UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM10-Q

~~(Mark One)~~

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

For the quarterly period ended ~~June 30, 2017~~March 31, 2018

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

~~For the transition period from~~to

Commission File Number:1-11859

PEGASYSTEMS INC.

(Exact name of Registrant as specified in its charter)


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

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

(617)374-9600

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the ~~registrant~~Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of RegulationS-T during the preceding 12 months (or for such shorter period that the ~~registrant~~Registrant was required to submit and post such files). Yes ☒ No ☐

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


Large accelerated filer	☒	Accelerated filer ☐	☐

Non-accelerated filer	☐ ~~(Do~~ (Do not check if smaller reporting company)	Smaller reporting company	☐

		Emerging growth company	☐

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

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

There were ~~77,624,615~~78,575,803 shares of the Registrant’s common stock, ~~$.01~~$0.01 par value per share, outstanding on ~~July 28, 2017.~~

May 1, 2018.

PEGASYSTEMS INC.

QUARTERLY REPORT ON FORM10-Q

~~Index to Form 10-Q~~TABLE OF CONTENTS


	Page
PART I—I - FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements

Unaudited Condensed Consolidated Balance Sheets as of ~~June 30, 2017~~March 31, 2018 and December 31, ~~2016~~		3

~~Unaudited Condensed Consolidated Statements of Operations for the three and six months ended June 30,~~ 2017 ~~and 2016~~		4

Unaudited Condensed Consolidated Statements of ~~Comprehensive Income~~Operations for the three ~~and six~~ months ended ~~June 30,~~March 31, 2018 and 2017 ~~and 2016~~		5

Unaudited Condensed Consolidated Statements of ~~Cash Flows~~Comprehensive Income for the ~~six~~three months ended ~~June 30,~~March 31, 2018 and 2017 ~~and 2016~~		6

Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2018 and 2017		7

Notes to Unaudited Condensed Consolidated Financial Statements		78

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		1620

Item 3. Quantitative and Qualitative Disclosures About Market Risk		2627

Item 4. Controls and Procedures		2628

PART ~~II—~~II - OTHER INFORMATION

Item 1A. Risk Factors		2629

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		2629

Item 6. Exhibits		2729

Signature		2830

PART I—I - FINANCIAL INFORMATION

ITEM 1.

UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)


							March 31, 2018		December 31, 2017
	June 30, 2017			December 31, 2016					As Adjusted⁽¹⁾
Assets
Current assets:
Cash and cash equivalents	$	121,626		$	70,594		$	165,790	$	162,279
Marketable securities		58,414			63,167			89,047		61,469

Total cash, cash equivalents, and marketable securities		180,040			133,761			254,837		223,748
Trade accounts receivable, net of allowance of $5,590 and $4,126		217,020			265,028
Income taxes receivable		22,081			14,155
Accounts receivable								164,981		222,735
Unbilled receivables								153,657		158,898
Other current assets		18,505			12,188			50,692		41,135

Total current assets		437,646			425,132			624,167		646,516
Property and equipment, net		38,881			38,281
Deferred income taxes		71,096			69,898
Long-term other assets		4,615			3,990
Intangible assets, net		37,844			44,191
Long-term unbilled receivables								180,077		160,708
Goodwill		72,890			73,164			73,017		72,952
Other long-term assets								128,694		131,391

Total assets	$	662,972		$	654,656		$	1,005,955	$	1,011,567

Liabilities and Stockholders’ Equity
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	13,500		$	14,414		$	12,175	$	17,370
Accrued expenses		38,237			36,751			48,278		45,508
Accrued compensation and related expenses		44,287			60,660			44,093		66,040
Deferred revenue		169,926			175,647			175,586		166,297

Total current liabilities		265,950			287,472			280,132		295,215
Income taxes payable		4,438			4,263
Long-term deferred revenue		8,431			10,989
Deferred income tax liabilities								39,932		38,463
Other long-term liabilities		15,518			16,043			23,768		23,652

Total liabilities		294,337			318,767			343,832		357,330

Stockholders’ equity:
Preferred stock, 1,000 shares authorized; no shares issued and outstanding		—			—			—		—
Common stock, 200,000 shares authorized; 77,604 shares and 76,591 shares issued and outstanding		776			766
Common stock, 200,000 shares authorized; 78,546 shares and 78,081 issued and outstanding at March 31, 2018 and December 31, 2017, respectively								785		781
Additional paid-in capital		140,088			143,903			145,962		152,097
Retained earnings		232,100			198,315			517,893		508,051
Accumulated other comprehensive loss		(4,329	)		(7,095	)		(2,517)		(6,692)

Total stockholders’ equity		368,635			335,889			662,123		654,237

Total liabilities and stockholders’ equity	$	662,972		$	654,656		$	1,005,955	$	1,011,567

⁽¹⁾

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

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)


	Three Months Ended June 30,						Six Months Ended June 30,						Three Months Ended March 31,
	2017			2016			2017			2016			2018		2017
Revenue:
															As Adjusted⁽¹⁾
Revenue
Software license	$	61,037		$	70,671		$	153,427		$	139,016		$	87,773	$	127,008
Maintenance		59,590			55,161			118,555			108,136			64,525		58,713
Services		77,353			63,164			149,245			120,702			82,884		70,588

Total revenue		197,980			188,996			421,227			367,854			235,182		256,309

Cost of revenue:
Cost of revenue
Software license		1,250			1,312			2,550			2,333			1,255		1,300
Maintenance		7,011			6,315			14,229			12,230			6,082		7,218
Services		59,614			52,473			119,186			102,047			68,277		59,572

Total cost of revenue		67,875			60,100			135,965			116,610			75,614		68,090

Gross profit		130,105			128,896			285,262			251,244			159,568		188,219

Operating expenses:
Operating expenses
Selling and marketing		75,887			74,016			147,175			135,094			88,383		69,681
Research and development		39,762			35,574			80,058			70,494			46,785		40,296
General and administrative		12,706			11,294			25,041			22,342			16,464		12,335
Acquisition-related		—			1,623			—			2,542
Restructuring		—			29			—			287

Total operating expenses		128,355			122,536			252,274			230,759			151,632		122,312

Income from operations		1,750			6,360			32,988			20,485			7,936		65,907
Foreign currency transaction (loss) gain		(917	)		306			(241	)		1,682

Foreign currency transaction (loss)/gain														(1,085)		745
Interest income, net		161			188			326			478			764		205
Other income (expense), net		566			(1,356	)		287			(3,654	)
Other income/(expense), net														363		(279)

Income before (benefit)/provision for income taxes		1,560			5,498			33,360			18,991			7,978		66,578
(Benefit)/provision for income taxes		(9,846	)		962			(5,067	)		4,055			(4,222)		13,615

Net income	$	11,406		$	4,536		$	38,427		$	14,936		$	12,200	$	52,963

Earnings per share:
Earnings per share
Basic		0.15			0.06			0.50			0.20		$	0.16	$	0.69

Diluted		0.14			0.06			0.47			0.19		$	0.15	$	0.65

Weighted-average number of common shares outstanding:
Weighted-average number of common shares outstanding
Basic		77,313			76,318			77,039			76,347			78,236		76,761
Diluted		82,945			79,422			82,412			79,329			83,102		81,875
Cash dividends declared per share	$	0.03		$	0.03		$	0.06		$	0.06		$	0.03	$	0.03

⁽¹⁾

The Company adopted ASC 606 on January 1, 2018 and has adjusted prior periods to conform. See Note 2. “New Accounting Pronouncements” for additional information.

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)


												Three Months Ended March 31,
	Three Months Ended June 30,						Six Months Ended June 30,					2018		2017
	2017			2016			2017		2016					As Adjusted⁽¹⁾
Net income	$	11,406		$	4,536		$	38,427	$	14,936		$	12,200	$	52,963
Other comprehensive income (loss), net of tax
Unrealized (loss) gain on available-for-sale marketable securities, net of tax		(1	)		56			126		342
Other comprehensive income, net of tax
Unrealized (loss)/gain onavailable-for-sale marketable securities, net of tax													(188)		127
Foreign currency translation adjustments		1,859			(1,224	)		2,640		(1,231	)		4,363		2,229

Total other comprehensive income (loss), net of tax		1,858			(1,168	)		2,766		(889	)
Total other comprehensive income, net of tax													4,175		2,356

Comprehensive income	$	13,264		$	3,368		$	41,193	$	14,047		$	16,375	$	55,319

⁽¹⁾

The Company adopted ASC 606 on January 1, 2018 and has adjusted prior periods to conform. See Note 2. “New Accounting Pronouncements” for additional information.

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

   Six Months Ended
June 30,
   2017 2016
Operating activities:

Net income
   $ 38,427 $ 14,936
Adjustments to reconcile net income to cash provided by operating activities:

Deferred income taxes
   (465 ) (1,190 )
Depreciation and amortization
   12,356 11,675
Stock-based compensation expense
   26,440 19,816
Foreign currency transaction loss (gain)
   241 (1,682 )
Other non-cash
   (408 ) 4,576
Change in operating assets and liabilities:

Trade accounts receivable
   52,966 10,853
Income taxes receivable and other current assets
   (14,294 ) (18,349 )
Accounts payable and accrued expenses
   (17,734 ) (19,259 )
Deferred revenue
   (11,890 ) (11,222 )
Other long-term assets and liabilities
   130 1,415


Cash provided by operating activities
   85,769 11,569


Investing activities:

Purchases of marketable securities
   (16,656 ) (20,942 )
Proceeds from maturities and called marketable securities
   20,824 21,139
Sales of marketable securities
   —   52,483
Payments for acquisitions, net of cash acquired
   (290 ) (49,113 )
Investment in property and equipment
   (5,037 ) (11,497 )


Cash used in investing activities
   (1,159 ) (7,930 )


Financing activities:

Dividend payments to shareholders
   (4,613 ) (4,592 )
Common stock repurchases for tax withholdings for net settlement of equity awards
   (27,261 ) (7,849 )
Common stock repurchases under share repurchase programs
   (2,986 ) (19,225 )


Cash used in financing activities
   (34,860 ) (31,666 )


Effect of exchange rates on cash and cash equivalents
   1,282 (738 )


Net increase (decrease) in cash and cash equivalents
   51,032 (28,765 )
Cash and cash equivalents, beginning of period
   70,594 93,026


Cash and cash equivalents, end of period
   $ 121,626 $ 64,261


	Three Months Ended March 31,
	2018		2017
			As Adjusted⁽¹⁾
Operating activities:
Net income	$	12,200	$	52,963
Adjustments to reconcile net income to cash provided by operating activities:
Change in operating assets and liabilities, net		19,591		(47,555)
Stock-based compensation expense		15,109		12,508
Depreciation and amortization of intangible assets		6,145		6,088
Othernon-cash		2,610		8,440

Cash provided by operating activities		55,655		32,444
Investing activities:
Purchases of investments		(35,204)		(3,322)
Proceeds from maturities and called investments		5,995		2,300
Other		(2,069)		(2,705)

Cash used in investing activities		(31,278)		(3,727)
Financing activities:
Dividend payments to shareholders		(2,344)		(2,298)
Common stock repurchases		(20,708)		(13,696)

Cash used in financing activities		(23,052)		(15,994)
Effect of exchange rates on cash and cash equivalents		2,186		521

Net increase in cash and cash equivalents		3,511		13,244
Cash and cash equivalents, beginning of period		162,279		70,594

Cash and cash equivalents, end of period	$	165,790	$	83,838

⁽¹⁾

The Company adopted ASC 606 on January 1, 2018 and has adjusted prior periods to conform. See Note 2. “New Accounting Pronouncements” for additional information.

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

Pegasystems Inc. (together with its subsidiaries, “the Company”) has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“U.S.”) for complete financial statements and should be read in conjunction with the Company’s audited financial statements included in the Annual Report on Form10-K for the year ended December 31, ~~2016.~~2017.

On January 1, 2018 the Company adopted Accounting Standards Update (“ASU”) ASUNo. 2014-09, “Revenue from Contracts with Customers (Topic 606)” using the full retrospective method which required each prior reporting period presented to be adjusted to reflect the application of this ASU. See Note 2. “New Accounting Pronouncements” for additional information.

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

The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year ~~2017.~~2018.

2. NEW ACCOUNTING PRONOUNCEMENTS

~~Stock-Based Compensation~~

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

Financial Instruments

In June 2016, the ~~FASB~~Financial Accounting Standards Board (“FASB”) issued ASUNo. 2016-13, “Financial ~~Instruments—~~Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which requires measurement and recognition of expected credit losses for financial assets measured at amortized cost, including ~~trade~~ accounts receivable, upon initial recognition of that financial asset using a forward-looking expected loss model, rather than an incurred loss model for credit losses. Credit losses relating toavailable-for-sale debt securities should be recorded through an allowance for credit losses when the fair value is below the amortized cost of the asset, removing the concept of “other-than-temporary” impairments. The effective date for the Company will be January 1, 2020, with early adoption permitted. The Company is currently evaluating the effect this ASU will have on its consolidated financial statements and related disclosures.

Leases

In February 2016, the FASB issued ASUNo. 2016-02, “Leases (Topic 842),” which requires lessees to record most leases on their balance sheets, recognizing a lease liability for the obligation to make lease payments and aright-of-use asset for the right to use the underlying asset for the lease term. The effective date for the Company will be January 1, 2019, with early adoption permitted. The Company expects that most of its operating lease commitments will be subject to this ASU and recognized as operating lease liabilities andright-of-use assets upon adoption with no material impact to its results of operations and cash flows.

~~Revenue~~ASC 606 and ASC340-40

In May 2014, the FASB issued ASUNo. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. ~~This ASU amends the guidance for revenue recognition, creating the new Accounting Standards Codification Topic 606 (“ASC 606”).~~The Company adopted ASC 606 ~~requires entities to apportion consideration from contracts to performance obligations~~and ASC340-40 on a relative standalone selling price basis, based on a five-step model. Under ASC 606, revenue is recognized when a customer obtains control of a promised good or service and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for the good or service. In addition, ASC 606 requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

~~The Company has elected~~January 1, 2018 using the full retrospective ~~adoption model, effective January 1, 2018. The Company’s quarterly results beginning with~~method, which required the ~~quarter ending March 31, 2018 and comparative~~Company to retrospectively adjust the prior periods ~~will be compliant with~~presented.

The most significant impacts of adopting ASC ~~606. The Company’s Annual Report on Form 10-K for the year ended December 31, 2018 will be the Company’s first Annual Report that will be issued in compliance with~~606 and ASC ~~606.~~340-40 were as follows:

•

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

•

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

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

•

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

~~The Company is still~~

•

Taxes - The corresponding effect on tax balances in relation to all of the above impacts has also been recognized.

For additional information on the ~~process of quantifying the implications~~Company’s accounting policies as a result of the adoption of ASC ~~606. However~~606 and ASC340-40 see Note 4. “Receivables, Contract Assets, and Deferred Revenue”, Note 5. “Deferred Contract Costs”, and Note 9. “Revenue”.

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

Currently, the Company recognizes revenue from term licenses and perpetual licenses with extended payment terms over the term of the agreement as payments become due or earlier if prepaid, provided all other criteria for revenue recognition have been met, and any corresponding maintenance over the term of the agreement. The adoption of ASC 606 will result in revenue for performance obligations being recognized as they are satisfied. Therefore, revenue from the term and perpetual license performance obligations with extended payment terms is recognized when control is transferred to the customer. Revenue from the maintenance performance obligations is expected to be recognized on a straight-line basis over the contractual term. Due to the revenue from term and perpetual licenses with extended payment terms being recognized prior to amounts being billed to the customer, the Company expects to recognize a net contract asset on the balance sheet.


	December 31, 2017
(in thousands)	Previously reported		Adjustments		As adjusted
Accounts receivable and unbilled receivables	$	248,331	$	133,302	$	381,633
Contract assets		—		914		914
Long-term unbilled receivables		—		160,708		160,708
Deferred income taxes		57,127		(42,887)		14,240
Deferred contract costs		—		37,924		37,924
Other assets⁽¹⁾		416,148		—		416,148

Total Assets		721,606		289,961		1,011,567

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

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

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

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

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

⁽¹⁾ Includes cash and cash equivalents, marketable securities, income taxes receivable, other current assets, property and equipment, intangible assets, goodwill, and other long-term assets (as reflected in the consolidated balance sheets in the Annual Report on Form10-K for the year ended December 31, 2017).
⁽²⁾ Includes accounts payable, accrued expenses, accrued compensation and related expenses, income taxes payable, and other long-term liabilities (as reflected in the consolidated balance sheets in the Annual Report on Form10-K for the year ended December 31, 2017).
⁽³⁾ Includes common stock, additionalpaid-in capital, and net unrealized loss onavailable-for-sale marketable securities (as reflected in the consolidated balance sheets in the Annual Report on Form10-K for the year ended December 31, 2017).

Currently, the Company does not have VSOE for fixed price services, time and materials services in certain geographical areas, and unspecified future products, which results in revenue being deferred in such instances until such time as VSOE exists for all undelivered elements or recognized ratably over the longest performance period. The adoption of ASC 606 eliminates the requirement for VSOE and replaces it with the concept of a stand-alone selling price. Once the transaction price is allocated to each of the performance obligations, the Company can recognize revenue as the performance obligations are delivered, either at a point in time or over time. Under ASC 606, license revenue will be recognized when control is transferred to the customer.

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

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

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

~~3. MARKETABLE SECURITIES~~

~~The Company’s marketable securities are as follows:~~

   June 30, 2017
(in thousands)    Amortized
Cost    Unrealized
Gains    Unrealized
Losses    Fair
Value
Municipal bonds
   $ 32,238    $ 11    $ (30 )    $ 32,219
Corporate bonds
   26,234    3    (42 )    26,195








   $ 58,472    $ 14    $ (72 )    $ 58,414

   December 31, 2016
(in thousands)    Amortized
Cost    Unrealized
Gains    Unrealized
Losses    Fair
Value
Municipal bonds
   $ 36,746    $ —      $ (139 )    $ 36,607
Corporate bonds
   26,610    1    (51 )    26,560








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

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)


	Three Months Ended
	March 31, 2017
(in thousands, except per share amounts)	Previously reported		Adjustments			As adjusted
Revenue:
Software license	$	92,390	$	34,618		$	127,008
Maintenance		58,965		(252)			58,713
Services		71,892		(1,304)			70,588

Total revenue		223,247		33,062			256,309

Cost of revenue:
Software license		1,300		—			1,300
Maintenance		7,218		—			7,218
Services		59,572		—			59,572

Total cost of revenue		68,090		—			68,090

Gross profit		155,157		33,062			188,219

Operating expenses:
Selling and marketing		71,288		(1,607	)		69,681
Research and development		40,296		—			40,296
General and administrative		12,335		—			12,335

Total operating expenses		123,919		(1,607	)		122,312

Income from operations		31,238		34,669			65,907

Foreign currency transaction gain		676		69			745
Interest income, net		165		40			205
Other expense, net		(279)		—			(279)

Income before provision for income taxes		31,800		34,778			66,578
Provision for income taxes		4,779		8,836			13,615

Net income	$	27,021	$	25,942		$	52,963

Earnings per share:
Basic	$	0.35				$	0.69

Diluted	$	0.33				$	0.65

Weighted-average number of common shares outstanding:
Basic		76,761					76,761
Diluted		81,875					81,875

Adoption of ASC 606 had no impact on total cash from or used in operating, financing, or investing activities in the Company’s unaudited condensed consolidated statements of cash flows for the three months ended March 31, 2017.

3. MARKETABLE SECURITIES


	March 31, 2018
(in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
Municipal bonds	$	50,782	$	—	$	(191)	$	50,591
Corporate bonds		38,761		1		(306)		38,456

	$	89,543	$	1	$	(497)	$	89,047


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

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

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

As of ~~June 30, 2017,~~March 31, 2018, the Company did not hold any investments with unrealized losses that are considered to be other-than-temporary.

As of ~~June 30, 2017,~~March 31, 2018, remaining maturities of marketable ~~debt~~ securities ranged from ~~July 2017~~May 2018 to ~~September 2020,~~February 2021, with a weighted-average remaining maturity of approximately ~~15 months.~~1.4 years.

4. ~~DERIVATIVE INSTRUMENTS~~RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE

Receivables


(in thousands)	March 31, 2018		December 31, 2017
Accounts receivable	$	164,981	$	222,735
Unbilled receivables		153,657		158,898
Long-term unbilled receivables		180,077		160,708

Total receivables	$	498,715	$	542,341

Unbilled receivables is the amount due from clients where the only condition on the right of payment is the passage of time. The Company ~~has historically used foreign currency forward contracts (“forward contracts”)~~regularly reassesses receivables for collectability. As of March 31, 2018 and December 31, 2017, the allowance for doubtful accounts was not material.

Long-term unbilled receivables are expected to ~~hedge its exposure to fluctuations~~be billed as follows:


(in thousands)	March 31, 2018
2019	$	82,518
2020		58,433
2021		31,129
2022 and thereafter		7,997

	$	180,077

Contract assets and deferred revenue


(in thousands)	March 31, 2018		December 31, 2017
Contract assets⁽¹⁾	$	788	$	914
Deferred revenue		175,586		166,297
Long-term deferred revenue⁽²⁾	$	3,277	$	3,706

⁽¹⁾Included in foreign currency exchange rates associated with its foreign currency denominated cash, accounts receivable, and intercompany receivables and payables held primarily by the U.S. parent company and its United Kingdom (“U.K.”) subsidiary.

~~The Company is primarily exposed to foreign currency exchange rate fluctuations~~other current assets in the Euro relative to the U.S. dollar for the U.S. parent and in the U.S. dollar, the Euro, and the Australian dollar relative to the British pound for the Company’s U.K. subsidiary. The forward contracts are not designated as hedging instruments. As a result, the Company records the fair value of these contracts at the end of each reporting period in the accompanying unaudited condensed consolidated balance ~~sheets as other current assets for unrealized gains and accrued expenses for unrealized losses, with any fluctuations in the value of these contracts recognized~~sheets.

⁽²⁾ Included in other ~~expense, net,~~long-term liabilities in the ~~accompanying~~ unaudited condensed consolidated ~~statements~~balance sheets.

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

The ~~cash flows related to these forward contracts are classified as operating activities~~change in deferred revenue in the ~~accompanying unaudited condensed consolidated statements~~three months ended March 31, 2018, excluding the impact of ~~cash flows. The Company does not enter into any forward contracts for trading or speculative purposes.~~

~~In May 2017,~~ the ~~Company discontinued its forward contracts program, however, it will continue~~netting of contract assets and deferred revenue, was primarily due to ~~periodically evaluate its foreign exchange exposures~~new billings in advance of revenue recognition and ~~may re-initiate this program if it is deemed necessary. At~~$101.6 million of revenue recognized that was included in deferred revenue at December 31, ~~2016, the total notional value~~2017.

Major clients

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

5. DEFERRED CONTRACT COSTS

Sales incentives paid by the Company are considered incremental and recoverable costs of obtaining a contract with a client. These costs are deferred, as a long-term asset, and then amortized using the straight-line method over the period of benefit which is on average five years. The Company determined the period of benefit by taking into consideration client contracts, ~~was $128.4 million.~~

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

December 31, 2016

(in thousands)
Recorded In:
   Fair Value
Asset Derivatives

Foreign currency forward contracts
   Other current assets    $ 628
Liability Derivatives

Foreign currency forward contracts
   Accrued expenses    $ 883

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

technology, and other factors. The Company ~~had forward contracts outstanding with total notional values~~utilizes a practical expedient available under ASC 606 to expense costs to obtain a contract as ~~of June 30, 2016 as follows:~~

(in thousands)
Euro
   € 24,735
British pound
   £ 7,885
Australian dollar
   A$ 25,830
Indian rupee
   Rs 353,500
United States dollar
   $ 93,460

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

   Three Months Ended
June 30,    Six Months Ended
June 30,
(in thousands)    2017    2016    2017    2016
Gain (loss) from the change in the fair value of forward contracts included in other income (expense), net
   $ 565    $ (1,421 )    $ 286    $ (3,718 )
Foreign currency transaction (loss) gain from the remeasurement of foreign currency assets and liabilities
   $ (917 )    $ 306    $ (241 )    $ 1,682








   $ (352 )    $ (1,115 )    $ 45    $ (2,036 )

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

amortization period is one year or less. During the three months ended March 31, 2018 and 2017, impairment of deferred contract costs was not material.


(in thousands)	March 31, 2018	December 31, 2017
Deferred contract costs⁽¹⁾	$ 39,781	$ 37,924
⁽¹⁾ Included in other long-term assets in the unaudited condensed consolidated balance sheets. Amortization of deferred contract costs was as follows:
	Three Months Ended March 31,
(in thousands)	2018	2017
Amortization of deferred contract costs⁽¹⁾	$3,789	$2,594

5.⁽¹⁾ Included in selling and marketing expenses in the unaudited condensed consolidated statement of operations.

6. GOODWILL AND OTHER INTANGIBLE ASSETS

The changes in the carrying amount of goodwill were as follows:


(in thousands)	Three Months Ended March 31,
(in thousands)	2018
Balance as of January 1,	$	72,952
Purchase price adjustments to goodwill		—
Currency translation adjustments		65

Balance as of March 31,	$	73,017

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


		March 31, 2018
(in thousands)	Useful Lives	Cost	Accumulated Amortization	Net Book Value⁽¹⁾
Client-related intangibles	9-10 years	$ 63,197	$ (46,456)	$ 16,741
Technology	7-10 years	58,942	(46,603)	12,339
Other intangibles	—	5,361	(5,361)	—

		$ 127,500	$ (98,420)	$ 29,080


⁽¹⁾ Included in other long-term assets in the unaudited condensed consolidated balance sheet.

		December 31, 2017
(in thousands)	Useful Lives	Cost	Accumulated Amortization	Net Book Value⁽¹⁾
Client-related intangibles	9-10 years	$ 63,164	$ (44,835)	$ 18,329
Technology	7-10 years	58,942	(45,372)	13,570
Other intangibles	—	5,361	(5,361)	—

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

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

⁽¹⁾

Included in other long-term assets in the unaudited condensed consolidated balance sheets.

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


	Three Months Ended March 31,
(in thousands)	2018		2017
Cost of revenue	$	1,232	$	1,334
Selling and marketing		1,605		1,866

	$	2,837	$	3,200

7. ACCRUED EXPENSES


(in thousands)	March 31, 2018		December 31, 2017
Outside professional services	$	15,152	$	14,468
Income and other taxes		7,272		7,420
Marketing and sales program expenses		8,724		6,444
Dividends payable		2,358		2,344
Employee-related expenses		5,091		4,065
Other		9,681		10,767

	$	48,278	$	45,508

8. FAIR VALUE MEASUREMENTS

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The Company records its ~~money market funds,~~cash equivalents, marketable securities, and ~~forward contracts~~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)~~

Level 1 - observable inputs such as quoted prices in active markets for identical assets or liabilities; ~~(Level 2)~~

Level 2 - significant other inputs that are observable either directly or indirectly; and ~~(Level 3)~~

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~~as Level 1 ofand 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 ~~foreign currency forward contracts, which were all~~investments in privately-held companies are classified within Level 23 of the fair value hierarchy and are valued ~~based on the notional amounts~~using model-based techniques, including option pricing models and ~~rates under the contracts and observable market inputs such as currency exchange rates and credit risk.~~ discounted cash flow models.

If applicable, the Company will recognize transfers into and out of levels within the fair value hierarchy at the end of the reporting period in which the actual event or change in circumstance occurs. There were no transfers between ~~Level 1 and Level 2~~levels during the ~~six~~three months ended ~~June 30, 2017.~~March 31, 2018.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

      Fair Value Measurements at
Reporting Date Using
(in thousands)    June 30,
2017    Level 1    Level 2
Fair Value Assets:

Money market funds
   $ 5,633    $ 5,633    $ —
Marketable securities:

Municipal bonds
   $ 32,219    $ —      $ 32,219
Corporate bonds
   26,195    —      26,195






Total marketable securities
   $ 58,414    $ —      $ 58,414
      Fair Value Measurements at
Reporting Date Using
(in thousands)    December 31,
2016    Level 1    Level 2
Fair Value Assets:

Money market funds
   $ 458    $ 458    $ —
Marketable securities:

Municipal bonds
   $ 36,607    $ —      $ 36,607
Corporate bonds
   26,560    —      26,560






Total marketable securities
   $ 63,167    $ —      $ 63,167
Foreign currency forward contracts
   $ 628    $ —      $ 628
Fair Value Liabilities:

Foreign currency forward contracts
   $ 883    $ —      $ 883

~~PEGASYSTEMS INC.~~

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


	March 31, 2018
	Level 1		Level 2		Level 3		Total
Cash equivalents	$	130	$	30,072	$	—	$	30,202
Marketable securities:
Municipal bonds	$	—	$	50,591	$	—	$	50,591
Corporate bonds		—		38,456		—		38,456

Total marketable securities	$	—	$	89,047	$	—	$	89,047
Investments in privately-held companies⁽¹⁾	$	—	$	—	$	2,060	$	2,060
⁽¹⁾ Included in other long-term assets in the unaudited condensed consolidated balance sheets.

	December 31, 2017
	Level 1		Level 2		Level 3		Total
Cash equivalents	$	2,720	$	40,051	$	—	$	42,771
Marketable securities:
Municipal bonds	$	—	$	32,848	$	—	$	32,848
Corporate bonds		—		28,621		—		28,621

Total marketable securities	$	—	$	61,469	$	—	$	61,469
Investments in privately-held companies⁽¹⁾	$	—	$	—	$	1,030	$	1,030
⁽¹⁾ Included in other long-term assets in the unaudited condensed consolidated balance sheets.

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

Assets Measured at Fair Value on a Nonrecurring Basis

Assets recorded at fair value on a nonrecurring basis, ~~such as~~including property and equipment and intangible assets, are recognized at fair value when they are impaired. During the ~~six~~three months ended ~~June 30,~~March 31, 2018 and 2017, ~~and 2016,~~ the Company did not recognize any impairments of its assets recorded at fair value on a nonrecurring basis.

~~6. TRADE ACCOUNTS RECEIVABLE, NET OF ALLOWANCE~~9. REVENUE

Revenue policy

The Company’s revenue is derived from sales of software licenses, maintenance fees related to the Company’s software licenses, and services.

(in thousands)    June 30,
2017    December 31,
2016
Trade accounts receivable
   $ 188,304    $ 234,473
Unbilled trade accounts receivable
   34,306    34,681




Total accounts receivable
   222,610    269,154
Allowance for sales credit memos
   (5,590 )    (4,126 )




   $ 217,020    $ 265,028

~~Unbilled trade accounts receivable~~

License revenue is primarily ~~relate~~derived from sales of the Company’s software applications and Pega Platform.

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

Cloud revenue is derived from sales of the Company’s hosted Pega Platform and software application environments.

Consulting revenue is primarily related to ~~services earned under time and materials arrangements and to~~new license ~~maintenance,~~implementations.

Contracts with multiple performance obligations

The Company’s license and cloud arrangements often contain multiple performance obligations, including maintenance, consulting, and training. For contracts with multiple performance obligations, the Company accounts for individual performance obligations separately if they are distinct. The transaction price is allocated to the separate performance obligations on a relative stand-alone selling price basis. If the transaction price contains discounts or expects to provide a future price concession, these elements are considered when determining the transaction price prior to allocation. Variable fees within the transaction price will be estimated and recognized in revenue as the Company satisfies its performance obligations to the extent it is probable that ~~have commenced~~a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable fee is resolved. If the contract grants the client the option to acquire additional products or ~~been delivered~~services, the Company assesses whether or not any discount on the products and services is in excess of ~~scheduled invoicing.~~

~~7. GOODWILL AND OTHER INTANGIBLE ASSETS~~

~~The changes in the carrying amount of goodwill are:~~

(in thousands)    2017
Balance as of January 1,
   $ 73,164
Purchase price adjustments to goodwill
   (354 )
Currency translation adjustments
   80


Balance as of June 30,
   $ 72,890

~~Intangible assets are recorded at cost~~levels normally available to similar clients and, ~~are amortized using the straight-line method over their estimated useful lives:~~if so, accounts for that discount as an additional performance obligation.

(in thousands)    Range of
Remaining
Useful Lives    Cost    Accumulated
Amortization    Net Book
Value
June 30, 2017

Customer related intangibles
   4-10 years    $ 63,132    $ (41,322 )    $ 21,810
Technology
   3-10 years    58,942    (42,908 )    16,034
Other intangibles
   —      5,361    (5,361 )    —






      $ 127,435    $ (89,591 )    $ 37,844






December 31, 2016

Customer related intangibles
   4-10 years    $ 63,091    $ (37,573 )    $ 25,518
Technology
   3-10 years    58,942    (40,269 )    18,673
Other intangibles
   —      5,361    (5,361 )    —






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

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Software licenses

The Company has concluded that its software licenses are distinct performance obligations as the client can benefit from the software on its own. Software license revenue is typically recognized at a point in time when control is transferred to the client, which is defined as the point in time when the client can use and benefit from the license. The software license is delivered before related services are provided and is functional without services, updates, and technical support. The Company’s license arrangements generally contain multiple performance obligations, including consulting, training, and maintenance. Stand-alone selling price for software licenses is determined using the residual approach. The Company utilizes the residual approach as license performance obligations are sold for a broad range of amounts (the selling price is highly variable) and a stand-alone selling price is not discernible from past transactions or other observable evidence. Periodically, the Company evaluates whether the residual approach is appropriate for its license and cloud performance obligations when sold with other performance obligations. As a result, if the standalone selling price analysis illustrates that the license and cloud performance obligations are no longer highly variable, the Company will utilize the relative allocation method for such arrangements.

Term license fees are usually payable in advance on a monthly, quarterly, or annual basis over the term of the license agreement, which is typically three to five years and may be renewed for additional terms at the client’s option. Perpetual license fees are usually payable when the contract is executed. The Company recognizes software license revenue when control is transferred, and the corresponding difference between the amount invoiced and recognized as revenue is recorded as unbilled receivables, as the payment of consideration is subject only to the passage of time.

Maintenance

Maintenance revenue includes revenue from client support and related professional services. Client support includes software upgrades on a whenand-if available basis, telephone support, and bug fixes or patches. Maintenance is priced as a percentage of the selling price of the related software license, which is highly variable. The Company determined the standalone selling price of maintenance based on this pricing relationship, which has remained constant within a narrow range, and observable data from standalone sales of maintenance, along with all other observable data.

The Company has identified two separate distinct performance obligations of maintenance:

software upgrades and updates; and

~~Amortization expense~~

technical support.

These performance obligations are distinct within the contract and, although they are not sold separately, the components are not essential to the functionality of ~~intangibles assets~~the other components. Each of the performance obligations included in maintenance revenue is ~~reflected~~a stand-alone obligation that is recognized over the passage of the contractual term, which is typically one year. Maintenance fees are usually payable in advance on a monthly, quarterly, or annual basis over the term of the agreement.

Services

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

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

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

The stand-alone selling price of ~~operations~~cloud sales of production environments is determined based on the residual approach when sold with services and is recognized over the term of the service. The Company utilizes the residual approach as ~~follows:~~

   Three Months Ended
June 30,    Six Months Ended
June 30,
(in thousands)    2017    2016    2017    2016
Cost of revenue
   $ 1,305    $ 1,638    $ 2,639    $ 2,984
Operating expenses
   1,869    1,966    3,735    3,585








Total amortization expense
   $ 3,174    $ 3,604    $ 6,374    $ 6,569

~~Future estimated amortization expense related to intangible assets as~~cloud performance obligations are sold for a broad range of ~~June 30, 2017~~amounts (the selling price is ~~as follows:~~highly variable) and a stand-alone selling price is not discernible from past transactions or other observable evidence. The stand-alone selling price for cloud sales of development and testing environments is developed using observable prices in similar transactions without multiple performance obligations and is recognized over time over the term of the service. Cloud fees are usually payable in advance on a monthly, quarterly, or annual basis over the term of the service.

(in thousands)
Remainder of 2017
   $ 5,953
2018
   11,343
2019
   5,551
2020
   2,655
2021
   2,631
2022 and thereafter
   9,711


   $ 37,844

~~8. ACCRUED EXPENSES~~

(in thousands)    June 30,
2017    December 31,
2016
Professional services contractor fees
   $ 7,125    $ 6,550
Other taxes
   5,338    9,031
Marketing and sales program expenses
   5,188    1,508
Professional fees
   3,276    3,654
Other
   3,084    2,411
Self-insurance health and dental claims
   2,523    2,182
Fixed assets in progress
   2,417    855
Dividends payable
   2,328    2,298
Employee reimbursable expenses
   2,120    1,624
Short-term deferred rent
   1,954    1,770
Partner commissions
   1,748    2,199
Income taxes payable
   1,038    1,391
Restructuring
   98    105
Acquisition-related expenses and merger consideration
   —      290
Foreign currency forward contracts
   —      883




   $ 38,237    $ 36,751

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Contract modifications

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

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

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

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

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

a cumulativecatch-up basis.

Geographic revenue


	Three Months Ended March 31,
(in thousands)	2018			2017
U.S.	$	113,985	48%	$	169,662	67%
Other Americas		17,715	8%		10,406	4%
United Kingdom		26,094	11%		26,342	10%
Europe, Middle East, and Africa excluding the United Kingdom		31,826	14%		24,211	9%
Asia-Pacific		45,562	19%		25,688	10%

Total Revenue	$	235,182	100%	$	256,309	100%

Major products and services


	Three Months Ended March 31,
(in thousands)	2018		2017
Perpetual license	$	23,078	$	37,899
Term license		64,695		89,109

Performance obligations transferred at a point in time		87,773		127,008
Maintenance		64,525		58,713
Cloud		15,582		10,402
Consulting and training		67,302		60,186

Performance obligations transferred over time		147,409		129,301

Total Revenue	$	235,182	$	256,309

During the three months ended March 31, 2018 and 2017, there were no material changes in the Company’s estimate of variable fees. The amount of revenue recognized from performance obligations satisfied in prior periods was not material.

Transaction price allocated to remaining performance obligations

Transaction price allocated to remaining performance obligations represents contracted revenue that has not yet been recognized. Transaction price on remaining performance obligations was $291 million as of March 31, 2018, of which the Company expects to recognize $198.3 million prior to January 1, 2020. These amounts do not include contracts that have an original expected duration of one year or less. For reporting periods ending prior to January 1, 2018, the date of initial adoption of ASC 606, the Company has elected the practical expedient and not compiled and disclosed the amount of the transaction price allocated to the remaining performance obligations.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

~~9. DEFERRED REVENUE~~Major clients

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

(in thousands)    June 30,
2017    December 31,
2016
Term license
   $ 6,294    $ 15,843
Perpetual license
   24,709    23,189
Maintenance
   111,759    112,397
Cloud
   17,677    13,604
Services
   9,487    10,614




Current deferred revenue
   169,926    175,647
Term license
   —      —
Perpetual license
   5,833    7,909
Maintenance
   1,465    1,802
Cloud
   1,133    1,278




Long-term deferred revenue
   8,431    10,989




   $ 178,357    $ 186,636


	Three Months Ended March 31,
(in thousands)	2018			2017

Total revenue		$ 235,182	$		256,309
Client A		*			14%
Client B		*			11%

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

10. STOCK-BASED COMPENSATION

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

   Three Months Ended
June 30,    Six Months Ended
June 30,
(in thousands)    2017    2016    2017    2016
Cost of revenues
   $ 3,677    $ 2,914    $ 7,299    $ 5,594
Operating expenses
   $ 10,255    $ 7,967    $ 19,141    $ 14,222








Total stock-based compensation before tax
   $ 13,932    $ 10,881    $ 26,440    $ 19,816








Income tax benefit
   $ (4,287 )    $ (3,085 )    $ (8,102 )    $ (5,690 )

During the six months ended June 30, 2017, the Company issued approximately 1,068,000 shares of common stock to its employees and 13,000 shares of common stock to its non-employee directors under the Company’s stock-based compensation plans.

During the six months ended June 30, 2017, the Company granted approximately 954,000 restricted stock units (“RSUs”) and 1,441,000 non-qualified stock options to its employees with total fair values of approximately $41.9 million and $19.2 million, respectively. This includes approximately 175,000 RSUs which were granted in connection with the election by employees to receive 50% of their 2017 target incentive compensation under the Company’s Corporate Incentive Compensation Plan in the form of RSUs instead of cash. Stock-based compensation of approximately $7.7 million associated with this RSU grant will be recognized over a one-year period beginning on the grant date.


	Three Months Ended March 31,
(in thousands)	2018		2017
Cost of revenues	$	3,701	$	3,622
Selling and marketing		4,658		3,405
Research and development		3,637		3,312
General and administrative		3,113		2,169

	$	15,109	$	12,508

Income tax benefit	$	(3,141)	$	(3,815)

The Company recognizes ~~stock based~~stock-based compensation on the accelerated recognition method, treating each vesting tranche as if it were an individual grant. As of ~~June 30, 2017,~~March 31, 2018, the Company had, ~~approximately $64.7~~net of estimated forfeitures, $92.5 million of unrecognized stock-based compensation expense, ~~net of estimated forfeitures,~~ related to all unvested ~~RSUs~~restricted stock units (“RSUs”) and ~~unvested~~ stock options, ~~that is~~which was expected to be recognized over a weighted-average period of ~~2.1~~2.3 years.

Grants

The Company granted the following stock-based compensation awards:


	Three Months Ended March 31,
(in thousands)	Shares		Total Fair Value
RSUs⁽¹⁾		858	$	49,600
Non-qualified stock options		1,377	$	24,700

⁽¹⁾

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

RSU vestings and stock option exercises

During the three months ended March 31, 2018, 0.6 million shares of common stock were issued due to stock option exercises and RSU vestings under the Company’s stock-based compensation plans.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

11. INCOME TAXES

Effective Tax Rate

The Company computes its (benefit)/provision for income taxes by applying the estimated annual effective tax rate to year to date income before (benefit)/provision for income taxes and adjusts for discrete tax items recorded in the period.


	Three Months Ended March 31,
(Dollars in thousands)	2018		2017
(Benefit)/provision for income taxes	$	(4,222)	$	13,615
Effective income tax rate		(53)%		20%

During the three months ended March 31, 2018, the Company’s effective tax rate changed primarily due to the following factors:

excess tax benefits from stock-based compensation were disproportionately greater relative to income before (benefit)/provision for income taxes;

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

an increase in U.S. research and development tax credits.

Tax Reform Act

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

Under the SEC Staff Accounting Bulletin No. 118 (“SAB 118”), the Company recognized the provisional tax impacts in the three months ended December 31, 2017 that included $20.4 million of income tax expense tore-measure its net deferred tax assets to the 21% enacted rate. However, the Company has revised its provisional amount to reflect the impact of the retrospective adoption of ASC 606 and has recognized a $12.6 million income tax benefit for the remeasurement of its net deferred tax liabilities on a retrospective basis in the three months ended December 31, 2017.

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

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

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

The GILTI provisions require the Company to include in its U.S. income tax base foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary’s tangible assets. The Company expects that it will be subject to incremental U.S. tax resulting from GILTI inclusions beginning in 2018. As of March 31, 2018, the Company has included an estimate of the effect of its GILTI provisions in its estimated annual effective tax rate. The Company continues to monitor IRS guidance and will update its estimates as guidance is issued.

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

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

~~11.~~12. EARNINGS PER SHARE

Basic earnings per share is computed using the weighted-average number of common shares outstanding during the applicable period. Diluted earnings per share is computed using the weighted-average number of common shares outstanding during the applicable period, plus the dilutive effect of outstanding stock options and RSUs, using the treasury stock method. ~~Certain shares related to some~~In periods of ~~the Company’s outstanding~~loss, all stock options and RSUs ~~were~~are excluded, ~~from the computation of diluted earnings per share because they were anti-dilutive in the periods presented, but could~~as their inclusion would be ~~dilutive in the future.~~anti-dilutive.

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

   Three Months Ended
June 30,    Six Months Ended
June 30,
(in thousands, except per share amounts)    2017    2016    2017    2016
Basic

Net income
   $ 11,406    $ 4,536    $ 38,427    $ 14,936








Weighted-average common shares outstanding
   77,313    76,318    77,039    76,347








Earnings per share, basic
   $ 0.15    $ 0.06    $ 0.50    $ 0.20








Diluted

Net income
   $ 11,406    $ 4,536    $ 38,427    $ 14,936








Weighted-average effect of dilutive securities:

Stock options
   3,694    1,924    3,439    1,808
RSUs
   1,938    1,180    1,934    1,174








Effect of assumed exercise of stock options and RSUs
   5,632    3,104    5,373    2,982








Weighted-average common shares outstanding, assuming dilution
   82,945    79,422    82,412    79,329








Earnings per share, diluted
   $ 0.14    $ 0.06    $ 0.47    $ 0.19








Outstanding stock options and RSUs excluded as impact would be anti-dilutive
   237    315    276    404

~~12. GEOGRAPHIC INFORMATION AND MAJOR CLIENTS~~

~~Geographic Information~~

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

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

~~PEGASYSTEMS INC.~~

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

~~The Company’s international revenue is from clients based outside of the U.S. The Company derived its revenue from the following geographic areas:~~

   Three Months Ended
June 30, Six Months Ended
June 30,
(Dollars in thousands)    2017 2016 2017 2016
U.S.
   $ 118,447    60 % $ 103,547    55 % $ 256,056    60 % $ 196,775    53 %
Other Americas
   12,086    6 % 15,983    8 % 21,577    5 % 41,542    12 %
U.K.
   19,228    10 % 31,336    17 % 49,418    12 % 55,691    15 %
Other EMEA⁽¹⁾
   27,395    13 % 22,391    12 % 49,241    12 % 43,658    12 %
Asia Pacific
   20,824    11 % 15,739    8 % 44,935    11 % 30,188    8 %










   $ 197,980    100 % $ 188,996    100 % $ 421,227    100 % $ 367,854    100 %


	Three Months Ended March 31,
(in thousands, except per share amounts)	2018	2017
Basic
Net income	$ 12,200	$ 52,963
Weighted-average common shares outstanding	78,236	76,761

Earnings per share, basic	$ 0.16	$ 0.69


Diluted
Net income	$ 12,200	$ 52,963
Weighted-average effect of dilutive securities:
Stock options	3,119	3,184
RSUs	1,747	1,930

Effect of dilutive securities	4,866	5,114

Weighted-average common shares outstanding, assuming dilution	83,102	81,875

Earnings per share, diluted	$ 0.15	$ 0.65


Outstanding anti-dilutive stock options and RSUs⁽¹⁾	397	314

⁽¹⁾	~~Includes Europe,~~Certain outstanding stock options and RSUs were excluded from the ~~Middle East and Africa, but excludes~~computation of diluted earnings per share because they were anti-dilutive in the ~~United Kingdom.~~period presented. These awards may be dilutive in the future.

~~Major Clients~~

~~No client accounted for 10% or more of the Company’s total revenue during the three and six months ended June 30, 2017 or 2016.~~

~~No client accounted for 10% or more of the Company’s total outstanding trade receivables as of June 30, 2017 or December 31, 2016.~~

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

~~Forward-Looking Statements~~FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form10-Q contains or incorporates forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, statements about our future financial performance and business plans, the adequacy of our liquidity and capital resources, the continued payment of quarterly dividends, ~~by the Company,~~ and the timing of revenue recognition ~~under existing license and cloud arrangements~~ and are described more completely in Part I of our Annual Report on Form10-K for the year ended December 31, ~~2016.~~ 2017.

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

These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict. Important factors that could cause actual future activities and results to differ materially from those expressed in such forward-looking statements include, among others, variation in demand for our products and services and the difficulty in predicting ~~the completion of product acceptance and other~~ factors affecting the timing of license revenue recognition; ~~the ongoing consolidation in the financial services, insurance, healthcare, and communications markets;~~ reliance on third party relationships; our beliefs and the ~~potential loss~~timing of ~~vendor specific objective evidence for~~the completion of our ~~consulting services;~~analysis regarding the impact of the Tax Cuts and Jobs Act of 2017, including its impact on income tax expense and deferred tax assets; the inherent risks associated with international operations and the continued uncertainties in ~~international economies;~~the global economy; our continued effort to market and sell both domestically and internationally; foreign currency exchange rates; the financial impact of ~~the Company’s past acquisitions and~~ any future acquisitions; the potential legal and financial liabilities and reputation damage due to cyber-attacks and security breaches; and management of ~~the Company’s~~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 ~~Item 1A of~~ Part I of our Annual Report on Form10-K for the year ended December 31, ~~2016. We have~~2017 as well as other filings we make with the U.S. Securities and Exchange Commission (“SEC”).

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

~~Business overview~~BUSINESS OVERVIEW

We develop, market, license, and support software applications for ~~marketing, sales, service,~~customer engagement and ~~operations. In~~digital process automation, in addition ~~we license~~to licensing our Pega^® Platform application development product for clients that wish to build and extend their own applications. The Pega Platform ~~assists our clients~~and applications help connect enterprises to their customers in ~~building, deploying,~~real-time across channels, streamline business operations, and ~~evolving enterprise applications, creating an environment in which business and IT can collaborate~~adapt to manage back office operations, front office sales, marketing, and/or customer service needs. We also provide consulting services, maintenance, and training for our software. Our software applications and Pega Platform can be deployed on Pega, partner, or customer-managed cloud architectures.meet changing requirements.

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

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

Financial and Performance Metrics

To provide additional insight into how management evaluates our financial performance, we have used a number of performance metrics to supplement our selected financial metrics. These performance metrics are periodically revisited to reflect any changes in our business. Historically, Recurring Revenue and License and Cloud Backlog have been our primary performance metrics. However, due to the change in the revenue recognition patterns of term license arrangements as a result of the expected implementation ofWe adopted the new revenue ~~accounting~~recognition standard ~~(ASC 606 “Revenue from Contracts with Customers”~~(“ASC 606”) ineffective January 1, 2018 using the first quarter of 2018, we have started tracking the performance measure Annualized Contract Value (“ACV”). The change in ACV measures the growth and predictability of future cash flows from committed term license, cloud, and maintenance arrangements as of the end of the particular reporting period. Additional information about our future adoption of the new revenue standard and its impact can be found infull retrospective method. See Note 2. “New Accounting Pronouncements” ~~contained elsewhere~~included in ~~this Quarterly Report on Form 10-Q.~~

~~Selected~~Item 1. “Unaudited Condensed Consolidated Financial ~~Metrics~~Statements” for additional information.

(Dollars in thousands,
except per share amounts)
   Three Months Ended
June 30, Change Six Months Ended
June 30,
   2017 2016 2017 2016 Change
Total revenue
   197,980 188,996 8,984    5 % 421,227 367,854 53,373    15 %
Operating margin
   1 % 3 %    8 % 6 %
Diluted earnings per share
   0.14 0.06 0.08    133 % $ 0.47 $ 0.19 $ 0.28    147 %
Cash flow provided by operating activities
      85,769 11,569 74,200    641 %
~~Recurring Revenue~~
~~A measure of the predictability and repeatability of our revenue.~~

   Three Months Ended
June 30,    Six Months Ended
June 30,
(Dollars in thousands)    2017 2016 Change 2017 2016 Change
Recurring revenue:

Term license
   30,782 18,864    84,492 73,196
Maintenance
   59,590 55,161    118,555 108,136
Cloud
   12,733 11,269    23,560 19,767





Total recurring revenue
   103,105 85,294 $ 17,811    21 % 226,607 201,099 $ 25,508    13 %





Recurring revenue as a percent of total revenue
   52 % 45 %    54 % 55 %
(Dollars in thousands, except per share amounts) Three Months Ended
March 31,
        2018                 2017                         Change
Total revenue
$ 235,182 $ 256,309 $ (21,127 ) (8)%
Net income
$ 12,200 $ 52,963 $ (40,763 ) (77)%
Diluted earnings per share
$ 0.15 $ 0.65 $ (0.50 ) (77)%
Cash provided by operating activities
$ 55,655 $ 32,444 $ 23,211 72%
The ~~increase~~decrease in recurring revenue was primarily driven by increased term license revenue recognized from term backlog and a large term license renewal for which the first year of the term was prepaid and recognized astotal revenue in the three months ended ~~June 30, 2017. The increase in term revenue would have been greater if not for~~March 31, 2018 was primarily due to a large term ~~deal greater than $10 million for which the~~ license ~~fee for the full license term was~~arrangement recognized in revenue in the ~~first quarter~~three months ended March 31, 2017 and a shift in client preferences to cloud arrangements. Cloud arrangements are generally recognized in revenue over the term of ~~2016.~~the cloud contract, as compared to other arrangements, which are generally recognized in revenue on the contract effective date.
~~License and Cloud Backlog~~
~~A measure of the continued growth of our business as a result of future contractual commitments by our clients.~~
It is computed by adding deferred license and cloud revenue recorded on the balance sheet (See Note 9 “Deferred Revenue”) and client license and cloud contractual commitments, which are not recorded on our balance sheet because we have not yet invoiced our clients, nor have we recognized the associated revenues (See “Future Cash Receipts from Committed License and Cloud Arrangements” which can be found in “Liquidity and Capital Resources” contained elsewhere in this Quarterly Report on Form 10-Q for additional information). License and cloud backlog may vary in any given period depending on the amount and timing of when the arrangements are executed, as well as the mix between perpetual, term, and cloud license arrangements, which may depend on our clients’ deployment preferences.

   June 30,
(Dollars in thousands)    2017 2016 Change
Deferred license and cloud revenue on the balance sheet:

Term license and cloud
   $ 25,104    45 % $ 19,021    37 % 32 %
Perpetual license
   30,542    55 % 32,834    63 % (7 )%





Total deferred license and cloud revenue
   55,646    100 % 51,855    100 % 7 %





License and cloud contractual commitments not on the balance sheet:

Term license and cloud
   422,414    91 % 309,338    91 % 37 %
Perpetual license
   39,949    9 % 31,439    9 % 27 %





Total license and cloud commitments
   462,363    100 % 340,777    100 % 36 %





Total license (term and perpetual) and cloud backlog
   $ 518,009    $ 392,632    32 %





Total term license and cloud backlog
   447,518    86 % 328,359    84 % 36 %





~~Annualized~~Annual Contract Value (“ACV”) )⁽¹⁾
The change in ACV measures the growth and predictability of future cash flows from committed term, ~~license,~~ cloud, and maintenance arrangements as of the end of the particular reporting period.
March 31,
(in thousands)         2018                 2017                         Change
Term and Cloud ACV
$ 236,025 $ 193,004 $ 43,021 22%
Maintenance ACV
258,100 234,852 $ 23,248 10%

Total ACV
$ 494,125 $ 427,856 $ 66,269 15%

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

~~Term~~The sum of the annual value of each term and ~~Cloud~~cloud contract in effect on such date, with the annual value of a term or cloud contract being equal to the total value of the contract divided by the total number of ~~committed contract~~ years of the contract.

~~Quarterly~~ Maintenance revenue reported for the ~~three months~~quarter ended on such date, multiplied by 4.four.
~~Critical accounting policies~~CRITICAL ACCOUNTING POLICES
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the ~~U.S.~~United States (U.S.) and the rules and regulations of the SEC for interim financial reporting. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and the related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, knowledge of current conditions, and expectations of what could occur in the future given available information.
Revenue
We account for revenue in accordance with ASC 606. Our revenue recognition policies require us to make significant judgments and estimates.
~~There~~Our clients’ contracts typically contain promises to transfer multiple products and services. Judgment is required to determine whether each product and service is considered to be a distinct performance obligation that should be accounted for separately under the contract. We allocate the transaction price to the distinct performance obligations based on relative stand-alone selling price. We estimate stand-alone selling price based on the prices charged to clients, or by using information such as market conditions and other observable inputs. However, the selling price of our software licenses and cloud performance obligations are highly variable. Thus, we estimate stand-alone selling price for software licenses and cloud performance obligations using the residual approach, determined based on total transaction price minus the stand-alone selling price of other performance obligations promised in the contract.
In applying our revenue recognition policy, we must determine which portions of our revenue are recognized currently and which portions must be deferred and recognized in future periods. We analyze various factors including, but not limited to, the selling price of undelivered services when sold on a stand-alone basis, our pricing policies, and contractual terms and conditions in helping us to make such judgments about revenue recognition. Changes in judgment on any of these factors could materially impact the timing and amount of revenue recognized in a given period.
Deferred Contract Costs
Sales incentives paid by us are considered incremental and recoverable costs of obtaining a contract with a client. These costs are deferred and then amortized over the period of benefit, which is on average five years. We determined the period of benefit by taking into consideration our client contracts, our technology, and other factors.
Except as described above, there have been no changes in our critical accounting policies as disclosed in our Annual Report on Form10-K for the year ended December 31, ~~2016.~~ 2017.
For more information regarding our critical accounting policies, we encourage you to read the discussion contained in ~~Item 7 under~~ the ~~heading “Critical~~following locations:
“Critical Accounting Estimates and Significant Judgments” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 22. “Significant Accounting Policies” ~~included~~ in ~~the notes to the Consolidated Financial~~Item 8. “Financial Statements and Supplementary Data” both of which are contained in our Annual Report on Form10-K for the year ended December 31, ~~2016.~~2017.
~~Results~~
Note 2. “New Accounting Pronouncements”, Note 4. “Receivables, Contract Assets, and Deferred Revenue”, and Note 9. “Revenue” contained in Item 1. “Unaudited Condensed Consolidated Financial Statements” of ~~Operations~~this Quarterly Reporting on Form10-Q for the three months ended March 31, 2018.
RESULTS OF OPERATIONS

   Three Months Ended
June 30, Six Months Ended
June 30,    Three Months Ended
March 31,
(Dollars in thousands)    2017 2016 Change 2017 2016 Change         2018                 2017                          Change
Total revenue
   $ 197,980 $ 188,996 $ 8,984 5 % $ 421,227 $ 367,854 $ 53,373    15 % $ 235,182 $ 256,309 $ (21,127 ) (8)%
Gross profit
   $ 130,105 $ 128,896 $ 1,209 1 % $ 285,262 $ 251,244 $ 34,018    14 % $ 159,568 $ 188,219 $ (28,651 ) (15)%
Total operating expenses
   $ 128,355 $ 122,536 $ 5,819 5 % $ 252,274 $ 230,759 $ 21,515    9 %
Income from operations
   $ 1,750 $ 6,360 $ (4,610 ) (72 )% $ 32,988 $ 20,485 $ 12,503    61 % $ 7,936 $ 65,907 $ (57,971 ) (88)%
Operating margin
   1 % 3 % 8 % 6 %
Income before (benefit)/provision for income taxes
   $ 1,560 $ 5,498 $ (3,938 ) (72 )% $ 33,360 $ 18,991 $ 14,369    76 %
Net income
$ 12,200 $ 52,963 $ (40,763 ) (77)%
Revenue
~~Revenue~~Software license
~~Software license revenue~~

   Three Months Ended
June 30, Six Months Ended
June 30,
(Dollars in thousands)    2017 2016 Change 2017 2016 Change
Perpetual license
   $ 30,255    50 % $ 51,807    73 % $ (21,552 ) (42 )% $ 68,935    45 % $ 65,820    47 % $ 3,115    5 %
Term license
   30,782    50 % 18,864    27 % 11,918 63 % 84,492    55 % 73,196    53 % 11,296    15 %











Total license revenue
   $ 61,037    100 % $ 70,671    100 % $ (9,634 ) (14 )% $ 153,427    100 % $ 139,016    100 % $ 14,411    10 %











The mix between perpetual and term license arrangements executed in a particular period varies based on client needs. A change in the mix may cause our revenues to vary materially from period to period. A higher proportion of term license arrangements executed would generally result in more license revenue being recognized over longer periods. Additionally, some of our perpetual license arrangements include extended payment terms or additional rights of use, which may also result in the recognition of revenue over longer periods.
(Dollars in thousands)    Three Months Ended
March 31,
                   2018                                  2017                                         Change
Perpetual license
   $ 23,078    26% $ 37,899    30%    $ (14,821 )         (39)%
Term license
   64,695    74% 89,109    70%    (24,414 ) (27)%



Total software license
   $             87,773    100% $             127,008    100%    $           (39,235 ) (31)%



The decrease in perpetual license revenue in the three months ended ~~June 30, 2017~~March 31, 2018 was primarily due to a ~~lower percentage of perpetual arrangements executed and recognized in revenue in the current period and a~~ decrease in the ~~average value of perpetual arrangements executed. The increase in perpetual license revenue in the six months ended June 30, 2017 was primarily due to the higher~~ value of perpetual arrangements executed ~~and higher percentage of perpetual arrangements recognized~~ in ~~revenue during~~ the three months ended March 31, ~~2017 compared~~2018 driven primarily by a shift in client preferences to ~~the three months ended March 31, 2016.~~cloud arrangements.
The ~~increase~~decrease in term license revenue in the three months ended ~~June 30, 2017~~March 31, 2018 was primarily due to ~~an increase in revenue from term license backlog and~~ a large term license renewal for which the first year of the term was prepaid and recognized as revenue in the three months ended June 30, 2017. The increase in term license revenue in the six months ended June 30, 2017 was primarily due to revenue from term license backlog and a term license renewal for which the first year of the term was prepaid and recognized as revenue in the three months ended June 30, 2017, partially offset by the effect of a large three year term license arrangement ~~which was paid in advance and~~ recognized in ~~full~~revenue in the three months ended March 31, ~~2016.~~2017 and a shift in client preferences to cloud arrangements.
The aggregate value of future revenue expected to be recognized under all noncancellable perpetual licenses was $39.9 million as of June 30, 2017 compared to $31.4 million as of June 30, 2016. We expect to recognize $14.6 million of the $39.9 million as revenue during the remainder of 2017. The aggregate value of future revenue expected to be recognized under all noncancellable term and cloud licenses was $422.4 million as of June 30, 2017 compared to $309.3 million as of June 30, 2016. We expect to recognize $57.1 million of the $422.4 million as revenue during the remainder of 2017. See “Future Cash Receipts from Committed License and Cloud Arrangements” which can be found in “Liquidity and Capital Resources.”
Maintenance ~~revenue~~

   Three Months Ended
June 30,       Six Months Ended
June 30,       Three Months Ended
March 31,
(Dollars in thousands)    2017    2016    Change 2017    2016    Change         2018                 2017                         Change
Maintenance
   $ 59,590    $ 55,161    $ 4,429    8 % $ 118,555    $ 108,136    $ 10,419    10 % $ 64,525 $ 58,713 $ 5,812    10%
The ~~increases were~~increase in maintenance revenue was primarily due to the continued growth in the aggregate value of the installed base of our software and ~~continued~~ strong renewal rates significantly in excess of 90%.
Services ~~revenue~~

   Three Months Ended
June 30,    Six Months Ended
June 30,       Three Months Ended
March 31,
(Dollars in thousands)    2017 2016 Change 2017 2016 Change                    2018                                    2017                                      Change
Consulting services
   $ 62,660    81 % $ 50,258    79 % $ 12,402    25 % $ 121,912    82 % $ 97,434    81 % $ 24,478    25 %
Cloud
   12,733    16 % 11,269    18 % 1,464    13 % 23,560    16 % 19,767    16 % 3,793    19 %    $ 15,582 19% $ 10,402 15%    $ 5,180            50%
Training
   1,960    3 % 1,637    3 % 323    20 % 3,773    2 % 3,501    3 % 272    8 %
Consulting and training
   67,302 81% 60,186 85%    7,116    12%












��


Total services
   $ 77,353    100 % $ 63,164    100 % $ 14,189    22 % $ 149,245    100 % $ 120,702    100 % $ 28,543    24 %    $             82,884     100% $             70,588     100%    $         12,296    17%















~~Consulting services~~The increase in cloud revenue iswas primarily ~~generated from new license implementations.~~due to the continued growth of our cloud client base driven by a shift in client preferences to cloud arrangements.
The increase in consulting and training revenue was primarily due to higher billable hours during the three months ended March 31, 2018. Our consulting ~~services~~and training revenue may fluctuate in future periods depending on the mix of new implementation projects we perform as compared to those performed by our enabled clients or led by our partners.
The increases in consulting services revenue were primarily due to higher billable hours during the three and six months ended June 30, 2017 driven by a large project which began in the second half of 2016.
~~Cloud revenue represents revenue from our Pega Cloud offerings. The increases in cloud revenue were primarily due to continued growth of our cloud client base.~~
Gross profit

   Three Months Ended
June 30, Six Months Ended
June 30,       Three Months Ended
March 31,
(Dollars in thousands)    2017 2016 Change 2017 2016 Change                    2018                                     2017                                     Change
Software license
   $ 59,787 $ 69,359 $ (9,572 ) (14 )% $ 150,877 $ 136,683 $ 14,194    10 %    $ 86,518    99%    $ 125,708    99%    $ (39,190 ) (31)%
Maintenance
   52,579 48,846 3,733 8 % 104,326 95,906 8,420    9 %    58,443    91%    51,495    88%    6,948         13 %
Cloud
   7,861    50%    4,669    45%    3,192 68 %
Consulting and training
   6,746    10%    6,347    11%    399 6 %





Services
   17,739 10,691 7,048 66 % 30,059 18,655 11,404    61 %    14,607    18%    11,016    16%    3,591 33 %







Total gross profit
   $ 130,105 $ 128,896 $ 1,209 1 % $ 285,262 $ 251,244 $ 34,018    14 %    $             159,568        68%    $             188,219        73%    $           (28,651 ) (15) %







Total gross profit %
   66 % 68 % 68 % 68 %
Software license gross profit %
   98 % 98 % 98 % 98 %
Maintenance gross profit %
   88 % 89 % 88 % 89 %
Services gross profit %
   23 % 17 % 20 % 15 %
The ~~increase~~decrease in total gross profit in the three months ended March 31, 2018 was primarily due to ~~increased total revenue.~~a large term license arrangement recognized in revenue in the three months ended March 31, 2017. Additionally we have experienced a shift in client preferences to cloud arrangements, which are generally recognized in revenue over the term of the cloud contract, as compared to other arrangements, which are generally recognized in revenue on the contract effective date.
The increase in ~~service~~maintenance gross profit percent in the three months ended March 31, 2018 was driven by a ~~large project which began~~$0.5 million decrease in client support expenses as we transferred client support resources to support our growing cloud business.
The increase in cloud gross profit percent in the ~~second half of 2016.~~three months ended March 31, 2018 was driven by cost efficiency gains as our cloud business continues to grow and scale, partially offset by a $0.5 million increase in client support expenses as we expanded our cloud client support function to sustain our growing cloud business.
If we had transferred these resources on January 1, 2017, the change in maintenance and cloud gross profit and gross profit percent would have been as follows:
                   Three Months Ended
March 31,    Change
(Dollars in thousands)    2018    2017
Maintenance
   $             58,443          91%    $             51,995          89%    $             6,448                12%
Cloud
   $ 7,861    50%    $ 4,169    40%    $ 3,692    89%
Operating expenses
~~Operating expenses~~

Selling and marketing

   Three Months Ended
June 30,    Six Months Ended
June 30,
(Dollars in thousands)    2017 2016 Change 2017 2016 Change
Selling and marketing
   $ 75,887 $ 74,016 $ 1,871    3 % $ 147,175 $ 135,094 $ 12,081    9 %
As a percent of total revenue
   38 % 39 %    35 % 37 %
Selling and marketing headcount at June 30
      916 855 61    7 %

   Three Months Ended
March 31,    Change
(Dollars in thousands)    2018    2017
Selling and marketing
   $             88,383       $             69,681       $             18,702                    27%
As a percent of total revenue
   38%    27%
Selling and marketing headcount, end of period
   1,082       900       182    20%

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

The increase in the three ~~and six~~ months ended ~~June 30, 2017~~March 31, 2018 was primarily due to ~~increases~~an increase in compensation and benefits of $3$11.6 million, ~~and $10.7 million, respectively,~~ driven by increased ~~head count~~headcount and equity compensation, ~~partially offset by decreases~~amortization of deferred commissions, increased spending on event marketing and digital advertising, and the expenses associated with assigning contract negotiation resources to drive efficiencies in ~~brand marketing program expenses~~the sales process in support of ~~approximately $2.2 million in both periods.~~our long-term growth.

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

Research and development


	Three Months Ended June 30,										Six Months Ended June 30,										Three Months Ended March 31,				Change
(Dollars in thousands)	2017			2016			Change				2017			2016			Change				2018		2017		Change
Research and development	$	39,762		$	35,574		$	4,188	12	%	$	80,058		$	70,494		$	9,564	14	%	$	46,785	$	40,296	$	6,489	16%
As a percent of total revenue		20	%		19	%						19	%		19	%						20%		16%
Research and development headcount at June 30												1,455			1,374			81	6	%
Research and Development headcount, end of period																						1,602		1,441		161	11%

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

The ~~increases were~~increase in the three months ended March 31, 2018 was primarily due to ~~higher~~an increase in compensation and benefits ~~expense driven by~~of $4.6 million attributable to increased ~~head count~~headcount, and ~~equity compensation.~~the expansion of our application development team to support the continued development of our software.

General and administrative


	Three Months Ended June 30,										Six Months Ended June 30,										Three Months Ended March 31,				Change
(Dollars in thousands)	2017			2016			Change				2017			2016			Change				2018		2017		Change
General and administrative	$	12,706		$	11,294		$	1,412	13	%	$	25,041		$	22,342		$	2,699	12	%	$	16,464	$	12,335	$	4,129		33 %
As a percent of total revenue		6	%		6	%						6	%		6	%						7%		5%
General and administrative headcount at June 30												401			378			23	6	%
General and administrative headcount, end of period																						299		384		(85	)	(22)%

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

The increase in the three ~~and six~~ months ended ~~June 30, 2017~~March 31, 2018 was primarily due to ~~increases~~an increase in compensation and benefits of ~~$1.4~~$1.1 million, ~~and $3.5 million, respectively, caused by increased head count and~~attributable to equity compensation, ~~partially offset in six months ended June 30, 2017 by a decrease~~and an increase of ~~$1.5~~$1 million in legal fees. The decrease in headcount reflects the realignment of contract negotiation and product development resources to augment our selling and marketing and research development functions, respectively.

Stock-based compensation

   Three Months Ended
June 30,    Six Months Ended
June 30,
(Dollars in thousands)    2017 2016 Change 2017 2016 Change
Cost of revenues
   $ 3,677 $ 2,914 $ 763    26 % $ 7,299 $ 5,594 $ 1,705    30 %
Operating expenses
   10,255 7,967 2,288    29 % 19,141 14,222 4,919    35 %





Total stock-based compensation before tax
   $ 13,932 $ 10,881 $ 3,051    28 % $ 26,440 $ 19,816 $ 6,624    33 %





Income tax benefit
   $ (4,287 ) $ (3,085 )    $ (8,102 ) $ (5,690 )


	Three Months Ended March 31,				Change
(in thousands)	2018		2017		Change
Cost of revenues	$	3,701	$	3,622	$	79	2 %
Selling and marketing		4,658		3,405		1,253	37 %
Research and development		3,637		3,312		325	10 %
General and administrative		3,113		2,169		944	44 %

	$	15,109	$	12,508	$	2,601	21 %

Income tax benefit	$	(3,141)	$	(3,815)	$	674	(18)%

The ~~increases were~~increase was primarily due to the increased value of our annual periodic equity awards granted in March ~~2016~~2018 and 2017. These awards generally have a five-year vesting schedule.

~~Amortization of intangibles~~

   Three Months Ended
June 30,    Six Months Ended
June 30,
(Dollars in thousands)    2017    2016    Change 2017    2016    Change
Cost of revenue
   $ 1,305    $ 1,638    $ (333 ) (20 )% $ 2,639    $ 2,984    $ (345 ) (12 )%
Operating expenses
   1,869    1,966    (97 ) (5 )% 3,735    3,585    150 4 %









   $ 3,174    $ 3,604    $ (430 ) (12 )% $ 6,374    $ 6,569    $ (195 ) (3 )%

~~The decrease in amortization of intangibles in the three and six months ended June 30, 2017 was due to the amortization in full of certain intangibles acquired through past acquisitions.~~

Non-operating ~~income and expenses,~~ income/(expense), net

   Three Months Ended
June 30, Six Months Ended
June 30,
(Dollars in thousands)    2017 2016 Change 2017 2016 Change
Foreign currency transaction (loss) gain
   $ (917 ) $ 306 $ (1,223 ) (400 )% $ (241 ) $ 1,682 $ (1,923 ) (114 )%
Interest income, net
   161 188 $ (27 ) (14 )% 326 478 (152 ) (32 )%
Other income (expense), net
   566 (1,356 ) $ 1,922 (142 )% 287 (3,654 ) 3,941 (108 )%


Non-operating (loss) income
   $ (190 ) $ (862 ) $ 672 (78 )% $ 372 $ (1,494 ) $ 1,866 (125 )%


	Three Months Ended March 31,				Change
(Dollars in thousands)	2018		2017		Change
Foreign currency transaction (loss)/gain	$	(1,085)	$	745	$	(1,830)	n/m
Interest income, net		764		205		559	273 %
Other income/(expense), net		363		(279)		642	n/m

	$	42	$	671	$	(629)	(94)%

~~In May 2017, we discontinued our forward contracts program, however, we will continue~~n/m - not meaningful

The change in foreign currency transaction (loss)/gain is primarily due to ~~evaluate periodically our~~unrealized losses on foreign ~~exchange exposures and may re-initiate this program if it is deemed necessary.~~

~~Historically,~~currency denominated receivables. The adoption of ASC 606 materially increased the unbilled receivables we have ~~used foreign currency forward contracts (“forward contracts”) to hedge our exposure to~~recorded, which has increased 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 U.S. parent company in currencies other than the U.S. dollar and by our U.K. subsidiary in currencies other than the British pound. These forward contracts were not designated as hedging instruments. As a result, we record the fair value of the outstanding contracts at the end of the reporting periodreported in our unaudited condensed consolidated ~~balance sheet, with any fluctuations in the value~~statements of ~~these contracts recognized in other~~operations. See Item 3. “Quantitative and Qualitative Disclosures about Market Risk” for additional information.

(Benefit)/provision for income ~~(expense), net. See Note 4 “Derivative Instruments” of this Quarterly Report on Form 10-Q for discussion of our use of forward contracts.~~taxes

~~The total change in the fair value of our foreign currency forward contracts recorded in other income (expense), net, during~~


	Three Months Ended March 31,				Change
(Dollars in thousands)	2018		2017		Change
(Benefit)/provision for income taxes	$	(4,222)	$	13,615	$	(17,837)	n/m
Effective income tax rate		(53)%		20%

n/m - not meaningful

During the three months ended ~~June 30, 2017 and 2016 was a gain of $0.6 million and loss of $1.4 million, respectively. The total change in the fair value of~~March 31, 2018, our ~~foreign currency forward contracts recorded in other income (expense), net, during the six months ended June 30, 2017 and 2016 was a gain of $0.3 million and a loss of $3.7 million.~~

~~(Benefit)/provision for income taxes~~

   Three Months Ended
June 30, Six Months Ended
June 30,
(Dollars in thousands)    2017 2016 Change 2017 2016 Change
(Benefit)/provision for income taxes
   $ (9,846 ) $ 962 $ (10,808 ) (1,123 )% $ (5,067 ) $ 4,055 $ (9,122 ) (225 )%
Effective income tax rate
   (631 )% 17 % (15 )% 21 %

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

~~The decrease in the~~ effective ~~income~~ tax rate ~~in the three months ended June 30, 2017 is~~changed primarily due to the ~~significant increase of $10.2 million in~~ following factors:

excess tax benefits ~~generated by our stock~~from stock-based compensation ~~plans on significantly lower~~were disproportionately greater relative to income before (benefit)/provision for income ~~taxes, which decreased by $3.9 million.~~taxes;

~~The~~

a decrease in the estimated annual effective income tax rate ~~in the six months ended June 30, 2017 is~~ primarily due to the ~~significant~~reduction of the U.S. statutory federal tax rate from 35% to 21% pursuant to the Tax Reform Act; and

an increase ~~of $15.7 million~~ in ~~excess~~U.S. research and development tax ~~benefits generated by our stock compensation plans, partially offset by higher income before (benefit)/provision for income taxes, which increased $14.4 million.~~

credits.

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

~~Liquidity and capital resources~~LIQUIDITY AND CAPITAL RESOURCES

   Six Months Ended
June 30,
(in thousands)    2017    2016
Cash provided by (used in):

Operating activities
   $ 85,769    $ 11,569
Investing activities
   (1,159 )    (7,930 )
Financing activities
   (34,860 )    (31,666 )
Effect of exchange rate on cash
   1,282    (738 )




Net increase (decrease) in cash and cash equivalents
   $ 51,032    $ (28,765 )




   June 30,
2017    December 31,
2016
Total cash, cash equivalents, and marketable securities
   $ 180,040    $ 133,761

The increase in cash and cash equivalents during the six months ended June 30, 2017 was primarily due to the $74.2 million increase in cash provided by operating activities driven by the $42.1 million increase in cash provided by trade accounts receivable, largely due to the increase in cash collections and the timing of billings, and a $23.5 million increase in net income.


	Three Months Ended March 31,
(in thousands)	2018		2017
Cash provided by (used in):
Operating activities	$	55,655	$	32,444
Investing activities		(31,278)		(3,727)
Financing activities		(23,052)		(15,994)
Effect of exchange rates on cash and cash equivalents		2,186		521

Net increase in cash and cash equivalents	$	3,511	$	13,244


(in thousands)	March 31, 2018		December 31, 2017
Held in U.S. entities	$	168,135	$	136,444
Held in foreign entities		86,702		87,304

Total cash, cash equivalents, and marketable securities	$	254,837	$	223,748

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

We evaluate acquisition opportunities from time to time, which if pursued, could require use of our funds. On April 11, 2016, we acquired OpenSpan for $48.8 million in cash, net of cash acquired. As of June 30, 2017, $7.4 million of the cash consideration remained in escrow and will act as security for the indemnification obligations of the selling shareholders through October 2017. We paid $0.3 million during both the six months ended June 30, 2017 and 2016, representing additional cash consideration to the selling shareholders of one of the three companies acquired in 2014 based on the achievement of certain performance milestones.

~~As of June 30, 2017, approximately $56.9 million of our cash and cash equivalents was held in our foreign subsidiaries.~~ If it ~~becomes~~became necessary to repatriate ~~these~~foreign funds, we may be required to pay U.S. ~~tax, net of any applicable~~state and local taxes, as well as foreign ~~tax credits,~~taxes, upon repatriation. ~~We consider~~Due to the ~~earnings~~complexity of ~~our foreign subsidiaries to be permanently reinvested~~the income tax laws and ~~as a result, U.S. taxes on such earnings are not provided. It~~the effects of the Tax Reform Act, it is ~~impractical~~impracticable to estimate the amount of ~~U.S. tax~~taxes we ~~could~~would have to pay upon repatriation due to the complexity of the foreign tax credit calculations. There can be no assurance that changes in our plans or other events affecting our operations will not result in materially accelerated or unexpected expenditures.pay.

Cash provided by operating activities

The primary drivers during the ~~six~~three months ended ~~June 30, 2017~~March 31, 2018 were net income of ~~$38.4~~$12.2 million and ~~$53~~$49.6 million from ~~trade accounts receivable,~~receivables and contract assets, largely due to ~~the increase in~~increased cash collections and the timing of billings.

The primary driver during the ~~six~~three months ended ~~June 30, 2016~~March 31, 2017 was net income of ~~$14.9~~$53.0 million.

~~Future Cash Receipts from Committed License and Cloud Arrangements~~

As of June 30, 2017, none of the amounts shown in the table below had been billed and no revenue had been recognized. The timing of cash receipts may not coincide with the timing of future expected revenue recognition.

   June 30,2017
(in thousands)    Term and cloud contracts    Perpetual contracts ⁽¹⁾    Total
Remainder of 2017
   $ 57,075    $ 14,561    $ 71,636
2018
   141,523    18,739    160,262
2019
   111,585    4,773    116,358
2020
   74,300    1,521    75,821
2021
   31,077    355    31,432
2022 and thereafter
   6,854    —      6,854






Total
   $ 422,414    $ 39,949    $ 462,363

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

~~Total contractual future cash receipts due from our existing license and cloud arrangements were approximately $340.8 million as of June 30, 2016~~

Cash used in investing activities

During the ~~six~~three months ended ~~June 30, 2017,~~March 31, 2018, we purchased ~~$16.7~~investments of $35.2 million ~~of marketable debt securities~~ and made investments of $5$2.1 million in property and equipment, partially offset by proceeds received from maturities of ~~marketable debt securities~~investments (including called marketable debt securities) of ~~$20.8~~$6 million.

During the ~~six~~three months ended ~~June 30, 2016,~~March 31, 2017, we ~~made~~purchased investments of ~~$11.5~~$3.3 million, ~~in internally developed software and~~partially offset by proceeds received from maturities of investments (including called marketable debt securities) of $2.3 million. We also invested $2.4 million primarily for leasehold improvements for the build out of additional office space at our corporate headquarters in Cambridge, Massachusetts. We acquired OpenSpan for $48.8 million in cash, net of $1.8 million in cash acquired, which was funded through the sales of marketable debt securities of $52.5 million.Hyderabad, India location.

Cash used in financing activities

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

Since 2004, our Board of Directors has approved annual stock repurchase programs that have authorized the repurchase in the aggregate of up to $195 million of our common stock. Purchases under these programs have been made on the open market. As of March 31, 2018, $159.2 million had been repurchased, $29.2 million remained available for repurchase, and $6.4 million had expired.

~~The following table is a summary of our repurchase activity under all of our repurchase programs:~~Common stock repurchases

   Six Months Ended
June 30,
   2017    2016
(in thousands)    Shares    Amount    Shares    Amount
Authorization remaining, beginning of period
      $ 39,385       $ 40,534
Authorizations
      —         25,879
Repurchases paid
   68    (2,986 )    784    (19,005 )
Repurchases unsettled
   —      —      11    (297 )




Authorization remaining, end of period
      $ 36,399       $ 47,111


	Three Months Ended March 31,
	2018				2017
(in thousands)	Shares		Amount		Shares		Amount
Tax withholdings for net settlement of equity awards		270	$	15,575		289	$	12,504
Stock repurchase program⁽¹⁾
Repurchases paid		89		4,998		29		1,260
Repurchases unsettled at period end		12		690		5		238

Activity in Period⁽²⁾		371	$	21,263		323	$	14,002

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

During the six months ended June 30, 2017 and 2016, option and RSU holders net settled a total of 2 million shares and 1.1 million shares, respectively, of which only 1 million shares and 0.6 million shares, respectively, were issued to the option and RSU holders. The balance of the shares were surrendered to us to pay for the exercise price with respect to options and the applicable taxes for both options and RSUs. During the six months ended June 30, 2017 and 2016, instead of receiving cash from the equity holders, we withheld shares with a value of $27.9 million and $8.2 million, respectively, for withholding taxes, and $20.7 million and $5.8 million, respectively, for the exercise price of options.

⁽¹⁾

Represents activity under our publicly announced stock repurchase programs.

⁽²⁾

During the three months ended March 31, 2018 and 2017, instead of receiving cash from the equity holders, we withheld shares with a value of $11.2 million and $7.7 million for the exercise price of options. These amounts have been excluded from the table above.

Dividends

   Six Months Ended
June 30,
(per share)    2017    2016
Dividends Declared
   $ 0.06    $ 0.06
Dividends Paid
   $ 0.06    $ 0.06


	Three Months Ended March 31,
(per share)	2018	2017
Dividends declared	$ 0.03	$ 0.03

During the three months ended March 31, 2018 and 2017, we paid cash dividends of $2.3 million. It is our current intention to pay a quarterly cash dividend of $0.03 per share, however, the Board of Directors may terminate or modify this dividend program at any time without prior notice.

~~ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE~~

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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

Other than the item discussed ~~above,~~below, there were no significant changes to our ~~quantitative and qualitative disclosures about~~ market risk exposure during the first ~~six~~three months ended ~~June 30, 2017.~~ March 31, 2018.

See ~~Part II,~~ Item 7A. ~~Quantitative~~“Quantitative and Qualitative Disclosures about Market ~~Risk~~Risk” and Item 1A. “Risk Factors - We are exposed to fluctuations in currency exchange rates that could negatively impact our financial results and cash flows” included in our Annual Report on Form10-K for the year ended December 31, ~~2016~~2017 for a more complete discussion of our market risk exposure.

Foreign currency exposure

Translation Risk

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

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


	Three Months Ended March 31,
	2018	2017
Revenue	(4)%	(3)%
Net Income	(13)%	(4)%

Remeasurement Risk⁽¹⁾

We have experienced and expect to continue to experience fluctuations in our results of operations as a result of transaction gains or losses related to remeasuring monetary assets and liabilities that are denominated in currencies other than the functional currency of the entities in which they are recorded. We are primarily exposed to changes in foreign currency exchange rates associated with Australian dollar, Euro, and U.S. dollar denominated cash and cash equivalents, accounts receivable, unbilled receivables, and intercompany receivables and payables held by our U.K. subsidiary, a British pound functional entity.

A hypothetical 10% strengthening in the British pound exchange rate in comparison to the Australian dollar, Euro, and U.S. dollar would result in the following impact:



(Dollars in thousands)	March 31, 2018		December 31, 2017
Foreign currency transaction (loss)/gain	$	(8,200)	$	(5,800)

⁽¹⁾

The adoption of ASC 606 materially increased the unbilled receivables we have recorded, which has increased the impact of fluctuations in foreign exchange rates reported in our unaudited condensed consolidated statements of operations.

ITEM 4.

CONTROLS AND PROCEDURES

~~ITEM 4. CONTROLS AND PROCEDURES~~

(a) Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer ~~or CEO,~~(“CEO”) and Chief Financial Officer ~~or CFO,~~(“CFO”) evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules13a-15(e) and15d-15(e) under the Securities Exchange ~~Act)~~Act of 1934, as amended (“Exchange Act”)) as of ~~June 30, 2017.~~March 31, 2018. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of ~~June 30, 2017.~~March 31, 2018.

(b) Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting (as defined in Rules13a-15(f) and15d-15(f) under the ~~Securities~~ Exchange ~~Act)~~Act during the quarter ended ~~June 30, 2017~~March 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART ~~II—~~II - OTHER INFORMATION

~~ITEM 1A. RISK FACTORS~~

ITEM 1A.

RISK FACTORS

We encourage you to carefully consider the risk factors identified in ~~Part I,~~ Item 1A. “Risk Factors” inof our Annual Report onForm 10-K for the year ended December 31, ~~2016.~~2017. These risk factors could materially affect our business, financial condition, and future results and could cause our actual business and financial results to differ materially from those contained in forward-looking statements made in this Quarterly Report on Form10-Q or elsewhere by management from time to time. There have been no material changes during the ~~six~~three months ended ~~June 30, 2017~~March 31, 2018 to the risk factors disclosed in our Annual Report on Form10-K for the year ended December 31, ~~2016.~~2017.

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

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table sets forth information regarding our repurchases of our common stock during the three months ended ~~June 30, 2017:~~March 31, 2018:

Period
   Total
Number
of Shares
Purchased ⁽¹⁾    Average
Price
Paid per
Share⁽¹⁾    Total Number
of Shares
Purchased as Part
of Publicly
Announced Share
Repurchase
Programs⁽²⁾
(in thousands)    Approximate Dollar
Value of Shares That
May Yet Be Purchased
Under Publicly
Announced Share
Repurchase
Programs⁽²⁾
(in thousands)
April 1, 2017 - April 30, 2017
   28,350    $ 44.13    28,350    $ 36,636
May 1, 2017 - May 31, 2017
   5,130    46.19    5,130    36,399
June 1, 2017 - June 30, 2017
   —      —      —      36,399



Total
   33,480    $ 44.44


(in thousands, except per share amounts)	Total Number of Shares Purchased⁽¹⁾	Average Price Paid per Share⁽¹⁾	Total Number of Shares Purchased as Part of Publicly Announced Share Repurchase Program	Approximate Dollar Value of Shares That May Yet Be Purchased at Period End Under Publicly Announced Share Repurchase Programs⁽²⁾
January 1, 2018 - January 31, 2018	58	$ 49.63	21	$	33,855
February 1, 2018 - February 28, 2018	68	55.06	17		32,985
March 1, 2018 - March 31, 2018	435	59.37	63		29,204

Total	561	57.84

⁽¹⁾

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

⁽²⁾

Since 2004, our Board of Directors has approved stock repurchase programs that have authorized the repurchase, in the aggregate, of up to $195 million of our common stock. On May 30, 2017, we announced that our Board of Directors extended the expiration date of the current stock repurchase program to June 30, 2018 (the “Current Program”). Under the Current Program, purchases may be made

from time to time on the open market or in privately negotiated transactions. Shares may be repurchased in such amounts as market conditions warrant, subject to regulatory and other considerations. We have established apre-arranged stock repurchase plan, intended to comply with the requirements of Rule10b5-1 ~~under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Rule 10b-18~~ under the Exchange Act, and Rule10b-18 under the Exchange Act (the ~~“10b5-1~~“10b5-1 Plan”). All ~~share~~stock repurchases under the Current Program during closed trading window periods will be made pursuant to the10b5-1 Plan.

ITEM 6.

EXHIBITS

~~ITEM 6. EXHIBITS~~


Exhibit No.		Description

10.1++		2018 Executive Officers Base Salaries and Target Bonsus Percentages and Incentives (Filed as Exhibit 99.1 to the Registrant’s March 9, 2018 Form8-K and incorporated herein by reference).

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

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

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

101.INS		XBRL Instance document.

101.SCH		XBRL Taxonomy Extension Schema Document.

101.CAL		XBRL Taxonomy Calculation Linkbase Document.

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document.

101.LAB		XBRL Taxonomy Label Linkbase Document.

101.PRE		XBRL Taxonomy Presentation Linkbase Document.

~~The exhibits listed in~~ + Indicates that the ~~Exhibit Index immediately preceding such exhibits are filed or~~exhibit is being furnished ~~as the case may be, as part of~~with this report and ~~such Exhibit Index~~ is ~~incorporated herein by reference.~~not filed as a part of it.

++Management contracts and compensatory plan or arrangements

SIGNATURE

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


	Pegasystems Inc.

~~Date: August 9, 2017~~ Dated: May 10, 2018	By:	/s/ KENNETH STILLWELL
		Kenneth Stillwell
		Chief Financial Officer and Chief Administrative Officer
		(Principal Financial Officer)

~~PEGASYSTEMS INC.~~

~~EXHIBIT INDEX~~30


~~Exhibit No.~~		~~Description~~

~~10.1~~⁺⁺		~~First Amendment to the Pegasystems Inc. 2004 Long-Term Incentive Plan (As Amended And Restated)~~

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

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

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

~~101~~		The following materials from Pegasystems Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2017 formatted in XBRL (Extensible Business Reporting Language): (i) the Unaudited Condensed Consolidated Balance Sheets, (ii) the Unaudited Condensed Consolidated Statements of Operations, (iii) the Unaudited Condensed Consolidated Statements of Comprehensive Income, (iv) the Unaudited Condensed Consolidated Statements of Cash Flows, and (v) the Notes to Unaudited Condensed Consolidated Financial Statements.

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


	June 30, 2017
(in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
Municipal bonds	$	32,238	$	11	$	(30	)	$	32,219
Corporate bonds		26,234		3		(42	)		26,195

	$	58,472	$	14	$	(72	)	$	58,414


	December 31, 2016
(in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
Municipal bonds	$	36,746	$	—	$	(139	)	$	36,607
Corporate bonds		26,610		1		(51	)		26,560

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


	December 31, 2016
(in thousands)	Recorded In:	Fair Value
Asset Derivatives
Foreign currency forward contracts	Other current assets	$	628
Liability Derivatives
Foreign currency forward contracts	Accrued expenses	$	883


(in thousands)
Euro	€	24,735
British pound	£	7,885
Australian dollar	A$	25,830
Indian rupee	Rs	353,500
United States dollar	$	93,460


(in thousands)	Range of Remaining Useful Lives		Cost		Accumulated Amortization			Net Book Value
June 30, 2017
Customer related intangibles		4-10 years	$	63,132	$	(41,322	)	$	21,810
Technology		3-10 years		58,942		(42,908	)		16,034
Other intangibles		—		5,361		(5,361	)		—

			$	127,435	$	(89,591	)	$	37,844

December 31, 2016
Customer related intangibles		4-10 years	$	63,091	$	(37,573	)	$	25,518
Technology		3-10 years		58,942		(40,269	)		18,673
Other intangibles		—		5,361		(5,361	)		—

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


(in thousands)
Remainder of 2017	$	5,953
2018		11,343
2019		5,551
2020		2,655
2021		2,631
2022 and thereafter		9,711

	$	37,844


(Dollars in thousands, except per share amounts)	Three Months Ended March 31,
(Dollars in thousands, except per share amounts)	2018		2017		Change
Total revenue	$	235,182	$	256,309	$	(21,127	)	(8)%
Net income	$	12,200	$	52,963	$	(40,763	)	(77)%
Diluted earnings per share	$	0.15	$	0.65	$	(0.50	)	(77)%
Cash provided by operating activities	$	55,655	$	32,444	$	23,211		72%


	June 30,
(Dollars in thousands)	2017				2016				Change
Deferred license and cloud revenue on the balance sheet:
Term license and cloud	$	25,104	45	%	$	19,021	37	%		32	%
Perpetual license		30,542	55	%		32,834	63	%		(7	)%

Total deferred license and cloud revenue		55,646	100	%		51,855	100	%		7	%

License and cloud contractual commitments not on the balance sheet:
Term license and cloud		422,414	91	%		309,338	91	%		37	%
Perpetual license		39,949	9	%		31,439	9	%		27	%

Total license and cloud commitments		462,363	100	%		340,777	100	%		36	%

Total license (term and perpetual) and cloud backlog	$	518,009			$	392,632				32	%

Total term license and cloud backlog		447,518	86	%		328,359	84	%		36	%


	March 31,
(in thousands)	2018		2017		Change
Term and Cloud ACV	$	236,025	$	193,004	$	43,021	22%
Maintenance ACV		258,100		234,852	$	23,248	10%

Total ACV	$	494,125	$	427,856	$	66,269	15%


	Three Months Ended June 30,								Six Months Ended June 30,								Three Months Ended March 31,
(Dollars in thousands)	2017		2016		Change				2017		2016		Change				2018		2017		Change
Maintenance	$	59,590	$	55,161	$	4,429	8	%	$	118,555	$	108,136	$	10,419	10	%	$	64,525	$	58,713	$	5,812	10%


	June 30,2017
(in thousands)	Term and cloud contracts		Perpetual contracts ⁽¹⁾		Total
Remainder of 2017	$	57,075	$	14,561	$	71,636
2018		141,523		18,739		160,262
2019		111,585		4,773		116,358
2020		74,300		1,521		75,821
2021		31,077		355		31,432
2022 and thereafter		6,854		—		6,854

Total	$	422,414	$	39,949	$	462,363


Period	Total Number of Shares Purchased ⁽¹⁾		Average Price Paid per Share⁽¹⁾		Total Number of Shares Purchased as Part of Publicly Announced Share Repurchase Programs⁽²⁾ (in thousands)		Approximate Dollar Value of Shares That May Yet Be Purchased Under Publicly Announced Share Repurchase Programs⁽²⁾ (in thousands)
April 1, 2017 - April 30, 2017		28,350	$	44.13		28,350	$	36,636
May 1, 2017 - May 31, 2017		5,130		46.19		5,130		36,399
June 1, 2017 - June 30, 2017		—		—		—		36,399

Total		33,480	$	44.44