquisitions.

 

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Non-operating (expense)/income, net

 

     Three Months Ended
September 30,
          Nine Months Ended
September 30,
       
(Dollars in thousands)    2017     2016     Change     2017     2016     Change  

Foreign currency transaction (loss)/gain

   $ (552   $ 1,082     $ (1,634     n/m     $ (793   $ 2,764     $ (3,557     n/m  

Interest income, net

     144       172     $ (28     (16 )%      470       650       (180     (28 )% 

Other (expense)/income, net

     —         (1,237   $ 1,237       (100 )%      287       (4,891     5,178       n/m  
  

 

 

   

 

 

       

 

 

   

 

 

     
   $ (408   $ 17     $ (425     n/m     $ (36   $ (1,477   $ 1,441       (98 )% 
  

 

 

   

 

 

       

 

 

   

 

 

     

n/m - not meaningful

In May 2017, we discontinued our forward contracts program; however, we will continue to evaluate periodically our foreign exchange exposures and may re-initiate this program if it is deemed necessary.

Historically, we have used foreign currency forward contracts (“forward contracts”) to hedge our exposure to fluctuations in foreign currency exchange rates associated with our foreign currency denominated cash, accounts receivable, and intercompany receivables and payables held primarily by the U.S. parent company and its United Kingdom (“U.K.”) subsidiary. See Note 4 “Derivative Instruments” of this Quarterly Report on Form 10-Q for additional information.

The total change in the fair value of our foreign currency forward contracts recorded in other income (expense), net, during the three months ended September 30, 2016 was a loss of $1.2 million. The total change in the fair value of our foreign currency forward contracts recorded in other (expense)/income, net, during the nine months ended September 30, 2017 and 2016 was a gain of $0.3 million and a loss of $5 million, respectively.

(Benefit)/provision for income taxes

 

     Three Months Ended
September 30,
           Nine Months Ended
September 30,
       
(Dollars in thousands)    2017     2016     Change      2017     2016     Change  

(Benefit)/provision for income taxes

   $ (12,885   $ 2,214     $ (15,099     n/m      $ (17,952   $ 6,269     $ (24,221     n/m  

Effective income tax rate

     88     40          (96 )%      26    

n/m - not meaningful

The (benefit)/provision for income taxes represents current and future amounts for federal, state, and foreign taxes.

The increase in the effective income tax rate in the three months ended September 30, 2017 is primarily due to the significant increase of $3.5 million in excess tax benefits generated by our stock compensation plans on significantly lower income before (benefit)/provision for income taxes, which decreased by $20.2 million.

The decrease in the effective income tax rate in the nine months ended September 30, 2017 is primarily due to the significant increase of $19.1 million in excess tax benefits generated by our stock compensation plans, on significantly lower income before (benefit)/provision for income taxes, which decreased by $5.8 million.

The inclusion of excess tax benefits as a component of the provision for income taxes may increase volatility in the effective tax rates of future periods as the amount of excess tax benefits from share-based compensation awards varies depending on our future stock price in relation to the fair value of awards, the timing of RSU vesting and exercise behavior of our stock option holders, and the total value of future grants of share-based compensation awards.

 

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Liquidity and capital resources

 

     Nine Months Ended
September 30,
 
(in thousands)    2017      2016  

Cash provided by (used in):

     

Operating activities

   $ 113,926      $ 20,556  

Investing activities

     (11,966      (2,859

Financing activities

     (44,040      (43,031

Effect of exchange rate on cash

     2,054        (1,309
  

 

 

    

 

 

 

Net increase/(decrease) in cash and cash equivalents

   $ 59,974      $ (26,643
  

 

 

    

 

 

 
(in thousands)    September 30,
2017
     December 31,
2016
 

Total cash, cash equivalents, and marketable securities

   $ 194,380      $ 133,761  

We believe that our current cash, cash equivalents, marketable securities, and cash flow from operations will be sufficient to fund our operations, our dividend payments, and our share repurchase program for at least the next 12 months.

As of September 30, 2017, approximately $61.1 million of our cash and cash equivalents was held in our foreign subsidiaries. If it becomes necessary to repatriate these funds, we may be required to pay U.S. tax, net of any applicable foreign tax credits, upon repatriation. We consider the earnings of our foreign subsidiaries to be permanently reinvested and, as a result, U.S. taxes on such earnings are not provided. It is impractical to estimate the amount of U.S. tax we may be required to pay upon repatriation due to the complexity of the foreign tax credit calculations. There can be no assurance that changes in our plans or other events affecting our operations will not result in materially accelerated or unexpected expenditures.

Cash provided by operating activities

The primary drivers during the nine months ended September 30, 2017 were net income of $36.6 million and $80.6 million from trade accounts receivable, largely due to increased cash collections and the timing of billings.

The primary driver during the nine months ended September 30, 2016 was net income of $18.2 million.

Future Cash Receipts from Committed License and Cloud Arrangements

As of September 30, 2017, none of the amounts shown in the table below had been billed and no revenue had been recognized.

The below amounts for 2018 and subsequent periods may not be recognized in the periods shown below as a result of the adoption of the new revenue recognition standard (ASC 606). (See Note 2. New Accounting Pronouncements contained elsewhere in this Quarterly Report on Form 10-Q for additional information)

 

     September 30,
2017
 
(in thousands)    Term and cloud
contracts
     Perpetual contracts (1)      Total  

Remainder of 2017

   $ 37,723      $ 13,274      $ 50,997  

2018

     150,629        21,213        171,842  

2019

     125,165        10,033        135,198  

2020

     85,939        1,572        87,511  

2021

     38,203        367        38,570  

2022 and thereafter

     12,876        —          12,876  
  

 

 

    

 

 

    

 

 

 

Total

   $ 450,535      $ 46,459      $ 496,994  
  

 

 

    

 

 

    

 

 

 

 

(1)  These amounts are for perpetual licenses with extended payment terms and/or additional rights of use.

Total contractual future cash receipts due from our existing license and cloud arrangements were approximately $376.3 million as of September 30, 2016.

 

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Cash used in investing activities

During the nine months ended September 30, 2017, we purchased $25.7 million of marketable debt securities and made investments of $9.1 million in property and equipment, partially offset by proceeds received from maturities of marketable debt securities (including called marketable debt securities) of $23.1 million.

During the nine months ended September 30, 2016, we acquired OpenSpan for $48.8 million, net of cash acquired, and invested $15.3 million primarily in internally developed software and leasehold improvements at our corporate headquarters, partially offset by proceeds received from the sales of marketable debt securities of $62.3 million.

Cash used in financing activities

We used cash primarily for repurchases of our common stock, share repurchases for tax withholdings for the net settlement of our equity awards, and the payment of our quarterly dividend.

Since 2004, our Board of Directors has approved annual stock repurchase programs that have authorized the repurchase in the aggregate of up to $195 million of our common stock. Purchases under these programs have been made on the open market.

The following table is a summary of our repurchase activity:

 

     Nine Months Ended
September 30,
 
     2017     2016  
(in thousands)    Shares      Amount     Authorization Remaining
Under Publicly Announced

Share Repurchased
Programs
    Shares      Amount     Authorization Remaining
Under Publicly Announced
Share Repurchased
Programs
 

Balance as of January 1,

        $ 39,385          $ 40,534  

Authorizations

     —          —         —         —          —         25,879  

Repurchase for net settlement of tax under stock-based compensation

     682        (34,791     —         414        (10,791     —    

Repurchases paid under authorized share repurchase program

     68        (2,986     (2,986     1,028        (25,530     (25,530

Repurchases unsettled

     —          —         —         6        (177     (177
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Activity in Period

     750      $ (37,777   $ (2,986     1,448      $ (36,498   $ 172  
       

 

 

        

 

 

 

Balance as of September 30,

        $ 36,399          $ 40,706  
       

 

 

        

 

 

 

In addition to the share repurchases made under our repurchase programs, we net settled the majority of our employee stock option exercises and RSU vestings, which resulted in the withholding of shares to cover the option exercise price and the minimum statutory tax withholding obligations.

During the nine months ended September 30, 2017 and 2016, option and RSU holders net settled a total of 2.4 million shares and 1.6 million shares, respectively, of which only 1.3 million shares and 0.8 million shares, respectively, were issued to the option and RSU holders. The balance of the shares were surrendered to us to pay for the exercise price with respect to options and the applicable taxes for both options and RSUs. During the nine months ended September 30, 2017 and 2016, instead of receiving cash from the equity holders, we withheld shares with a value of $23.7 million and $10.1 million, respectively, for the exercise price of options.

Dividends

 

     Nine Months Ended
September 30,
 
(per share)    2017      2016  

Dividends Declared

   $ 0.09      $ 0.09  

Dividends Paid

   $ 0.09      $ 0.09  

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 this dividend program at any time without notice.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE

Market risk represents the risk of loss that may affect us due to adverse changes in financial market prices and rates. Our market risk exposure is primarily related to fluctuations in foreign exchange rates.

As of September 30, 2017, we did not have any forward contracts outstanding. See Note 4 “Derivative Instruments” of this Quarterly Report on Form 10-Q for further discussion.

Other than the item discussed above, there were no significant changes to our quantitative and qualitative disclosures about market risk during the first nine months ended September 30, 2017. See Part II, Item 7A. Quantitative and Qualitative Disclosures about Market Risk included in our Annual Report on Form 10-K for the year ended December 31, 2016 for a more complete discussion of our market risk exposure.

 

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer, or CEO, and Chief Financial Officer, or 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) as of September 30, 2017. 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, 2017.

(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 Securities Exchange Act) during the quarter ended September 30, 2017 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

We encourage you to carefully consider the risk factors identified in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2016. 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 Form 10-Q or elsewhere by management from time to time. There have been no material changes during the nine months ended September 30, 2017 to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016.

 

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 30, 2017:

 

Period

   Total Number
of Shares
Purchased
(in thousands)
     Average Price
Paid per
Share
     Total Number of
Shares Purchased as Part
of Publicly Announced

Share Repurchase
Program (1)
(in thousands)
     Approximate Dollar
Value of Shares That
May Yet Be Purchased at
Period End Under Publicly
Announced Share
Repurchased Programs (1)
(in thousands)
 

July 1, 2017 - July 31, 2017

     12      $ 58.54        —        $ 36,399  

August 1, 2017 - August 31, 2017

     55        56.16        —          36,399  

September 1, 2017 - September 30, 2017

     108        56.56        —          36,399  
  

 

 

          

Total

     175      $ 56.57        
  

 

 

          

 

1. Shares withheld to cover the option exercise price and statutory tax withholding obligations under the net settlement provisions of the company’s stock compensation awards have been included in the above table.

 

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2. Since 2004, our Board of Directors has approved stock repurchase programs that have authorized the repurchase, in the aggregate, of up to $195 million of our common stock. On May 30, 2017, we announced that our Board of Directors extended the expiration date of the current stock repurchase program to June 30, 2018 (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 Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Rule 10b-18 under the Exchange Act (the “10b5-1 Plan”). All share repurchases under the Current Program during closed trading window periods will be made pursuant to the 10b5-1 Plan.

 

ITEM 6. EXHIBITS

The following exhibits are filed or furnished, as the case may be, as part of this report.

EXHIBIT INDEX

 

Exhibit No.

  

Description

31.1    Certification pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief Executive Officer.
31.2    Certification pursuant to Exchange Act Rules 13a-14 and 15d-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.

 

++ Management contracts and compensatory plan or arrangements

 

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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.
Date:   November 8, 2017   By:   /s/ KENNETH STILLWELL
      Kenneth Stillwell
      Chief Financial Officer and Chief Administrative Officer
      (Principal Financial Officer)

 

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