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 September 30, 20192020
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,MA02142-1209
(Address of principal executive offices)(Zip Code)
One Rogers Street, Cambridge, MA 02142-1209
(617) 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 79,332,66280,697,696 shares of the Registrant’s common stock, $0.01 par value per share, outstanding on October 31, 2019. 19, 2020.



Table of Contents

PEGASYSTEMS INC.

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

Page
PART I - FINANCIAL INFORMATION
Page
PART I - FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of September 30, 20192020 and December 31, 20182019
Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 20192020 and 20182019
Unaudited Condensed Consolidated Statements of Comprehensive (Loss) for the three and nine months ended September 30, 20192020 and 20182019
Unaudited Condensed Consolidated Statements of Stockholders’ Equity for the nine months ended September 30, 20192020 and 20182019
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 20192020 and 20182019
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 5. Other Information6. Exhibits
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)

September 30, 2020December 31, 2019
Assets
Current assets:
Cash and cash equivalents$281,218 $68,363 
Marketable securities186,810 
Total cash, cash equivalents, and marketable securities468,028 68,363 
Accounts receivable137,953 199,720 
Unbilled receivables208,823 180,219 
Other current assets89,406 57,308 
Total current assets904,210 505,610 
Unbilled receivables108,456 121,736 
Goodwill78,864 79,039 
Other long-term assets395,797 278,427 
Total assets$1,487,327 $984,812 
Liabilities and stockholders�� equity
Current liabilities:
Accounts payable$20,443 $17,475 
Accrued expenses43,447 48,001 
Accrued compensation and related expenses90,836 104,126 
Deferred revenue181,680 190,080 
Other current liabilities19,916 18,273 
Total current liabilities356,322 377,955 
Convertible senior notes, net513,794 
Operating lease liabilities62,544 52,610 
Other long-term liabilities25,345 15,237 
Total liabilities958,005 445,802 
Stockholders’ equity:
Preferred stock, 1,000 shares authorized; NaN issued
Common stock, 200,000 shares authorized; 80,697 and 79,599 shares issued and outstanding at
September 30, 2020 and December 31, 2019, respectively
807 796 
Additional paid-in capital201,882 140,523 
Retained earnings338,300 410,919 
Accumulated other comprehensive (loss)(11,667)(13,228)
Total stockholders’ equity529,322 539,010 
Total liabilities and stockholders’ equity$1,487,327 $984,812 
 September 30, 2019 December 31, 2018
Assets   
Current assets:   
Cash and cash equivalents$92,104

$114,422
Marketable securities20,465

93,001
Total cash, cash equivalents, and marketable securities112,569
 207,423
Accounts receivable123,268

180,872
Unbilled receivables172,090

172,656
Other current assets58,204

49,684
Total current assets466,131
 610,635
Long-term unbilled receivables123,962

151,237
Goodwill78,862

72,858
Other long-term assets248,069

147,823
Total assets$917,024
 $982,553
Liabilities and stockholders’ equity   
Current liabilities:   
Accounts payable$15,435

$16,487
Accrued expenses41,520

45,506
Accrued compensation and related expenses88,349

84,671
Deferred revenue159,849

185,145
Other current liabilities15,742
 
Total current liabilities320,895
 331,809
Operating lease liabilities56,904
 
Other long-term liabilities10,393

29,213
Total liabilities388,192
 361,022
Stockholders’ equity:   
Preferred stock, 1,000 shares authorized; none issued
 
Common stock, 200,000 shares authorized; 79,324 and 78,526 shares issued and outstanding at
September 30, 2019 and December 31, 2018, respectively
793

785
Additional paid-in capital129,559

123,205
Retained earnings412,389

510,863
Accumulated other comprehensive (loss)(13,909) (13,322)
Total stockholders’ equity528,832
 621,531
Total liabilities and stockholders’ equity$917,024
 $982,553

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
September 30,
Nine Months Ended
September 30,
2020201920202019
Revenue
Software license$39,784 $58,005 $187,023 $165,543 
Maintenance74,670 70,371 220,587 207,406 
Pega Cloud54,776 35,153 147,080 94,610 
Consulting56,721 53,174 164,227 167,282 
Total revenue225,951 216,703 718,917 634,841 
Cost of revenue
Software license691 676 2,354 2,982 
Maintenance5,478 6,688 16,645 19,315 
Pega Cloud19,717 17,824 56,238 47,769 
Consulting51,913 55,710 158,781 162,349 
Total cost of revenue77,799 80,898 234,018 232,415 
Gross profit148,152 135,805 484,899 402,426 
Operating expenses
Selling and marketing132,053 115,237 395,684 341,064 
Research and development60,024 52,492 177,620 152,802 
General and administrative17,907 14,843 49,192 41,693 
Total operating expenses209,984 182,572 622,496 535,559 
(Loss) from operations(61,832)(46,767)(137,597)(133,133)
Foreign currency transaction gain (loss)4,236 (1,970)2,545 (3,577)
Interest income243 598 1,092 1,865 
Interest expense(5,956)(42)(13,791)(42)
Gain on capped call transactions18,989 19,816 
Other income, net323 1,374 378 
(Loss) before (benefit from) income taxes(44,320)(47,858)(126,561)(134,509)
(Benefit from) income taxes(25,053)(17,520)(61,182)(43,158)
Net (loss)$(19,267)$(30,338)$(65,379)$(91,351)
(Loss) per share
Basic$(0.24)$(0.38)$(0.82)$(1.16)
Diluted$(0.24)$(0.38)$(0.82)$(1.16)
Weighted-average number of common shares outstanding
Basic80,537 79,200 80,191 78,928 
Diluted80,537 79,200 80,191 78,928 

Three Months Ended
September 30,
 Nine Months Ended
September 30,
 2019 2018 2019 2018
Revenue       
Software license$58,005
 $52,342
 $165,543
 $184,899
Maintenance70,371
 66,017
 207,406
 196,448
Services88,327
 84,904
 261,892
 253,877
Total revenue216,703
 203,263
 634,841
 635,224
Cost of revenue       
Software license676
 1,255
 2,982
 3,772
Maintenance6,688
 6,079
 19,315
 18,035
Services73,534
 67,089
 210,118
 202,047
Total cost of revenue80,898
 74,423
 232,415
 223,854
Gross profit135,805
 128,840
 402,426
 411,370
Operating expenses       
Selling and marketing115,237
 87,490
 341,064
 269,845
Research and development52,492
 46,504
 152,802
 135,261
General and administrative14,843
 12,104
 41,693
 38,749
Total operating expenses182,572
 146,098
 535,559
 443,855
(Loss) from operations(46,767) (17,258) (133,133) (32,485)
Foreign currency transaction (loss) gain(1,970) 399
 (3,577) 558
Interest income, net556
 683
 1,823
 2,076
Other income, net323
 
 378
 363
(Loss) before (benefit from) income taxes(47,858) (16,176) (134,509) (29,488)
(Benefit from) income taxes(17,520) (8,589) (43,158) (23,692)
Net (loss)$(30,338) $(7,587) $(91,351) $(5,796)
(Loss) per share       
Basic$(0.38) $(0.10) $(1.16) $(0.07)
Diluted$(0.38) $(0.10) $(1.16) $(0.07)
Weighted-average number of common shares outstanding       
Basic79,200
 78,700
 78,928
 78,525
Diluted79,200
 78,700
 78,928
 78,525

See notes to unaudited condensed consolidated financial statements.
4


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

Three Months Ended
September 30,
Nine Months Ended
September 30,
2020201920202019
Net (loss)$(19,267)$(30,338)$(65,379)$(91,351)
Other comprehensive (loss) income, net of tax
Unrealized (loss) gain on available-for-sale securities(166)(216)(66)396 
Foreign currency translation adjustments113 (2,201)1,627 (983)
Total other comprehensive (loss) income, net of tax$(53)$(2,417)$1,561 $(587)
Comprehensive (loss)$(19,320)$(32,755)$(63,818)$(91,938)
 Three Months Ended
September 30,
 Nine Months Ended
September 30,
 2019 2018 2019 2018
Net (loss)$(30,338) $(7,587) $(91,351) $(5,796)
Other comprehensive (loss), net of tax       
Unrealized (loss) gain on available-for-sale marketable securities(216) (162) 396
 (277)
Foreign currency translation adjustments(2,201) (1,934) (983) (4,898)
Total other comprehensive (loss), net of tax(2,417) (2,096) (587) (5,175)
Comprehensive (loss)$(32,755) $(9,683) $(91,938) $(10,971)

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 
Repurchase of common stock(88)(1)(6,301)— — (6,302)
Issuance of common stock for share-based compensation plans320 (11,217)— — (11,214)
Issuance of common stock under the employee stock purchase plan16 — 1,103 — — 1,103 
Stock-based compensation— — 20,113 — — 20,113 
Cash dividends declared ($0.03 per share)— — — (2,375)— (2,375)
Other comprehensive (loss)— — — — (171)(171)
Net (loss)— — — (32,296)— (32,296)
June 30, 201979,144 $791 $122,880 $445,108 $(11,492)$557,287 
Repurchase of common stock(88)(1)(6,396)— — (6,397)
Issuance of common stock for share-based compensation plans268 (8,804)— — (8,801)
Stock-based compensation— — 21,879 — — 21,879 
Cash dividends declared ($0.03 per share)— — — (2,381)— (2,381)
Other comprehensive (loss)— — — — (2,417)(2,417)
Net (loss)— — — (30,338)— (30,338)
September 30, 201979,324 $793 $129,559 $412,389 $(13,909)$528,832 
See notes to unaudited condensed consolidated financial statements.
6


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

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

PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except per share amounts)
Common Stock 
Additional
Paid-In Capital
 Retained Earnings 
Accumulated Other Comprehensive (Loss) Income 
 
Total
Stockholders’ Equity
Common StockAdditional
Paid-In Capital
Retained Earnings
Accumulated Other Comprehensive (Loss)
Total
Stockholders’ Equity
Number
of Shares
 Amount Number
of Shares
Amount
December 31, 201778,081
 $781
 $152,097
 $509,697
 $(6,705) $655,870
December 31, 2019December 31, 201979,599 $796 $140,523 $410,919 $(13,228)$539,010 
Equity component of convertible senior notes, netEquity component of convertible senior notes, net— — 61,604 — — 61,604 
Repurchase of common stock(101) (1) (5,688) 
 
 (5,689)Repurchase of common stock(87)(1)(5,999)— — (6,000)
Issuance of common stock for share-based compensation plans566
 5
 (15,556) 
 
 (15,551)Issuance of common stock for share-based compensation plans564 (23,017)— — (23,011)
Stock-based compensation
 
 15,109
 
 
 15,109
Stock-based compensation— — 23,199 — — 23,199 
Cash dividends declared ($0.12 per share)
 
 
 (2,355) 
 (2,355)
Other comprehensive income
 
 
 
 4,262
 4,262
Net income
 
 
 12,200
 
 12,200
March 31, 201878,546
 785
 145,962
 519,542
 (2,443) 663,846
Cash dividends declared ($0.03 per share)Cash dividends declared ($0.03 per share)— — — (2,405)— (2,405)
Other comprehensive (loss)Other comprehensive (loss)— — — — (414)(414)
Net (loss)Net (loss)— — — (25,372)— (25,372)
March 31, 2020March 31, 202080,076 $801 $196,310 $383,142 $(13,642)$566,611 
Repurchase of common stock(171) (2) (10,179) 
 
 (10,181)Repurchase of common stock(23)(2,199)— — (2,199)
Issuance of common stock for share-based compensation plans358
 4
 (11,395) 
 
 (11,391)Issuance of common stock for share-based compensation plans349 (14,085)— — (14,082)
Issuance of common stock under Employee Stock Purchase Plan15
 
 849
 
 
 849
Issuance of common stock under the employee stock purchase planIssuance of common stock under the employee stock purchase plan18 — 1,403 — — 1,403 
Stock-based compensation
 
 16,163
 
 
 16,163
Stock-based compensation— — 25,674 — — 25,674 
Cash dividends declared ($0.12 per share)
 
 
 (2,364) 
 (2,364)
Other comprehensive (loss)
 
 
 
 (7,341) (7,341)
Cash dividends declared ($0.03 per share)Cash dividends declared ($0.03 per share)— — — (2,413)— (2,413)
Other comprehensive incomeOther comprehensive income— — — — 2,028 2,028 
Net (loss)
 
 
 (10,409) 
 (10,409)Net (loss)— — — (20,740)— (20,740)
June 30, 201878,748
 787
 141,400
 506,769
 (9,784) 639,172
June 30, 2020June 30, 202080,420 $804 $207,103 $359,989 $(11,614)$556,282 
Repurchase of common stock(242) (2) (14,277) 
 
 (14,279)Repurchase of common stock(94)(1)(10,628)— — (10,629)
Issuance of common stock for share-based compensation plans310
 3
 (8,399) 
 
 (8,396)Issuance of common stock for share-based compensation plans371 (22,524)— — (22,520)
Stock-based compensation
 
 16,408
 

 
 16,408
Stock-based compensation— — 27,931 — — 27,931 
Cash dividends declared ($0.12 per share)
 
 
 (2,367) 
 (2,367)
Cash dividends declared ($0.03 per share)Cash dividends declared ($0.03 per share)— — — (2,422)— (2,422)
Other comprehensive (loss)
 
 
 
 (2,096) (2,096)Other comprehensive (loss)— — — — (53)(53)
Net (loss)
 
 
 (7,587) 
 (7,587)Net (loss)— — — (19,267)— (19,267)
September 30, 201878,816
 $788
 $135,132
 $496,815
 $(11,880) $620,855
See notes to unaudited condensed consolidated financial statements.
September 30, 2020September 30, 202080,697 $807 $201,882 $338,300 $(11,667)$529,322 

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

 Common Stock 
Additional
Paid-In Capital
 Retained Earnings 
Accumulated Other Comprehensive (Loss) Income 
 
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
 5
 (14,843) 
 
 (14,838)
Stock-based compensation
 
 18,406
 
 
 18,406
Cash dividends declared ($0.12 per share)
 
 
 (2,367) 
 (2,367)
Other comprehensive income
 
 
 
 2,001
 2,001
Net (loss)
 
 
 (28,717) 
 (28,717)
March 31, 201978,896
 789
 119,182
 479,779
 (11,321) 588,429
Repurchase of common stock(88) (1) (6,301) 
 
 (6,302)
Issuance of common stock for share-based compensation plans320
 3
 (11,217) 
 
 (11,214)
Issuance of common stock under Employee Stock Purchase Plan16
 
 1,103
 
 
 1,103
Stock-based compensation
 
 20,113
 
 
 20,113
Cash dividends declared ($0.12 per share)
 
 
 (2,375) 
 (2,375)
Other comprehensive (loss)
 
 
 
 (171) (171)
Net (loss)
 
 
 (32,296) 
 (32,296)
June 30, 201979,144
 791
 122,880
 445,108
 (11,492) 557,287
Repurchase of common stock(88) (1) (6,396) 
 
 (6,397)
Issuance of common stock for share-based compensation plans268
 3
 (8,804) 
 
 (8,801)
Stock-based compensation
 
 21,879
 
 
 21,879
Cash dividends declared ($0.12 per share)
 
 
 (2,381) 
 (2,381)
Other comprehensive (loss)
 
 
 
 (2,417) (2,417)
Net (loss)
 
 
 (30,338) 
 (30,338)
September 30, 201979,324
 $793
 $129,559
 $412,389
 $(13,909) $528,832

See notes to unaudited condensed consolidated financial statements.
7


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

Nine Months Ended
September 30,
20202019
Operating activities
Net (loss)$(65,379)$(91,351)
Adjustments to reconcile net (loss) to cash (used in) operating activities
Stock-based compensation76,755 60,242 
(Gain) on capped call transactions(19,816)
Deferred income taxes(43,476)(40,531)
Amortization of deferred commissions24,922 22,372 
Lease expense11,997 10,454 
Amortization of debt discount and issuance costs10,405 
Amortization of intangible assets and depreciation15,677 16,998 
Amortization of investments252 798 
Foreign currency transaction (gain) loss(2,545)3,577 
Other non-cash(1,374)(363)
Change in operating assets and liabilities, net(33,675)4,342 
Cash (used in) operating activities(26,257)(13,462)
Investing activities
Purchases of investments(190,319)(11,182)
Proceeds from maturities and called investments13,066 
Sales of investments1,424 68,937 
Payments for acquisitions, net of cash acquired(10,934)
Investment in property and equipment(21,806)(6,439)
Cash (used in) provided by investing activities(210,701)53,448 
Financing activities
Proceeds from issuance of convertible senior notes600,000 
Purchase of capped calls related to convertible senior notes(51,900)
Payment of debt issuance costs(14,527)
Dividend payments to shareholders(7,206)(7,105)
Common stock repurchases(76,737)(54,836)
Cash provided by (used in) financing activities449,630 (61,941)
Effect of exchange rate changes on cash and cash equivalents183 (363)
Net increase (decrease) in cash and cash equivalents212,855 (22,318)
Cash and cash equivalents, beginning of period68,363 114,422 
Cash and cash equivalents, end of period$281,218 $92,104 
 Nine Months Ended
September 30,
 2019 2018
Operating activities   
Net (loss)$(91,351) $(5,796)
Adjustments to reconcile net (loss) to cash (used in) provided by operating activities   
Stock-based compensation60,242
 47,573
Amortization and depreciation50,622
 31,742
Deferred income taxes(40,531) (1,388)
Foreign currency transaction loss (gain)3,577
 (558)
Other non-cash(363) (1,377)
Change in operating assets and liabilities, net4,342
 (3,108)
Cash (used in) provided by operating activities(13,462) 67,088
Investing activities

  
Purchases of investments(11,182) (68,177)
Proceeds from maturities and called investments13,066
 26,456
Sales of investments68,937
 
Payments for acquisitions, net of cash acquired(10,934) 
Investment in property and equipment(6,439) (7,874)
Cash provided by (used in) investing activities53,448
 (49,595)
Financing activities   
Dividend payments to shareholders(7,105) (7,067)
Common stock repurchases(54,836) (64,597)
Cash (used in) financing activities(61,941) (71,664)
Effect of exchange rate changes on cash and cash equivalents(363) (1,913)
Net (decrease) in cash and cash equivalents(22,318) (56,084)
Cash and cash equivalents, beginning of period114,422
 162,279
Cash and cash equivalents, end of period$92,104
 $106,195

See notes to unaudited condensed consolidated financial statements.
8

PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


1. BASIS OF PRESENTATION
Pegasystems Inc. (together with its subsidiaries, “the Company”) has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all the information required by accounting principles generally accepted in the United States of America (“U.S.”) for complete financial statements and should be read in conjunction with the Company’s audited financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2018.2019.
In the opinion of management, the Company has prepared the accompanying unaudited condensed consolidated financial statements on the same basis as its audited financial statements, and these financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented.
All intercompany transactions and balances have been eliminated in consolidation. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year 2019.2020.
2. NEW ACCOUNTING PRONOUNCEMENTS
Leases
On January 1, 2019, the Company adopted Accounting Standards Codification 842 “Leases” (“ASC 842”) using the modified retrospective method, reflecting any cumulative effect as an adjustment to equity. Results for reporting periods beginning on or after January 1, 2019 are presented under ASC 842, while prior period amounts were not adjusted and continue to be reported in accordance with the Company’s historical accounting under ASC 840 “Leases”.
The Company elected the permitted practical expedients to not reassess the following related to leases that commenced before the effective date of ASC 842: (i) whether any expired or existing contracts contain leases; (ii) the lease classification for any expired or existing leases; and (iii) initial direct costs for any existing leases. Upon adoption, the Company recorded right of use assets of $41.8 million and lease liabilities of $54.2 million. The difference between the value of the right of use assets and lease liabilities is due to the reclassification of existing deferred rent, prepaid rent, and unamortized lease incentives as of January 1, 2019.
See Note 9. “Leases” for additional information.
Financial instrumentsConvertible debt
In June 2016,August 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2020-06, “Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity” (ASU 2020-06), which simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts in an entity’s own equity. The standard eliminates the liability and equity separation model for convertible instruments with a cash conversion feature. As a result, after adoption, entities will no longer separately present in equity an embedded conversion feature for such debt. Additionally, the embedded conversion feature will no longer be amortized into income as interest expense over the instrument’s life. Instead, entities will account for a convertible debt instrument wholly as debt unless (1) a convertible instrument contains features that require bifurcation as a derivative under ASC Topic 815, Derivatives and Hedging, or (2) a convertible debt instrument was issued at a substantial premium. Additionally, the standard requires applying the if-converted method to calculate convertible instruments’ impact on diluted earnings per share (“EPS”). The standard is effective for fiscal years beginning after December 15, 2021, with early adoption permitted for fiscal years beginning after December 15, 2020. It can be adopted on either a full retrospective or modified retrospective basis. The Company is currently evaluating the effect this ASU will have on its consolidated financial statements and related disclosures. The Company expects to early adopt the new standard on January 1, 2021.
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 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 asset’s amortized cost, of the asset, removing the concept of “other-than-temporary” impairments. The effective date for the Company will beadopted this standard effective January 1, 2020, with early adoption permitted.2020. The Company does not expect the adoption of this standard willdid not have a material effect on itsthe Company’s financial position or results of operations.
3. MARKETABLE SECURITIES
 September 30, 2019
(in thousands)Amortized Cost Unrealized Gains Unrealized Losses Fair Value
Municipal bonds$10,680
 $69
 $
 $10,749
Corporate bonds9,611
 105
 
 9,716
 $20,291
 $174
 $
 $20,465
 December 31, 2018
(in thousands)Amortized Cost Unrealized Gains Unrealized Losses Fair Value
Municipal bonds$44,802
 $13
 $(110) $44,705
Corporate bonds48,499
 23
 (226) 48,296
 $93,301
 $36
 $(336) $93,001

September 30, 2020
(in thousands)Amortized CostUnrealized GainsUnrealized LossesFair Value
Government debt$50,987 $$(11)$50,976 
Corporate debt136,045 (212)135,834 
$187,032 $$(223)$186,810 
As of September 30, 2019,2020, maturities of marketable securities ranged from MayOctober 2020 to August 2022,September 2023, with a weighted-average remaining maturity of approximately 1.51.3 years.
As of December 31, 2019, the Company did not hold any marketable securities.
9

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



4. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE
Receivables
(in thousands)September 30, 2019 December 31, 2018
Accounts receivable$123,268
 $180,872
Unbilled receivables172,090
 172,656
Long-term unbilled receivables123,962
 151,237

$419,320
 $504,765

(in thousands)September 30, 2020December 31, 2019
Accounts receivable$137,953 $199,720 
Unbilled receivables208,823 180,219 
Long-term unbilled receivables108,456 121,736 
$455,232 $501,675 
Unbilled receivables are client committed amounts for which revenue recognition precedes billing, and billing is solely subject to the passage of time.
Unbilled receivables are expected to be billed in the future as follows:
(Dollars in thousands)September 30, 2019
1 year or less$172,090
59%
1-2 years84,045
28%
2-5 years39,917
13%
 $296,052
100%

(Dollars in thousands)September 30, 2020
1 year or less$208,823 66 %
1-2 years91,325 29 %
2-5 years17,131 %
$317,279 100 %
Unbilled receivables based upon contract effective date:
(Dollars in thousands)September 30, 2020
2020$105,380 33 %
201999,875 32 %
201839,281 12 %
201737,824 12 %
2016 and prior34,919 11 %
$317,279 100 %
Major clients
Clients accounting for 10% or more of the Company’s receivables:
September 30, 2020December 31, 2019
Client A11 %*
* Client accounted for less than 10% of total receivables.
Contract assets and deferred revenue
(in thousands)September 30, 2019 December 31, 2018(in thousands)September 30, 2020December 31, 2019
Contract assets (1)
$5,046
 $3,711
Contract assets (1)
$8,104 $5,558 
Long-term contract assets (2)
2,381
 2,543
Long-term contract assets (2)
5,579 5,420 
$7,427
 $6,254
13,683 10,978 
Deferred revenueDeferred revenue181,680 190,080 
Long-term deferred revenue (3)
Long-term deferred revenue (3)
6,673 5,407 
$188,353 $195,487 
(1) Included in other current assets. (2) Included in other long-term assets.
(in thousands)September 30, 2019 December 31, 2018
Deferred revenue$159,849
 $185,145
Long-term deferred revenue (1)
4,029
 5,344
 $163,878
 $190,489
(1) (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 nine months ended September 30, 20192020 was primarily due to new billings in advance of revenue recognition, and $170.5 million of revenue recognized during the period that was included in deferred revenue at December 31, 2018, partially offset by new billings in advance of revenue recognition.2019.
5. DEFERRED CONTRACT COSTSCOMMISSIONS
The Company recognizes an asset for the incremental costs of obtaining a client contract, which relate to sales commissions. The Company expects to benefit from those costs for more than one year, as the Company generally only pays sales commissions on the initial contract and not any subsequent contract renewals. As a result, there are no commensurate commissions paid on contract renewals. Deferred costs are amortized on a straight-line basis over the benefit period, which is on average 5 years.
(in thousands)September 30, 2020December 31, 2019
Deferred commissions (1)
$87,992 $85,314 
(in thousands)September 30, 2019 December 31, 2018
Deferred contract costs (1)
$67,182
 $64,367
(1) Included in other long-term assets.
10
 Three Months Ended
September 30,
 Nine Months Ended
September 30,
(in thousands)2019 2018 2019 2018
Amortization of deferred contract costs (1)
$8,193
 $4,208
 $22,372
 $11,806
(1)Included in selling and marketing expenses.

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



6. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
The change in the carrying amount of goodwill was:
(in thousands)Nine Months Ended
September 30, 2019
Balance as of January 1,$72,858
Acquisition (1)
6,179
Currency translation adjustments(175)
Balance as of September 30,$78,862



Three Months Ended
September 30,
Nine Months Ended
September 30,
(in thousands)2020201920202019
Amortization of deferred commissions (1)
$8,861 $8,193 $24,922 $22,372 
(1) Included in selling and marketing expense.
6. DEBT
Convertible senior notes and capped calls
Convertible senior notes
In May 2019,February 2020, the Company acquired Inissued Convertible Senior Notes (the "Notes") with an aggregate principal amount of $600 million, due March 1, 2025, in a private placement. The proceeds from the Chat Communications Inc.Notes were used or are anticipated to be used for the Capped Call Transactions (described below), working capital, and other general corporate purposes. There are no required principal payments prior to the maturity of the Notes. The Notes accrue interest at an annual rate of 0.75%, payable semi-annually in arrears on March 1 and September 1, beginning on September 1, 2020.
Proceeds from the Notes and Capped Call Transactions:
(in thousands)Amount
Principal$600,000 
Less: issuance costs(14,527)
Less: Capped Call Transactions(51,900)
$533,573 
Conversion rights
The conversion rate is 7.4045 shares of common stock per $1,000 principal amount of the Notes, representing an initial conversion price of approximately $135.05 per share of common stock. The Company will settle conversions by paying or delivering, as applicable, cash, shares of its common stock, or a privately-held software provider of digital customer service software, for $10.9 million, netcombination of cash acquired.and shares of its common stock, at the Company’s election, based on the applicable conversion rate. The Company also expects to issue up to approximately 15 thousand shares in retention-based bonus payments to a key employeeconversion rate will be adjusted upon the achievementoccurrence of specified retention milestones. Thecertain events, including spin-offs, tender offers, exchange offers, and certain stockholder distributions.
Beginning on September 1, 2024, noteholders may convert their Notes at any time at their election. Before September 1, 2024, noteholders may convert their Notes in the following circumstances:
During any calendar quarter commencing after the calendar quarter ending on June 30, 2020 (and only during such calendar quarter), if the last reported sale price per share of the Company’s common stock exceeds one hundred and thirty percent (130%) of the conversion price for each of at least twenty (20) trading days (whether or not consecutive) during the thirty (30) consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter.
���During the 5 consecutive business days immediately after any 5 consecutive trading day period (the “Measurement Period”), if the trading price per $1,000 principal assetsamount of Notes for each trading day of the Measurement Period was less than 98% of the product of the last reported sale price per share of common stock on such trading day and liabilities acquired asthe 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 September 30, 2020, no Notes were eligible for conversion at the noteholders’ election.
Repurchase rights
On or after March 1, 2023 and on or before the 40th scheduled trading day immediately before the maturity date, the Company may redeem for cash all or part of the business combination were additional goodwillNotes, at a repurchase price equal to 100% of the principal amount, plus accrued and technology intangible assetsunpaid interest, if the last reported sale price of $6.2 millionthe 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 $5.1 million.including, the trading day immediately preceding the date on which the Company provides a redemption notice.
Intangibles
Intangible assets are recordedIf certain corporate events that constitute a “Fundamental Change” (as described below) occur at costany 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 amortized usingunpaid interest. A fundamental change relates to events such as mergers, changes in control of the straight-line method over their estimated useful lives as follows:
   September 30, 2019
(in thousands)Useful Lives Cost Accumulated
Amortization
 
Net Book Value (1)
Client-related4-10 years $63,089
 $(53,960) $9,129
Technology2-10 years 64,843
 (53,252) 11,591
Other1 - 5 years 5,361
 (5,361) 
   $133,293
 $(112,573) $20,720
(1) Included in other long-term assets.Company, liquidation/dissolution of the Company, or the delisting of the Company’s common stock.
11
   December 31, 2018
(in thousands)Useful Lives Cost Accumulated Amortization 
Net Book Value (1)
Client-related4-10 years $63,115
 $(51,224) $11,891
Technology2-10 years 59,742
 (50,398) 9,344
Other1 - 5 years 5,361
 (5,361) 
   $128,218
 $(106,983) $21,235
(1) Included in other long-term assets.
Amortization of intangible assets was:
(in thousands)Three Months Ended
September 30,
 Nine Months Ended
September 30,
2019 2018 2019 2018
Cost of revenue$647
 $1,232
 $2,854
 $3,695
Selling and marketing370
 1,603
 2,754
 4,813
 $1,017
 $2,835
 $5,608
 $8,508

7. ACCRUED EXPENSES
(in thousands)September 30, 2019 December 31, 2018
Outside professional services expenses$8,568
 $10,367
Income and other taxes5,418
 10,387
Marketing and sales program expenses5,969
 5,860
Dividends payable2,381
 2,363
Employee-related expenses4,785
 3,536
Cloud hosting expenses10,158
 4,604
Other4,241
 8,389
 $41,520
 $45,506


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




Impact of the Notes
8.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 a similar debt instrument’s fair value that does not have an associated conversion feature. The excess of the Notes’ principal amount over the initial carrying amount of the liability component, the debt discount, is amortized as interest expense over the Notes’ contractual term.
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 Company incurred issuance costs of $14.5 million related to the Notes, allocated between the Notes’ liability and equity components proportionate to the initial carrying amount of the liability and equity components.
Issuance costs attributable to the liability component are recorded as an offset to the Notes’ principal balance. They 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 recorded as an offset to the equity component in additional paid-in capital and are not amortized.
Net carrying amount of the liability component:
(in thousands)September 30, 2020
Principal$600,000 
Unamortized debt discount(75,061)
Unamortized issuance costs(11,145)
$513,794 
Net carrying amount of the equity component, included in additional paid-in capital:
(in thousands)September 30, 2020
Conversion options (1)
$61,604 
(1) Net of issuance costs and taxes.
Interest expense related to the Notes:
Three Months Ended
September 30,
Nine Months Ended
September 30,
(in thousands)2020201920202019
Contractual interest expense (0.75% coupon)$1,125 $$2,700 $
Amortization of debt discount (1)
3,807 9,060 
Amortization of issuance costs (1)
565 1,345 
$5,497 $$13,105 $
(1) Amortized based upon an effective interest rate of 4.31%.
Future payments of principal and contractual interest:
September 30, 2020
(in thousands)PrincipalInterestTotal
2020$$$
20214,500 4,500 
20224,500 4,500 
20234,500 4,500 
20244,500 4,500 
2025600,000 1,488 601,488 
$600,000 $19,488 $619,488 
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. They are generally expected to reduce potential dilution to the common stock upon any conversion of Notes and/or offset any potential cash payments the Company is required to make in excess of the principal amount of converted Notes, as the case may be, with such reduction and/or offset subject to a cap. The cap price of the Capped Call Transactions is $196.44, subject to adjustment upon the occurrence of specified extraordinary events affecting the Company, including merger events and tender offers.
12

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



The Capped Call Transactions are accounted for as derivative instruments. The Capped Call Transactions do not qualify for the Company’s own equity scope exception in ASC 815 since, in some cases of early settlement, the settlement value of the Capped Call Transactions, calculated in accordance with the governing documents, may not represent a fair value measurement. The Capped Call Transactions are classified as “other long term assets” and remeasured to fair value at the end of each reporting period, resulting in a non-operating gain or loss.
Change in value of Capped Call Transactions:
(in thousands)Nine Months Ended
September 30, 2020
Value at issuance$51,900 
Fair value adjustment19,816 
Balance as of September 30,$71,716 
Credit facility
In November 2019, and as amended in February 2020, July 2020, and October 2020, the Company entered into a five-year $100 million senior secured revolving credit agreement (the “Credit Facility”) with PNC Bank, National Association (“PNC”). The Company may use borrowings to finance working capital needs and for general corporate purposes. Subject to specific conditions, the Credit Facility allows the Company to increase the aggregate commitment to $200 million. The commitments expire on November 4, 2024, and any outstanding loans will be payable on such date. The Credit Facility, as amended, contains customary covenants, including, but not limited to, those relating to additional indebtedness, liens, asset divestitures, and affiliate transactions.
The Company is also required to comply with financial covenants, including:
Beginning with the fiscal quarter ended on September 30, 2020 and ending with the fiscal quarter ended December 31, 2021 at least $200 million in cash and investments held by Pegasystems Inc.
Beginning with the quarter ended on March 31, 2022 a maximum net consolidated leverage ratio of 3.5 to 1.0 (with a step-up in the event of certain acquisitions) and a minimum consolidated interest coverage ratio of 3.5 to 1.0.
As of September 30, 2020 and December 31, 2019, we 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, marketable securities,Capped Call Transactions, and venture investments in privately-held companies at fair value on a recurring basis. Fair value is an exit price, representing the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants based on assumptions that market participants would use in pricing an asset or liability.
As a basis for classifying the fair value measurements, a three-tier fair value hierarchy, which classifies the fair value measurements based on the inputs used in measuring fair value, was established as follows:
Level 1 - observable inputs such as quoted prices in active markets for identical assets or liabilities;
Level 2 - significant other inputs that are observable either directly or indirectly; and
Level 3 - significant unobservable inputs on which there is little or no market data, which require the Company to develop its own assumptions. This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value.
The Company’s cash equivalents are composed of money market funds and time deposits, which are classified within Level 1 and Level 2, respectively, in the fair value hierarchy. The Company’s marketable securities, which are classified within Level 2 of the fair value hierarchy, are valued based on a market approach using quoted prices, when available, or matrix pricing compiled by third-party pricing vendors, using observable market inputs such as interest rates, yield curves, and credit risk. The Company’s investments in privately-held companies are classified within Level 3 of the fair value hierarchy.
If applicable, the Company will recognize transfers into and out of levels within the fair value hierarchyCapped Call Transactions at the end of theeach reporting period is determined using a Black-Scholes option-pricing model. The valuation models use various market-based inputs, including stock price, remaining contractual term, expected volatility, risk-free interest rate, and expected dividend yield, as applicable. The Company applies judgment in whichits determination of expected volatility. The Company considers both historical and implied volatility levels of the actual event or change in circumstance occurs. There were no transfers between levels duringunderlying equity security and, to a lesser extent, historical peer group volatility levels. The Company’s venture investments are recorded at fair value based on valuation methods using the nine months ended September 30, 2019.observable transaction price and other unobservable inputs, including the volatility, rights, and obligations of the securities the Company holds.
The Company’s assets and liabilities measured at fair value on a recurring basis were:
basis:
 September 30, 2019
(in thousands)Level 1 Level 2 Level 3 Total
Cash equivalents$88
 $
 $
 $88
Marketable securities:       
Municipal bonds$
 $10,749
 $
 $10,749
Corporate bonds
 9,716
 
 9,716
Total marketable securities$
 $20,465
 $
 $20,465
Investments in privately-held companies (1)
$
 $
 $4,583
 $4,583
September 30, 2020December 31, 2019
(in thousands)Level 1Level 2Level 3TotalLevel 1Level 2Level 3Total
Cash equivalents (1)
$212,917 $$$212,917 $$$$
Marketable securities$$186,810 $$186,810 $$$$
Capped Call Transactions (2) (3)
$$71,716 $$71,716 $$$$
Venture investments (2) (4)
$$$7,927 $7,927 $$$4,871 $4,871 
(1) Investments in money market funds. (2) Included in other long-term assets. (3) See "6. Debt" for additional information. (4) Investments in privately-held companies.
13

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



 December 31, 2018
(in thousands)Level 1 Level 2 Level 3 Total
Cash equivalents$10,155
 $10,000
 $
 $20,155
Marketable securities:       
Municipal bonds$
 $44,705
 $
 $44,705
Corporate bonds
 48,296
 
 48,296
Total marketable securities$
 $93,001
 $
 $93,001
Investments in privately-held companies (1)
$
 $
 $3,390
 $3,390
Change in venture investments:
(in thousands)Nine Months Ended
September 30, 2020
December 31, 2019$4,871 
New investments3,006 
Sales of investments(1,424)
Fair value adjustment1,474 
September 30, 2020$7,927 
(1) Included in other long-term assets.
ForThe carrying value of certain other financial instruments, including accounts receivablereceivables and accounts payable, the carrying value approximates fair value due to the relatively short maturity of these items.
9. LEASESFair value of the Notes
The fair value of the Company’s leases are primarily for office spaceNotes was recorded at $515.9 million upon issuance, which reflected the principal amount of the Notes less the fair value of the conversion feature. The fair value of the debt component was determined based on a discounted cash flow model. The discount rate used reflected both the time value of money and credit risk inherent in the ordinary course of business.
Accounting policy
All the Company’s leases are operating leases.Notes. The Company accounts for a contract as a lease when it has the right to control the asset for a period of time while obtaining substantially allcarrying value of the asset’s economic benefits. The Company determines the initial classification and measurement of its operating right of use assets and lease liabilities at the lease commencement date and thereafter if modified. Fixed lease costs are recognized on a straight-line basisNotes will be accreted, over the remaining term to maturity, to their principal value of $600 million.
The Notes’ fair value (inclusive of the lease. Variable lease costs are recognizedconversion feature, which is embedded in the Notes) was $680 million as of September 30, 2020. The fair value was determined based on the Notes’ quoted price in an over-the-counter market on the last trading day of the reporting period in which the obligation for those payments is incurred. The Company combines lease and non-lease componentsclassified within Level 2 in the determination of lease costsfair value hierarchy. See "6. Debt" for its office space leases. The lease liability includes lease payments related to options to extend or renew the lease term if the Company isadditional information.
8. REVENUE
Geographic revenue
Three Months Ended
September 30,
Nine Months Ended
September 30,
(Dollars in thousands)2020201920202019
U.S.$120,971 53 %$123,447 57 %$436,199 61 %$347,120 55 %
Other Americas10,737 %11,748 %35,009 %49,450 %
United Kingdom (“U.K.”)25,150 11 %23,034 11 %68,246 %64,269 10 %
Europe (excluding U.K.), Middle East, and Africa39,656 18 %34,761 16 %106,472 15 %102,342 16 %
Asia-Pacific29,437 13 %23,713 11 %72,991 10 %71,660 11 %
$225,951 100 %$216,703 100 %$718,917 100 %$634,841 100 %
Revenue streams
Three Months Ended
September 30,
Nine Months Ended
September 30,
(in thousands)2020201920202019
Perpetual license$3,852 $9,016 $16,568 $43,286 
Term license35,932 48,989 170,455 122,257 
Revenue recognized at a point in time39,784 58,005 187,023 165,543 
Maintenance74,670 70,371 220,587 207,406 
Pega Cloud54,776 35,153 147,080 94,610 
Consulting56,721 53,174 164,227 167,282 
Revenue recognized over time186,167 158,698 531,894 469,298 
$225,951 $216,703 $718,917 $634,841 

14

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



reasonably certain it will exercise those options. The Company’s leases do not contain any material residual value guarantees or restrictive covenants.
Expense
(in thousands)Three Months Ended
September 30, 2019
 Nine Months Ended
September 30, 2019
Fixed lease costs$4,763
 $13,344
Variable lease costs1,470
 4,153
 $6,233
 $17,497

Right of use assets and lease liabilities
(in thousands)September 30, 2019
Right of use assets (1)
$62,296
Lease liabilities (2)
$15,742
Long-term lease liabilities$56,904
(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:
September 30, 2019
Weighted-average remaining lease term4.2 years
Weighted-average discount rate (1)
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)September 30, 2019
Remainder of 2019$3,402
202021,061
202118,800
202217,642
2023 and thereafter21,375
Total lease payments82,280
Less: imputed interest (1)
(9,634)
Total short and long-term lease liabilities$72,646
(1) Lease liabilities are measured at the present value of the remaining lease payments using a discount rate determined at lease commencement unless the discount rate is updated as a result of a lease reassessment event.
As of December 31, 2018, the Company’s future minimum rental payments required under operating leases with noncancellable terms in excess of one year as determined before the adoption of ASC 842 were:
(in thousands)
Operating Leases (1)
2019$15,993
202014,807
202113,262
202212,279
202311,084
 $67,425
(1) Operating leases include future minimum rent payments, net of estimated sublease income for facilities that the Company has vacated pursuant to its restructuring activities.
Cash flow information
(in thousands)Nine Months Ended
September 30, 2019
Cash paid for leases14,586
Right of use assets recognized for new leases and amendments (non-cash)31,126

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



10. REVENUE
Geographic revenue
 Three Months Ended
September 30,
 Nine Months Ended
September 30,
(Dollars in thousands)2019 2018 2019 2018
U.S.$123,447
57% $103,075
51% $347,120
55% $327,409
51%
Other Americas11,748
5% 10,424
5% 49,450
8% 37,766
6%
United Kingdom (“U.K.”)23,034
11% 19,277
9% 64,269
10% 68,450
11%
Europe (excluding U.K.), Middle East, and Africa34,761
16% 42,254
21% 102,342
16% 101,150
16%
Asia-Pacific23,713
11% 28,233
14% 71,660
11% 100,449
16%
 $216,703
100% $203,263
100% $634,841
100% $635,224
100%

Revenue streams
 Three Months Ended
September 30,
 Nine Months Ended
September 30,
(in thousands)2019 2018 2019 2018
Perpetual license$9,016
 $20,276
 $43,286
 $56,829
Term license48,989
 32,066
 122,257
 128,070
Revenue recognized at a point in time58,005
 52,342
 165,543
 184,899
Maintenance70,371
 66,017
 207,406
 196,448
Cloud35,153
 22,184
 94,610
 57,967
Consulting53,174
 62,720
 167,282
 195,910
Revenue recognized over time158,698
 150,921
 469,298
 450,325
 $216,703
 $203,263
 $634,841
 $635,224
(in thousands)Three Months Ended
September 30,
 Nine Months Ended
September 30,
2019 2018 2019 2018
Term license$48,989
 $32,066
 $122,257
 $128,070
Cloud35,153
 22,184
 94,610
 57,967
Maintenance70,371
 66,017
 207,406
 196,448
Subscription (1)
154,513
 120,267
 424,273
 382,485
Perpetual license9,016
 20,276
 43,286
 56,829
Consulting53,174
 62,720
 167,282
 195,910
 $216,703
 $203,263
 $634,841
 $635,224
(in thousands)Three Months Ended
September 30,
Nine Months Ended
September 30,
2020201920202019
Pega Cloud$54,776 $35,153 $147,080 $94,610 
Maintenance74,670 70,371 220,587 207,406 
Term license35,932 48,989 170,455 122,257 
Subscription (1)
165,378 154,513 538,122 424,273 
Perpetual license3,852 9,016 16,568 43,286 
Consulting56,721 53,174 164,227 167,282 
$225,951 $216,703 $718,917 $634,841 
(1) Reflects client arrangements (term license, cloud, and maintenance) that are subject to renewal.
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



renewal (Pega Cloud, maintenance, and term license).
Remaining performance obligations (“RPO”("Backlog")
Expected future revenue on existing contracts:
 September 30, 2019
(Dollars in thousands)Perpetual license Term license Maintenance Cloud Consulting Total
1 year or less$7,689
 $25,948
 $158,220
 $133,785
 $13,145
 $338,787
56%
1-2 years853
 3,798
 18,590
 105,081
 863
 129,185
21%
2-3 years1,306
 591
 8,323
 72,915
 841
 83,976
14%
Greater than 3 years
 85
 4,959
 51,591
 
 56,635
9%
 $9,848
 $30,422
 $190,092
 $363,372
 $14,849
 $608,583
100%
September 30, 2018September 30, 2020
(Dollars in thousands)Perpetual license Term License Maintenance Cloud Consulting Total(Dollars in thousands)Perpetual licenseTerm licenseMaintenancePega CloudConsultingTotal
1 year or less$25,343
 $44,283
 $140,591
 $88,529
 $14,107
 $312,853
60%1 year or less$8,708 $50,788 $170,643 $211,661 $14,977 $456,777 54 %
1-2 years6,490
 10,063
 8,877
 70,815
 1,830
 98,075
19%1-2 years1,700 5,341 40,631 157,500 2,042 207,214 25 %
2-3 years360
 1,598
 2,586
 54,646
 449
 59,639
11%2-3 years7,052 18,277 93,283 770 119,382 14 %
Greater than 3 years1,306
 218
 1,079
 49,110
 50
 51,763
10%Greater than 3 years9,597 44,363 653 54,617 %
$33,499
 $56,162
 $153,133
 $263,100
 $16,436
 $522,330
100%$10,408 $63,185 $239,148 $506,807 $18,442 $837,990 100 %

Major clients
September 30, 2019
(Dollars in thousands)Perpetual licenseTerm licenseMaintenancePega CloudConsultingTotal
1 year or less$7,689 $25,948 $158,220 $133,785 $13,145 $338,787 56 %
1-2 years853 3,798 18,590 105,081 863 129,185 21 %
2-3 years1,306 591 8,323 72,915 841 83,976 14 %
Greater than 3 years85 4,959 51,591 56,635 %
$9,848 $30,422 $190,092 $363,372 $14,849 $608,583 100 %
Clients accounting for 10% or more of the Company’s total revenue were:
 Three Months Ended
September 30,
 Nine Months Ended
September 30,
(in thousands)2019 2018 2019 2018
Total revenue$216,703
 $203,263
 $634,841
 $635,224
Client A*
 10% *
 *
*Client accounted for less than 10% of total revenue.
11.9. STOCK-BASED COMPENSATION
Expense
 Three Months Ended
September 30,
 Nine Months Ended
September 30,
(in thousands)2019 2018 2019 2018
Cost of revenues$4,787

$4,319
 $14,216

$12,277
Selling and marketing8,317

6,198
 24,055

16,895
Research and development4,858

3,917
 13,990

11,356
General and administrative3,884

1,974
 7,981

7,045
 $21,846

$16,408
 $60,242

$47,573
Income tax benefit$(4,430)
$(3,555) $(12,226)
$(10,037)

Three Months Ended
September 30,
Nine Months Ended
September 30,
(in thousands)2020201920202019
Cost of revenue$5,100 $4,787 $15,636 $14,216 
Selling and marketing12,658 8,317 33,968 24,055 
Research and development5,765 4,858 17,066 13,990 
General and administrative4,402 3,884 10,085 7,981 
$27,925 $21,846 $76,755 $60,242 
Income tax benefit$(5,604)$(4,430)$(15,293)$(12,226)
As of September 30, 2019,2020, the Company had $95.6$115.0 million of unrecognized stock-based compensation expense, net of estimated forfeitures, which is expected to be recognized over a weighted-average period of 2.2 years.
Grants
The Company granted the following stock-based compensation awards:
Nine Months Ended
September 30, 2019
Nine Months Ended
September 30, 2020
(in thousands)Shares Total Fair Value(in thousands)SharesTotal Fair Value
RSUs1,153
 $75,510
RSUs1,026 $92,456 
Non-qualified stock options2,165
 $41,260
Non-qualified stock options1,886 $44,505 
Common stock11
 $800
Common stock$701 

15

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




10. INCOME TAXES
Common stock issuedEffective income tax rate

Three Months Ended
September 30,
Nine Months Ended
September 30,
(Dollars in thousands)2020201920202019
(Benefit from) income taxes$(25,053)$(17,520)$(61,182)$(43,158)
Effective income tax rate48 %32 %
During the nine months ended September 30, 2019, the Company issued 1.1 million shares of common stock under the Company’s stock-based compensation plans.
12. INCOME TAXES
Effective income tax rate
 Nine Months Ended
September 30,
(Dollars in thousands)2019 2018
(Benefit from) income taxes$(43,158) $(23,692)
Effective income tax rate32% 80%

During the nine months ended September 30, 2019,2020, the Company’s effective income tax rate decreasedbenefit increased primarily due to the Global Intangible Low-Taxed Income (“GILTI”) provision of the Tax Reform Act. The Company’s effective income tax rate was also affected by excess tax benefits from stock-based compensation and an increase in U.S. researcha carryback claim benefit as a result of the Coronavirus Aid, Relief, and development tax credits.Economic Security Act (“CARES Act”).
13. EARNINGS11. (LOSS) PER SHARE
Basic earnings(loss) per share is computedcalculated using the weighted-average number of common shares outstanding during the applicable period. Diluted earnings(loss) per share is computedcalculated using the weighted-average number of common shares outstanding during the applicable period, plus the dilutive effect of outstanding stock options, RSUs, and RSUs, usingthe conversion spread of the Company’s convertible senior notes.
Calculation of the basic and diluted earnings per share:
Three Months Ended
September 30,
Nine Months Ended
September 30,
(in thousands, except per share amounts)2020201920202019
Net (loss)$(19,267)$(30,338)$(65,379)$(91,351)
Weighted-average common shares outstanding80,537 79,200 80,191 78,928 
(Loss) per share, basic$(0.24)$(0.38)$(0.82)$(1.16)
Net (loss)$(19,267)$(30,338)$(65,379)$(91,351)
Weighted-average common shares outstanding, assuming dilution (1) (2)
80,537 79,200 80,191 78,928 
(Loss) per share, diluted$(0.24)$(0.38)$(0.82)$(1.16)
Outstanding anti-dilutive stock options and RSUs (3)
6,622 5,953 6,166 5,923 
(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 exceeds the initial conversion price of $135.05 per share for the Notes. In connection with the Notes’ issuance, the Company entered into Capped Call Transactions, which were not included in calculating the number of diluted shares outstanding, as their effect would have been anti-dilutive.
(2) In periods of loss, all stock options and RSUsdilutive securities are excluded as their inclusion would be anti-dilutive.
The calculation of the basic and diluted earnings per share was:
 Three Months Ended
September 30,
 Nine Months Ended
September 30,
(in thousands, except per share amounts)2019 2018 2019 2018
Basic       
Net (loss)$(30,338) $(7,587) $(91,351) $(5,796)
Weighted-average common shares outstanding79,200

78,700

78,928

78,525
(Loss) per share, basic$(0.38) $(0.10) $(1.16) $(0.07)
        
Diluted       
Net (loss)$(30,338) $(7,587) $(91,351) $(5,796)
Weighted-average effect of dilutive securities:       
Stock options
 
 
 
RSUs
 
 
 
Effect of dilutive securities
 
 
 
Weighted-average common shares outstanding, assuming dilution79,200
 78,700
 78,928
 78,525
(Loss) per share, diluted$(0.38) $(0.10) $(1.16) $(0.07)

       
Outstanding anti-dilutive stock options and RSUs (1)
5,953
 6,119
 5,923
 6,380
(1)(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.

PEGASYSTEMS INC.16
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)




14. SUBSEQUENT EVENTS
On November 6, 2019, the Company entered into a five-year $100 million, senior secured revolving credit agreement (the “Credit Agreement”) 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 Agreement allows the Company to increase the aggregate commitment up to $200 million.
The Credit Agreement contains customary covenants, including, but not limited to, those relating to additional indebtedness, liens, asset divestures 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.

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 identify forward-looking statements, which are based on current expectations and assumptions.
These forward-looking statements include,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, 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 others that may cause actual results to differ materially from those expressed in such forward-looking statements are described more completelyfurther in Part I of our Annual Report on Form 10-K for the year ended December 31, 2018.
These forward-looking statements are based on current expectations, estimates, forecasts, and projections about the industry and markets in which we operate and management’s beliefs and assumptions. In addition, other written or oral statements that constitute forward-looking statements may be made by us or on our behalf. Words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “could,” “estimate,” “may,” “target,” “strategy,” “is intended to,” “project,” “guidance,” “likely,” “usually,” or variations of such words and similar expressions are intended to identify such forward-looking statements.
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, reliance on third-party relationships, reliance on key personnel, the inherent risks associated with international operations and the continued uncertainties in the global economy, our continued effort to market and sell both domestically and internationally, foreign currency exchange rates, the potential legal and financial liabilities and reputation damage due to cyber-attacks and security breaches, and management of our growth. These risks and other factors that could cause actual results to differ materially from those expressed in such forward-looking statements are described more completely in Part I of our Annual Report on Form 10-K for the year ended December 31, 20182019, and other filings we make with the U.S. Securities and Exchange Commission (“SEC”).
Investors are cautioned not to place undue reliance on such forward-looking statements, and there are no assurances that the results contained in such statements will be achieved. Although new information, future events, or risks may cause actual results to differ materially from future results expressed or implied by such forward-looking statements, exceptExcept 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 wayhow they engage with their customers and process and complete work across their enterprise. We also license our no-codelow-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 no-codelow-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.
Cloud Transition
We are in the process of transitioning our business to primarily sell software through subscription arrangements, particularly Pega Cloud (“Cloud Transition”). Until we substantially complete our Cloud Transition, which we expect to occur in early 2023, we expect to continue to experience lower revenue growth and lower operating cash flow growth or negative cash flow. The actual mix of perpetual license, term license, and Pega Cloud in a given period can fluctuate based on client preferences.
Additional information on the transition’s impact can be found below and in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2019.
COVID-19
As of September 30, 2020, COVID-19 has not had a material impact on our results of operations or financial condition.
The ultimate 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, vendors, or employees, all of which are uncertain and unpredictable. 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 or delay the impact of COVID-19 on our business. However, it is not possible to estimate the ultimate impact that COVID-19 will have on our business. See “Coronavirus (“COVID-19”)” under Item 1A. Risk Factors for additional information.
17


Performance metrics
We utilize several performance metrics in analyzingto analyze and assessingassess our overall performance, makingmake operating decisions, and forecastingforecast and planningplan for future periods.
periods, including:
(Dollars in thousands,
except per share amounts)
Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
2019 2018  2019 2018 
Total revenue$216,703
 $203,263
 $13,440
7 % $634,841
 $635,224
 $(383) %
Subscription revenue (1)
$154,513
 $120,267
 $34,246
28 % $424,273
 $382,485
 $41,788
11 %
Net (loss)$(30,338) $(7,587) $(22,751)(300)% $(91,351) $(5,796) $(85,555)(1,476)%
(Loss) per share, diluted$(0.38) $(0.10) $(0.28)(280)% $(1.16) $(0.07) $(1.09)(1,557)%
(1)Reflects client arrangements (term license, cloud, and maintenance) that are subject to renewal.


Annual contract value (“ACV”) (1) (2)| Increased 21% since September 30, 2019
The change in ACV measuresrepresents the growth and predictabilityannualized value of future cash flows from Pega Cloud and Client Cloud committed arrangementsour active contracts as of the endmeasurement date. The contract's total value is divided by its duration in years to calculate ACV for term license and Pega Cloud contracts. Maintenance revenue for the quarter then ended is multiplied by four to calculate ACV for maintenance. Client Cloud ACV is composed of the particular reporting period.
acvslideq3timesfor10qa02.jpg
 September 30, Change Constant Currency
Change
(Dollars in thousands)2019 2018  
Maintenance$281,484
 $264,068
 $17,416
7% 9%
Term207,317
 174,320
 $32,997
19% 20%
Client Cloud488,801
 438,388
 $50,413
11% 13%
Pega Cloud145,549
 98,373
 47,176
48% 51%
Total ACV$634,350
 $536,761
 $97,589
18% 20%
(1)Totalmaintenance ACV as of a given date, is the sum of the following two components:
Client Cloud: the sum of (1) the annual value of each term license contract in effect on such date, which is equal to its total license value divided by the total number of years and (2) maintenance revenue reported for the quarter ended on such date, multiplied by four.and ACV from term license contracts. We do not provide hosting services for Client Cloud arrangements.
Pega Cloud: the sum of the annual value of each cloud contract in effect on such date, which is equal to its total value divided by the total number of years.
(2)As foreign currency exchange rates are an important factor in understanding period to period comparisons, we believe the presentation of ACV growth rates on a constant currency basis enhances the understanding of our results, and evaluationas it provides visibility into the impact of changes in foreign currency exchange rates, which are outside of our performance in comparison to prior periods.control. All periods shown reflect foreign currency exchange rates as of September 30, 2020.
Remaining performance obligations (“RPO”Backlog”) | Increased 38% since September 30, 2019
ExpectedBacklog represents contracted revenue that has not yet been recognized and includes deferred revenue and non-cancellable amounts expected to be invoiced and recognized as revenue in future periods.
Year to date Pega Cloud revenue on existing contracts:
 September 30, 2019
(Dollars in thousands)Perpetual license Term license Maintenance Cloud Consulting Total
1 year or less$7,689
 $25,948
 $158,220
 $133,785
 $13,145
 $338,787
56%
1-2 years853
 3,798
 18,590
 105,081
 863
 129,185
21%
2-3 years1,306
 591
 8,323
 72,915
 841
 83,976
14%
Greater than 3 years
 85
 4,959
 51,591
 
 56,635
9%
 $9,848
 $30,422
 $190,092
 $363,372
 $14,849
 $608,583
100%
Change in RPO Since September 30, 2018           

$(23,651) $(25,740) $36,959
 $100,272
 $(1,587) $86,253
 

(71)% (46)% 24% 38% (10)% 17% 
| Increased 55% since September 30, 2019
 September 30, 2018
(Dollars in thousands)Perpetual license Term license Maintenance Cloud Consulting Total
1 year or less$25,343
 $44,283
 $140,591
 $88,529
 $14,107
 $312,853
60%
1-2 years6,490
 10,063
 8,877
 70,815
 1,830
 98,075
19%
2-3 years360
 1,598
 2,586
 54,646
 449
 59,639
11%
Greater than 3 years1,306
 218
 1,079
 49,110
 50
 51,763
10%
 $33,499
 $56,162
 $153,133
 $263,100
 $16,436
 $522,330
100%
Pega Cloud revenue is revenue as reported under U.S. GAAP for cloud contracts.
pega-20200930_g1.jpg
18



pega-20200930_g2.jpgpega-20200930_g3.jpg
CRITICAL ACCOUNTING POLICIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“U.S.”) and the rules and regulations of the SEC for interim financial reporting. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and the related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, knowledge of current conditions, and expectations of what could occur in the future given the available information.
For more information regarding our critical accounting policies, we encourage you to read the discussion contained in the following locations in our Annual Report on Form 10-K for the year ended December 31, 2018:2019:
“Critical Accounting Estimates and Significant Judgments” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations”; and
Note 2. “Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary Data”.Data.”
There have been no significant changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018.2019 other than those listed below.
Capped Call Transactions
In February 2020, we entered into privately negotiated capped call transactions (“Capped Call Transactions”) with certain financial institutions. The Capped Call Transactions cover approximately 4.4 million shares (representing the number of shares for which the Notes are initially convertible) of our common stock and are generally expected to reduce potential dilution of our common stock upon any conversion of the Notes. The fair value of the Capped Call Transactions at the end of each reporting period is determined using a Black-Scholes option-pricing model. The valuation models use various market-based inputs, including stock price, remaining contractual term, expected volatility, risk-free interest rate, and expected dividend yield, as applicable. Management applies judgment in its determination of expected volatility. We consider both historical and implied volatility levels of the underlying equity security and, to a lesser extent, historical peer group volatility levels.
The Capped Call Transactions are classified as “other long-term assets” and remeasured to fair value at the end of each reporting period, resulting in a non-operating gain or loss.
See "6. Debt" and “7. Fair Value Measurements” in Item 1 of this Quarterly Report for additional information.
19


RESULTS OF OPERATIONS
Revenue
(Dollars in thousands)Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
2019 2018  2019 2018 
Cloud$35,153
16% $22,184
11% $12,969
58 % $94,610
15% $57,967
9% $36,643
63 %
Term license48,989
23% 32,066
16% 16,923
53 % 122,257
19% 128,070
20% (5,813)(5)%
Maintenance70,371
32% 66,017
32% 4,354
7 % 207,406
33% 196,448
31% 10,958
6 %
Subscription (1)
154,513
71% 120,267
59% 34,246
28 % 424,273
67% 382,485
60% 41,788
11 %
Perpetual license9,016
4% 20,276
10% (11,260)(56)% 43,286
7% 56,829
9% (13,543)(24)%
Consulting53,174
25% 62,720
31% (9,546)(15)% 167,282
26% 195,910
31% (28,628)(15)%
 $216,703
100% $203,263
100% $13,440
7 % $634,841
100% $635,224
100% $(383) %
(1)Reflects client arrangements (term license, cloud,Our Pega Cloud revenue is derived from our hosted Pega Platform and maintenance) that are subject to renewal.
software applications. Our license revenue is derived from sales of our applications and the Pega Platform. Our cloud revenue is derived from our hosted Pega Platform and software applications.
Cloud Transition
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 growthare in the near term. Revenueprocess of transitioning our business to primarily sell software through subscription arrangements, particularly Pega Cloud. As revenue from cloudPega Cloud arrangements is generally recognized over the service period,contract term while revenue from perpetual and term and perpetual license arrangementslicenses is generally recognized upfront when the license rights become effective.effective, the shift has and is expected to continue to result in slower revenue growth during the transition.
Subscription revenue
(Dollars in thousands)Three Months Ended
September 30,
ChangeNine Months Ended
September 30,
Change
2020201920202019
Pega Cloud$54,776 24 %$35,153 16 %$19,623 56 %$147,080 20 %$94,610 15 %$52,470 55 %
Maintenance74,670 33 %70,371 32 %4,299 %220,587 31 %207,406 33 %13,181 %
Term license35,932 16 %48,989 23 %(13,057)(27)%170,455 24 %122,257 19 %48,198 39 %
Subscription (1)
$165,378 73 %$154,513 71 %10,865 %$538,122 75 %$424,273 67 %113,849 27 %
Perpetual license3,852 %9,016 %(5,164)(57)%16,568 %43,286 %(26,718)(62)%
Consulting56,721 25 %53,174 25 %3,547 %164,227 23 %167,282 26 %(3,055)(2)%
$225,951 100 %$216,703 100 %$9,248 %$718,917 100 %$634,841 100 %$84,076 13 %
(1) Reflects client arrangements subject to renewal (Pega Cloud, maintenance, and term license).
The increaseschanges in cloudtotal revenue in the three and nine months ended September 30, 2020 generally reflect our Cloud Transition. Other factors impacting our revenue included:
Term license revenue was higher in the three months ended September 30, 2019 reflectprimarily due to a greater number of large deals than in the shiftthree months ended September 30, 2020.
An increasing portion of our term license contracts include multi-year committed maintenance periods instead of annually renewable maintenance. Under such arrangements, a greater portion of the total contract value is recorded as maintenance revenue, which is recognized over the contract term, rather than as term revenue, as the license rights become effective which is usually shortly after contract execution. In the three and nine months ended September 30, 2020 multi-year committed maintenance contributed $2.9 million and $7.7 million to maintenance revenue growth. In the nine months ended September 30, 2020 multi-year committed maintenance reduced term revenue growth by $10.2 million.
Maintenance renewal rates remained over 90% in client preferencesthe nine months ended September 30, 2020.
The decrease in consulting revenue in the nine months ended September 30, 2020 was primarily due to cloud arrangements from other typeslower billable travel expenses as a result of arrangements.COVID-19. The increase in term licenseconsulting revenue in the three months ended September 30, 20192020 was primarily due to revenue recognized from several large, multi-year term license contractsincreased billable hours which more than offset the impact of reduced billable travel expenses due to COVID-19.
Gross profit
Three Months Ended
September 30,
ChangeNine Months Ended
September 30,
Change
(Dollars in thousands)2020201920202019
Software license$39,093 98 %$57,329 99 %$(18,236)(32)%$184,669 99 %$162,561 98 %$22,108 14 %
Maintenance69,192 93 %63,683 90 %5,509 %203,942 92 %188,091 91 %15,851 %
Pega Cloud35,059 64 %17,329 49 %17,730 102 %90,842 62 %46,841 50 %44,001 94 %
Consulting4,808 %(2,536)(5)%7,344 *5,446 %4,933 %513 10 %
$148,152 66 %$135,805 63 %$12,347 %$484,899 67 %$402,426 63 %$82,473 20 %
* not meaningful
The changes in the three months ended September 30, 2019. The decrease in term license revenue in the nine months ended September 30, 2019 was attributable to revenue recognized from term license contracts in the nine months ended September 30, 2019 with multi-year committed maintenance periods, which resulted in a greater portion of the contract value being allocated to maintenance. The increases in maintenance revenuegross profit in the three and nine months ended September 30, 20192020 were primarily due to the continuedour Cloud Transition, revenue growth, and cost efficiency gains as Pega Cloud grows and scales.
The increase in consulting gross profit in the aggregate valuethree months ended September 30, 2020 was primarily due to an increase in consultant utilization. Consultant utilization is impacted by several factors, including the scope and timing of new implementation projects and our level of involvement in implementation projects compared to our consulting partners and enabled clients. To support our long-term strategy, we intend to grow and increasingly leverage our partners and enabled clients for future implementation projects, which may reduce the installed base of our softwarefuture growth rate.
20


Operating expenses
(Dollars in thousands)Three Months Ended
September 30,
ChangeNine Months Ended
September 30,
Change
2020201920202019
% of Revenue% of Revenue% of Revenue% of Revenue
Selling and marketing$132,053 58 %$115,237 53 %$16,816 15 %$395,684 55 %$341,064 54 %$54,620 16 %
Research and development$60,024 27 %$52,492 24 %$7,532 14 %$177,620 25 %$152,802 24 %$24,818 16 %
General and administrative$17,907 %$14,843 %$3,064 21 %$49,192 %$41,693 %$7,499 18 %
The increases in selling and strong renewal rates in excess of 90%.
Perpetual license
The decreases in perpetual license revenuemarketing in the three and nine months ended September 30, 2019 reflects the shift in client preferences in favor of our cloud offerings instead of our perpetual license arrangements.
Consulting
Our consulting revenue fluctuates depending upon the mix of new implementation projects we perform as compared to those performed by our enabled clients or led by our partners. The decreases in consulting revenue in the three and nine months ended September 30, 20192020 were primarily due to decreases in billable hours.

Gross profit
 Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
(Dollars in thousands)2019 2018  2019
2018 
Software license$57,329
99 % $51,087
98% $6,242
12% $162,561
98% $181,127
98% $(18,566)(10)%
Maintenance63,683
90 % 59,938
91% 3,745
6% 188,091
91% 178,413
91% 9,678
5 %
Cloud17,329
49 % 12,569
57% 4,760
38% 46,841
50% 31,853
55% 14,988
47 %
Consulting(2,536)(5)% 5,246
8% (7,782)*
 4,933
3% 19,977
10% (15,044)(75)%
 $135,805
63 % $128,840
63% $6,965
5% $402,426
63% $411,370
65% $(8,944)(2)%
* 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 total gross profit in the three months ended September 30, 2019 was primarily due to an increase in term revenue recognized from several large, multi-year term license contracts in the three months ended September 30, 2019. It was also due to an increase in cloud revenue reflecting the shift in client preferences to cloud arrangements from other types of arrangements, an increase in maintenance revenue due to the continued growth in the aggregate value of the installed base of our software and strong renewal rates in excess of 90%.
The decrease in total gross profit in the nine months ended September 30, 2019 was primarily due to a decrease in term and perpetual license revenue and a decrease in consulting revenue due to a decrease in billable hours.
The decrease in total gross profit percent in the nine months ended September 30, 2019 was driven by the shift in client preferences in favor of cloud arrangements, which are lower margin than our term and perpetual license revenue streams and decreases in cloud and consulting gross profit percent.
The decreases in cloud gross profit percent in the three and nine months ended September 30, 2019 were driven by an increase in costs as we accelerated our investments in cloud infrastructure and service delivery to support future growth. The decreases in consulting gross profit percent in the three and nine months ended September 30, 2019 were driven by a decrease in billable hours as consulting resources were transitioning to new projects after completing a large project and an increase in consulting resource availability as we continue growing and leveraging our partner network.
Operating expenses
Selling and marketing
 Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
(Dollars in thousands)2019 2018  2019 2018 
Selling and marketing (1)
$115,237
 $87,490
 $27,747
32% $341,064
 $269,845
 $71,219
26%
As a percent of total revenue53% 43%    54% 42%   
Selling and marketing headcount,
end of period
       1,532
 1,194
 338
28%
(1) Includes compensation, benefits, and other headcount-related expenses associated with selling and marketing activities, as well as advertising, promotions, trade shows, seminars, and the amortization of client-related intangibles.
The increases in the three and nine months ended September 30, 2019 were primarily due to compensation and benefits of $22.6$24.4 million and $58.1$76.0 million, attributable to increased headcount, equity compensation, and increases of $4.0 million and $10.6 million in deferred contract cost amortization. Also, contributing to the increases were travel and entertainment of $2.6 million and $4.5 million. The increase in headcount reflectsand equity compensation. The increases in headcount reflect our efforts to increase our sales capacity to deepen relationships with existing clients and target new accounts.accounts. These increases were partially offset by decreases in travel and entertainment of $8.5 million and $17.4 million as a result of COVID-19.
ResearchThe increases in research and development
 Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
(Dollars in thousands)2019 2018  2019 2018 
Research and development (1)
$52,492
 $46,504
 $5,988
13% $152,802
 $135,261
 $17,541
13%
As a percent of total revenue24% 23%    24% 21%   
Research and development headcount,
end of period
       1,631
 1,595
 36
2%
(1) Includes compensation, benefits, contracted services, and other headcount-related expenses associated with the development of our products, as well as enhancements and design changes to existing products and the integration of acquired technologies.

The increases in the three and nine months ended September 30, 20192020 were primarily due to increases in compensation and benefits of $3.8$7.8 million and $10.5$23.6 million, attributable to an increaseincreases in headcount and equity compensation, and $1.2 million and $4.5 million in cloud hosting expenses as we expand our cloud-focused research and development activities.
General and administrative
 Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
(Dollars in thousands)2019 2018  2019 2018 
General and administrative (1)
$14,843
 $12,104
 $2,739
23% $41,693
 $38,749
 $2,944
8%
As a percent of total revenue7% 6%    7% 6%   
General and administrative headcount,
end of period (2)
       420
 326
 94
29%
compensation.
(1) Includes compensation, benefits, and other headcount-related expenses associated with finance, legal, corporate governance, and other administrative headcount. It also includes accounting, legal, and other professional consultingThe increases in general and administrative fees. (2) The headcount includes employees in corporate services departments, whose costs are partially allocated to other operating expense areas.
The increases in the three and nine months ended September 30, 20192020 were primarily due to increases in compensation and benefits of $3.2$0.8 million and $3.7$3.0 million, dueattributed to increased headcount.increases in headcount and equity compensation, and increases in professional services fees of $1.5 million and $4.2 million.
Other income (expense), net
(Dollars in thousands)Three Months Ended
September 30,
ChangeNine Months Ended
September 30,
Change
2020201920202019
Foreign currency transaction gain (loss)$4,236 $(1,970)$6,206 *$2,545 $(3,577)$6,122 *
Interest income243 598 (355)(59)%1,092 1,865 (773)(41)%
Interest expense(5,956)(42)(5,914)(14,081)%(13,791)(42)(13,749)(32,736)%
Gain on capped call transactions18,989 — 18,989 *19,816 — 19,816 *
Other income, net— 323 (323)(100)%1,374 378 996 263 %

$17,512 $(1,091)$18,603 *$11,036 $(1,376)$12,412 *
* not meaningful
Stock-based compensation
 Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
(Dollars in thousands)2019 2018  2019 2018 
Cost of revenues$4,787
 $4,319
 $468
11% $14,216
 $12,277
 $1,939
16%
Selling and marketing8,317
 6,198
 2,119
34% 24,055
 16,895
 7,160
42%
Research and development4,858
 3,917
 941
24% 13,990
 11,356
 2,634
23%
General and administrative3,884
 1,974
 1,910
97% 7,981
 7,045
 936
13%
 $21,846
 $16,408
 $5,438
33% $60,242
 $47,573
 $12,669
27%
The increaseschanges in foreign currency transaction gain (loss) in the three and nine months ended September 30, 2019 were primarily due to the increased value of our annual periodic equity awards granted in March 2019 and 2018 and increased headcount. These awards generally have a five-year vesting schedule.
Other income (expense), net
 Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
(Dollars in thousands)2019 2018  2019 2018 
Foreign currency transaction (loss) gain$(1,970) $399
 $(2,369)*
 $(3,577) $558
 $(4,135)*
Interest income, net556
 683
 (127)(19)% 1,823
 2,076
 (253)(12)%
Other income, net323
 
 323
*
 378
 363
 15
4 %

$(1,091) $1,082
 $(2,173)*
 $(1,376) $2,997
 $(4,373)*
* not meaningful
The changes in foreign currency transaction (loss) gain2020 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 decreases in interest income in the three and nine months ended September 30, 2020 were due to the decreases in market interest rates.
The increases in interest expense in the three and nine months ended September 30, 2020 were due to our issuance of $600 million in aggregate principal amount of the Notes on February 24, 2020. See "6. Debt" in Item 1 of this Quarterly Report for additional information.
Interest expense related to the Notes:
Three Months Ended
September 30,
ChangeNine Months Ended
September 30,
Change
(in thousands)2020201920202019
Contractual interest expense (0.75% coupon)$1,125 $— $1,125 $2,700 $— $2,700 
Amortization of debt discount3,807 — 3,807 9,060 — 9,060 
Amortization of issuance costs565 — 565 1,345 — 1,345 
$5,497 $— $5,497 $13,105 $— $13,105 
The increases in the gain on capped call transactions in the three and nine months ended September 30, 2020 were due to fair value adjustments 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 increase in other income, net in the nine months ended September 30, 2020 was due to a gain from our venture investments portfolio.
21


(Benefit from) income taxes
Three Months Ended
September 30,
 Nine Months Ended
September 30,
Three Months Ended
September 30,
Nine Months Ended
September 30,
(Dollars in thousands)2019 2018 2019 2018(Dollars in thousands)2020201920202019
(Benefit from) income taxes$(17,520) $(8,589) $(43,158) $(23,692)(Benefit from) income taxes$(25,053)$(17,520)$(61,182)$(43,158)
Effective income tax rate    32% 80%Effective income tax rate48 %32 %
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 vestings,awards, the exercise behavior of our stock option holders, and the total value of future grants of stock-based compensation awards.
During the nine months ended September 30, 2019, the Company’s2020, our effective income tax rate changedbenefit increased primarily due to the Global Intangible Low-Taxed Income (“GILTI”) provision of the Tax Reform Act. The Company’s effective income tax rate was also affected by excess tax benefits from stock-based compensation and an increase in U.S. researcha carryback claim benefit as a result of the Coronavirus Aid, Relief, and development tax credits.Economic Security Act (“CARES Act”).

LIQUIDITY AND CAPITAL RESOURCES
 Nine Months Ended
September 30,
 (in thousands)2019 2018
Cash provided by (used in):   
Operating activities$(13,462) $67,088
Investing activities53,448
 (49,595)
Financing activities(61,941) (71,664)
Effect of exchange rates on cash and cash equivalents(363) (1,913)
Net (decrease) in cash and cash equivalents$(22,318) $(56,084)
(in thousands)September 30, 2019 December 31, 2018
Held by U.S. entities$41,484
 $143,533
Held by foreign entities71,085
 63,890
Total cash, cash equivalents, and marketable securities$112,569
 $207,423
Nine Months Ended
September 30,
 (in thousands)20202019
Cash provided by (used in):
Operating activities$(26,257)$(13,462)
Investing activities(210,701)53,448 
Financing activities449,630 (61,941)
Effect of exchange rates on cash and cash equivalents183 (363)
Net increase (decrease) in cash and cash equivalents$212,855 $(22,318)
On November 6, 2019, we entered into a five-year $100 million senior secured revolving credit agreement (the “Credit Agreement”) with PNC Bank, National Association (“PNC”). We may use borrowings to finance working capital needs and for general corporate purposes. Subject to specific circumstances, the Credit Agreement allows us to increase the aggregate commitment up to $200 million. See Item 5. “Other Information” for additional information.
(in thousands)September 30, 2020December 31, 2019
Held by U.S. entities$415,358 $23,437 
Held by foreign entities52,670 44,926 
Total cash, cash equivalents, and marketable securities$468,028 $68,363 
We believe that our current cash, cash equivalents, marketable securities, cash flow from operations, and borrowing capacity will be sufficient to fund our operations and quarterly cash dividends and stock repurchases for at least the next 12 months. Whether these resources are adequate to meet our liquidity needs beyond that period will depend on our growth, operating results, and the investments required to meetrespond to the possible increased demand for our services. If we require additional capital resources to grow our business, we may seek to finance our operations from available funds or additional external financing.
If it became necessary to repatriate foreign funds, we may be required to pay U.S. state and local taxes, as well as foreign taxes upon repatriation. Due to the complexity of income tax laws and regulations, and the effects of the Tax Reform Act,Act’s effects, it is impracticable to estimate the amount of taxes we would have to pay.
Cash (used in) provided by operating activities
We are in the process of transitioning our business to primarily sell software through subscription arrangements, particularly Pega Cloud. As cash from Pega Cloud and term arrangements is generally collected over the contract term while cash from perpetual licenses is generally collected when the license rights become effective, the shift has and is expected to continue to impact our cash collections. As client preferences continue to shift in favor of cloudPega Cloud arrangements, we could continue to experience slower operating cash flow growth, or negative cash flow, in the near term. Cash
In the nine months ended September 30, 2020, COVID-19 did not have a material impact on our cash flows from cloud 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.operations. See “Coronavirus (“COVID-19”)” under Item 1A. Risk Factors for additional information.
The primary driver of the decreasechange in cash (used in) operating activities in the nine months ended September 30, 20192020 was the recent shift inprimarily due to our revenue mix toward cloud arrangements, which are generally collected over an average service period of three years,Cloud Transition and increased costs as the Companywe accelerated investments in its cloud offeringsour Pega Cloud offering and selling and marketing activities to support future growth.

22


Cash (used in) provided by investing activities
The change in cash (used in) provided by investing activities in the nine months ended September 30, 2020 was primarily driven by purchases of financial instruments and investments in property and equipment at several of our office locations.
Cash provided by (used in) investing activities
The change in cash provided by (used in) investing activities was primarily driven by the payment of consideration for the acquisition of In the Chat Communications Inc. in May 2019.
Cash (used in) financing activities
We primarily used cashConvertible senior notes
In February 2020, we issued $600 million in financing activities for repurchasesaggregate principal amount of our common stockconvertible senior notes (“Notes”) due March 1, 2025, which provided proceeds as follows:
(in thousands)Amount
Principal$600,000 
Less: issuance costs(14,527)
Less: Capped Call Transactions(51,900)
$533,573 
A portion of the proceeds of the Notes was used to fund the Capped Call Transactions with the remainder to be used for working capital and other general corporate purposes. See "6. Debt" in Item 1 of this Quarterly Report for additional information.
Credit facility
In November 2019, and as amended in February 2020, July 2020, and October 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 September 30, 2020, we had no outstanding borrowings under our publicly announced stock repurchase programs, stock repurchasesthe Credit Facility. See "6. Debt" in Item 1 of this Quarterly Report for tax withholdings for the net settlement of our equity awards, and the payment of our quarterly dividend.additional information.
Stock repurchase program (1)
The changesChanges in the remaining stock repurchase authority were:
authority:
 Nine Months Ended
September 30,
(in thousands)2019
January 1,$6,620
Authorizations (2)
60,000
Repurchases(20,286)
September 30,$46,334
(in thousands)Nine Months Ended
September 30, 2020
December 31, 2019$45,484 
Authorizations (2)
20,516 
Repurchases(18,828)
September 30, 2020$47,172 
(1) Purchases under these programsthis program have been made on the open market. (2) On MarchJune 15, 2019,2020, we announced that our Board of Directors extended the expiration date of the current stock repurchase programprogram’s expiration date to June 30, 20202021 and increased the amount of commonremaining stock we are authorizedrepurchase authority to repurchase by $60 million .million.

Common stock repurchases
 Nine Months Ended
September 30,
 2019 2018
(in thousands)Shares Amount Shares Amount
Tax withholdings for net settlement of equity awards514
 $34,871
 591
 $35,530
Stock repurchase program (1)
       
Repurchases paid318
 20,086
 512
 29,949
Repurchases unsettled at period end3
 200
 3
 200
Activity in period (2)
835
 $55,157
 1,106
 $65,679
Nine Months Ended
September 30,
20202019
(in thousands)SharesAmountSharesAmount
Tax withholdings for net settlement of equity awards599 $59,613 514 $34,871 
Stock repurchase program204 18,828 321 20,286 
803 $78,441 835 $55,157 
(1)
Represents activity under our publicly announced stock repurchase programs. (2)
During the nine months ended September 30, 20192020 and 2018,2019, instead of receiving cash from the equity holders, we withheld shares with a value of $31.6$49.5 million and $28.2$31.6 million, respectively, for the exercise price of options. These amounts have been excluded from the table above.
Dividends
 Nine Months Ended
September 30,
(in thousands)2019 2018
Dividend payments to shareholders$7,105
 $7,067
Dividends
It is our current intention
Nine Months Ended
September 30,
(in thousands)20202019
Dividend payments to shareholders$7,206 $7,105 
We currently intend to pay a quarterly cash dividend of $0.03 per share, however,share. However, the Board of Directors may terminate or modify the dividend program at any time without prior notice.
23


Contractual obligations
As of September 30, 2020, our contractual obligations were:
Payments due by period
(in thousands)202020212022-20232024-20252026 and thereafterOtherTotal
Purchase obligations (1)
$21,627 $56,689 $61,117 $173 $— $— $139,606 
Investment commitments (2)
300 500 — — — — 800 
Liability for uncertain tax positions (3)
— — — — — 5,441 5,441 
Operating lease obligations5,490 22,887 43,888 13,187 9,959 — 95,411 
$27,417 $80,076 $105,005 $13,360 $9,959 $5,441 $241,258 
(1) Represents the fixed or minimum amounts due under purchase obligations for hosting services and sales and marketing programs.
(2) Represents the maximum funding that would be expected under existing venture investment agreements. Our investment agreements generally allow us to withhold unpaid committed funds at our discretion.
(3) We are unable to reasonably estimate the timing of the cash outflow due to uncertainties in the timing of the effective settlement of tax positions.
ITEM 3.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no materialMarket risk represents the risk of loss that may affect us due to adverse changes duringin financial market prices and rates.
Foreign currency exposure
Translation risk
Our foreign operations’ operating expenses are primarily denominated in foreign currencies. However, our international sales are also primarily denominated in foreign currencies, which partially offsets our foreign currency exposure.
A hypothetical 10% strengthening in the nine months ended September 30, 2019U.S. dollar against other currencies would result in the following impact:
Nine Months Ended
September 30,
20202019
(Decrease) increase in revenue(4)%(4)%
(Decrease) increase in net (loss)(13)%(6)%
Remeasurement risk
We experience fluctuations in transaction gains or losses from remeasurement of monetary assets and liabilities denominated in currencies other than the functional currency of the entities in which they are recorded.
We are primarily exposed to changes in foreign currency exchange rates associated with the Australian dollar, Euro, and U.S. dollar-denominated cash and cash equivalents, accounts receivable, unbilled receivables, and intercompany receivables and payables held by our U.K. subsidiary, a British pound functional entity.
A hypothetical 10% strengthening in the British pound exchange rate in comparison to the market risk exposure disclosedAustralian dollar, Euro, and U.S. dollar would result in our Annual Report on Form 10-K for the year ended December 31, 2018.following impact:
Nine Months Ended
September 30,
(in thousands)20202019
Foreign currency gain (loss)$(6,326)$1,099 

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 September 30, 2019.2020. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of September 30, 20192020.
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.
(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 September 30, 20192020 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, 2018.2019, filed with the Securities and Exchange Commission on February 12, 2020. These risk factors could materially affect our business, financial condition, and future results, and they could cause our actual business and financial results to differ materially from those contained in forward-looking statements made in this Quarterly Report on Form 10-Q or elsewhere by managementmanagement.
Coronavirus (“COVID-19”)
Epidemic diseases, such as the recent global COVID-19 outbreak, could harm our business and results of operations.
The recent outbreak of a novel coronavirus disease (“COVID-19”), which has been declared by the World Health Organization to be a pandemic, has spread across the globe and is impacting worldwide economic activity. A pandemic, including COVID-19, or other public health epidemics pose the risk that our employees, partners, and clients may be prevented from conducting business activities at full capacity for an indefinite period, including due to the spread of the disease within these groups or due to the 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 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 adjust our policies as more information and public health guidance become available. Precautionary measures that have been adopted, or may be adopted in the future, could negatively affect our client success efforts, sales, and marketing efforts, delay and lengthen our sales cycles, or create operational or other challenges, any of which could harm our business and results of operations. In addition, COVID-19 may disrupt our clients’, vendors’, and partners’ operations for an indefinite period, including as a result of travel restrictions and/or business shutdowns, all of which could negatively impact our business and results of operations, including cash flows.
At this time, it is not possible to time.estimate the ultimate impact that COVID-19 could have on our business, as the impact will depend on future developments, which are highly uncertain and cannot be predicted. Furthermore, due to our shift to a renewable model, the effect of COVID-19 may not be fully reflected in our results of operations until future periods. The extent to which COVID-19 impacts our business, operations, and financial results will depend on numerous evolving factors that we may not be able to predict accurately, including:
On November 6, 2019,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 entered into a five-year $100may still incur additional debt in the future, which may adversely affect our operations and financial results.
As of September 30, 2020, we had $600 million senior secured revolving credit agreementaggregate principal amount of indebtedness under our Convertible Senior Notes due 2025 (the “Credit Agreement”) with PNC Bank, National Association (“PNC”“Notes”). We may use borrowings
Our indebtedness may:
limit our ability to financeborrow additional funds for working capital, needs andcapital expenditures, acquisitions, or other business purposes;
limit our ability to use our cash flow or obtain additional financing for future working capital, capital expenditures, acquisitions, or other general corporate purposes. Subject to specific circumstances, the Credit Agreement allowsbusiness purposes;
require us to use a substantial portion of our cash flow from operations to make debt service payments;
limit our flexibility to plan for, or react to, changes in our business and industry;
place us at a competitive disadvantage compared to our less leveraged competitors;
dilute the interests of our existing stockholders as a result of issuing shares of our common stock upon the conversion of the Notes; and
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increase our vulnerability to the aggregate commitment up to $200 million. See Item 5. “Other Information” for additional information.
Any failure to meet our debt obligations would damage our business.impact of adverse economic and industry conditions.
Our ability to repay any amounts we borrow underpay our Credit Agreement will dependdebt when due or refinance our indebtedness, including the Notes, depends on market conditions and our future performance, which areis subject to economic, financial, competitive, and other factors beyond our control. If we areOur business may not profitablegenerate cash flow from operations in the future sufficient to service our debt and make necessary investments in our business. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations which could, in turn, result in that and our other indebtedness becoming immediately payable in full. In addition, we may incur additional debt to meet future financing needs. If we incur additional indebtedness, the risks related to our business and our ability to service or repay our indebtedness will increase.
The conditional conversion feature of the Notes, if triggered, may adversely affect our financial condition and operating results.
Under certain circumstances, the noteholders may convert their Notes at their option prior to the scheduled maturities. Upon conversion of the Notes, unless we use moreelect to deliver solely shares of our common stock to settle such conversion, we will be obligated to make cash than we generatepayments. In addition, holders of our Notes will have the right to require us to repurchase their Notes upon the occurrence of a fundamental change (as defined in the indenture, dated as of February 24, 2020, between U.S. Bank National Association, as trustee (the “Trustee”) and us (the “Indenture”)), at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest, if any, to, but not including, the fundamental change repurchase date. Although it is our intention and we currently expect to settle the conversion value of the Notes in cash up to the principal amount and any excess in shares, there is a risk that we may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of Notes surrendered therefor or Notes being converted. In addition, our ability to make payments may be limited by law, by regulatory authority, or by agreements governing our future indebtedness. Our failure to repurchase Notes when the Indenture requires the repurchase or to pay any cash payable on future conversions of the Notes as required by the Indenture would constitute a default under the Indenture. A default under the Indenture or the fundamental change itself could also lead to a default under agreements governing our levelfuture indebtedness. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase the Notes or make cash payments upon conversions thereof. In addition, even if holders of Notes do not elect to convert their Notes, we could be required under applicable accounting rules to reclassify all or a portion of the outstanding principal of the Notes as a current rather than long-term liability, which would result in a material reduction of our net working capital.
The accounting method for convertible debt securities that may be settled in cash, such as the Notes, could have a material impact on our reported financial results.
Under Accounting Standards Codification 470-20, Debt with Conversion and Other Options (ASC 470-20), an entity must separately account for the liability and equity components of the convertible debt instruments (such as the Notes) that may be settled entirely or partially in cash upon conversion in a manner that reflects the issuer’s economic interest cost. The effect of ASC 470-20 on the accounting for the Notes is that the equity component is required to be included in the additional paid-in capital section of stockholders’ equity on our consolidated balance sheet at such timethe issuance date and the value of the equity component is treated as debt discount for purposes of accounting for the debt component of the Notes. As a result, we will be required to record non-cash interest expense through the amortization of the excess of the face amount over the carrying amount of the expected life of the Notes. We will report larger net losses (or lower net income) in our financial results because ASC 470-20 requires interest to include both the amortization of the debt discount and the instrument’s cash coupon interest rate, which could adversely affect our operations by increasingreported or future financial results, the trading price of our vulnerabilitycommon 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 adverse changesthe extent that the conversion value of such Notes exceeds their principal amount. Under the treasury stock method, the number of common stock shares that would be necessary to settle such excess, if we elected to settle such excess in general economic and industry conditions and by limiting or prohibiting our abilityshares, is included in the denominator to obtain additional financing for additional capital expenditures, acquisitions and general corporate and other purposes.calculate diluted earnings per share. We cannot be sure that the accounting standards will continue to permit the treasury stock method. If we incur significantly more debt, thisare unable or otherwise elect not to use the treasury stock method in accounting for the shares issuable upon conversion of the Notes, our diluted earnings per share could intensifybe adversely affected.
The Capped Call Transactions may affect the risks described above.value of the Notes and our common stock.
In connection with the Notes’ issuance, we entered into Capped Call Transactions with certain financial institutions (“option counterparties”). The Capped Call Transactions are generally expected to reduce the potential dilution to our common stock upon any conversion of the Notes and/or offset any cash payments we are required to make in excess of the principal amount of converted Notes, as the case may be, with such reduction and/or offset subject to a cap. From time to time, 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.
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We are requiredsubject to complycounterparty risk with respect to the Capped Call Transactions.
The option counterparties are financial institutions, and we are subject to the risk that one or more of the option counterparties may default or otherwise fail to perform, or may exercise certain rights to terminate, their obligations under the Capped Call Transactions. Our exposure to the credit risk of the option counterparties is not secured by any collateral. Recent global economic conditions have resulted in the actual or perceived failure or financial and operating covenantsdifficulties of many financial institutions. If an option counterparty becomes subject to insolvency proceedings, we will become an unsecured creditor in those proceedings with a claim equal to our exposure at the time under such transaction. Our exposure depends on many factors, but our revolving credit facility. Any failureexposure will generally increase if the market price or the volatility of our common stock increases. In addition, upon default or other failures to complyperform, or termination of obligations, by an option counterparty, we may suffer more dilution than we currently anticipate with those covenants could cause amounts borrowedrespect to become immediately due and payable and/our common stock. We can provide no assurances as to the financial stability or viability of the option counterparties.
Provisions in the Notes’ Indenture may deter or prevent a business combination that may be favorable to our stockholders.
If a fundamental change occurs prior to the Notes’ maturity date, holders of the Notes will have the right, at their option, to require us from borrowing under the credit facility.
We are required to comply with certain financial and operating covenants under our Credit Agreement. Any failure to comply with those covenants could cause amounts borrowed to become immediately due and payable and/repurchase all or prevent us from borrowing under the Credit Agreement. We are required to comply with specified financial and operating covenants under our Credit Agreement and to make payments, which limit our ability to operate our business as we otherwise might operate it. Our failure to comply with anya portion of these covenants or to meet any debt payment obligations could result in an event of default which, if not cured or waived, would result in any amounts outstanding, including any accrued interest and/or unpaid fees, becoming immediately due and payable. We might not have sufficient working capital or liquidity to satisfy any repayment obligations in the event of an acceleration of those obligations.their Notes. In addition, if a “make-whole fundamental change” (as defined in the Indenture) occurs prior to the maturity date, we are notwill in compliancesome 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 financial and operating covenantsIndenture will prohibit us from engaging in certain mergers or acquisitions unless, among other things, the surviving entity assumes our obligations under the Credit Agreement atNotes. These and other provisions in the timeIndenture 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 wishdeliver 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 our common stock’s prevailing market prices. In addition, the existence of the Notes may encourage short selling by market participants because the conversion of the Notes could be used to borrow funds, we will be unable to borrow funds. The financial and operating covenants undersatisfy short positions, or anticipated conversion of the Credit Agreement also may limitNotes into shares of our ability to borrow funds, including for strategic acquisitions and share repurchases.common stock could depress the price of our common stock.
ITEM 2.     UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchasespurchases of Equity Securitiesequity securities
Common stock repurchased in the three months ended September 30, 20192020 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)
July 1, 2020 - July 31, 2020135$109.36 42$53,470 
August 1, 2020 - August 31, 2020162$120.08 26$50,321 
September 1, 2020 - September 30, 2020138$124.88 26$47,172 
435$118.29 94
(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)  
July 1, 2019 - July 31, 201937
 $75.30
 29
 $50,532
August 1, 2019 - August 31, 201994
 $72.06
 31
 $48,333
September 1, 2019 - September 30, 2019199
 $71.12
 28
 $46,334

330
 $71.86
    
(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 June 15, 2020, we announced that our Board of Directors extended the current stock repurchase program’s expiration date to June 30, 2021 and increased the remaining stock repurchase authority to $60 million. See “Liquidity"Liquidity and Capital Resources”Resources" in Item 2. “ Management’s Discussion and Analysis2 of Financial Condition and Results of Operations” for additional information.
ITEM 5.     OTHER INFORMATION
On November 6, 2019, we entered into a five-year $100 million senior secured revolving credit agreement (the “Credit Agreement”) with PNC Bank, National Association (“PNC”). We may use borrowings to finance working capital needs and for general corporate purposes. Subject to specific circumstances, the Credit Agreement allows us to increase the aggregate commitment up to $200 million.
The Credit Agreement contains customary representations and warranties, affirmative and negative covenants, and events of default. Principal covenants include 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. Our obligations under the Credit Agreement may be accelerated upon the occurrence of an event of default under the Credit Agreement, which includes, among other things, payment defaults, defaults in the performance of

affirmative and negative covenants, the inaccuracy of representations or warranties, cross-defaults, bankruptcy and insolvency-related defaults, defaults relating to judgments, certain events resulting in a material adverse effect on us and a change of control of us.
The interest rates applicable to revolving loans under the Credit Agreement are, at our option, either:
the London Interbank Offered Rates (“LIBOR”) Rate plus an interest margin based on our net consolidated leverage ratio; or
a base rate (which is the highest of (1) PNC’s prime rate, (2) the Federal Funds open rate in effect on such day plus 0.5%, and (3) the daily LIBOR Rate plus 1%) plus an interest margin based on our net consolidated leverage ratio.
We are obligated to pay an unused commitment fee during the term of the Credit Agreement that varies between 0.15% and 0.225% depending on our net consolidated leverage ratio. The credit facility includes a provision for the replacement of the LIBOR rate in the event that such rate is no longer available. The replacement rate will be determined by PNC in consultation with us. The revolving credit facility may be prepaid before maturity in whole or in part at our option without penalty or premium. We may at any time reduce or terminate the commitments under the credit facility.
The description of the Credit Agreement contained herein is qualified in its entirety by reference to the Credit Agreement, a copy of which is filed as Exhibit 10.1 to this Quarterly Report on Form 10-Q.for additional information.
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ITEM 6.     EXHIBITS
Exhibit No.Description
10.13.1
31.13.2
31.1+
31.231.2+
32++
101.INS10.1+
10.2+
10.3+
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)
+ Filed herewith.
++ 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:October 28, 2020Pegasystems Inc.
By:
Dated:November 7, 2019By:/s/ KENNETH STILLWELL
Kenneth Stillwell
Chief Financial Officer and Chief Administrative Officer
(Principal Financial Officer)


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