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 September 30, 2017

2019

OR

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

For the transition period fromto


Commission File Number:1-11859

____________________________

PEGASYSTEMS INC.

(Exact name of Registrant as specified in its charter)

____________________________
Massachusetts04-2787865

(State or other jurisdiction of

incorporation or organization)

(IRS Employer Identification No.)
 

(IRS Employer

Identification No.)

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

(617)

(617) 374-9600

(Registrant’s telephone number, including area code)

____________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading symbol(s)Name of each exchange on which registered
Common Stock, $.01 par value per sharePEGANASDAQ Global Select Market
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  ☒    x No

¨

Indicate by check mark whether the registrantRegistrant 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 registrantRegistrant was required to submit and post such files). Yes  ☒    x No

¨

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

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

If an emerging growth company, indicate by check mark if the registrantRegistrant 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 77,859,95879,332,662 shares of the Registrant’s common stock, $.01$0.01 par value per share, outstanding on October 27, 2017.


31, 2019. 


PEGASYSTEMS INC.

Index to Form


QUARTERLY REPORT ON FORM 10-Q


TABLE OF CONTENTS

 Page
PagePART I - FINANCIAL INFORMATION
 

PART I—FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements

 

Unaudited Condensed Consolidated Balance Sheets as of September 30, 20172019 and December 31, 2016

2018
2

Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 20172019 and 2016

2018
3

Unaudited Condensed Consolidated Statements of Comprehensive Income(Loss) for the three and nine months ended September 30, 20172019 and 2016

2018
4

Unaudited Condensed Consolidated Statements of Stockholders’ Equity for the nine months ended September 30, 2019 and 2018

Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 20172019 and 2016

2018
5

Notes to Unaudited Condensed Consolidated Financial Statements

6

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

15

Item 3. Quantitative and Qualitative Disclosures About Market Risk

25

Item 4. Controls and Procedures

 25 
PART II - OTHER INFORMATION

PART II—OTHER INFORMATION

Item 1A. Risk Factors

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

Item 5. Other Information
Item 6. Exhibits25
 

Item 6. Exhibits

Signature
26

27


PART I—I - FINANCIAL INFORMATION

ITEM 1.UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

ITEM 1.     UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

   September 30,
2017
  December 31,
2016
 

Assets

   

Current assets:

   

Cash and cash equivalents

  $130,568  $70,594 

Marketable securities

   63,812   63,167 
  

 

 

  

 

 

 

Total cash, cash equivalents, and marketable securities

   194,380   133,761 

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

   191,161   265,028 

Income taxes receivable

   34,864   14,155 

Other current assets

   17,679   12,188 
  

 

 

  

 

 

 

Total current assets

   438,084   425,132 

Property and equipment, net

   39,849   38,281 

Deferred income taxes

   73,459   69,898 

Long-term other assets

   5,982   3,990 

Intangible assets, net

   34,755   44,191 

Goodwill

   72,941   73,164 
  

 

 

  

 

 

 

Total assets

  $665,070  $654,656 
  

 

 

  

 

 

 

Liabilities and Stockholders’ Equity

   

Current liabilities:

   

Accounts payable

  $12,535  $14,414 

Accrued expenses

   39,681   36,751 

Accrued compensation and related expenses

   53,869   60,660 

Deferred revenue

   160,931   175,647 
  

 

 

  

 

 

 

Total current liabilities

   267,016   287,472 

Income taxes payable

   4,774   4,263 

Long-term deferred revenue

   6,130   10,989 

Other long-term liabilities

   15,449   16,043 
  

 

 

  

 

 

 

Total liabilities

   293,369   318,767 
  

 

 

  

 

 

 

Stockholders’ equity:

   

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

   —     —   

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

   778   766 

Additionalpaid-in capital

   146,728   143,903 

Retained earnings

   227,953   198,315 

Accumulated other comprehensive loss

   (3,758  (7,095
  

 

 

  

 

 

 

Total stockholders’ equity

   371,701   335,889 
  

 

 

  

 

 

 

Total liabilities and stockholders’ equity

  $665,070  $654,656 
  

 

 

  

 

 

 


 September 30, 2019 December 31, 2018
Assets   
Current assets:   
Cash and cash equivalents$92,104

$114,422
Marketable securities20,465

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

180,872
Unbilled receivables172,090

172,656
Other current assets58,204

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

151,237
Goodwill78,862

72,858
Other long-term assets248,069

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

$16,487
Accrued expenses41,520

45,506
Accrued compensation and related expenses88,349

84,671
Deferred revenue159,849

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

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

785
Additional paid-in capital129,559

123,205
Retained earnings412,389

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

See notes to unaudited condensed consolidated financial statements.


PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

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

Revenue:

     

Software license

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

Maintenance

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

Services

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

 

 

  

 

 

  

 

 

  

 

 

 

Total revenue

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

 

 

  

 

 

  

 

 

  

 

 

 

Cost of revenue:

     

Software license

   1,276   1,313   3,826   3,646 

Maintenance

   6,716   6,659   20,945   18,889 

Services

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

 

 

  

 

 

  

 

 

  

 

 

 

Total cost of revenue

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

 

 

  

 

 

  

 

 

  

 

 

 

Gross profit

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

 

 

  

 

 

  

 

 

  

 

 

 

Operating expenses:

     

Selling and marketing

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

Research and development

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

General and administrative

   13,133   11,725   38,174   34,067 

Acquisition-related

   —     74   —     2,903 
  

 

 

  

 

 

  

 

 

  

 

 

 

Total operating expenses

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

 

 

  

 

 

  

 

 

  

 

 

 

(Loss)/income from operations

   (14,289  5,498   18,699   25,983 

Foreign currency transaction (loss)/gain

   (552  1,082   (793  2,764 

Interest income, net

   144   172   470   650 

Other income/(expense), net

   —     (1,237  287   (4,891
  

 

 

  

 

 

  

 

 

  

 

 

 

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

   (14,697  5,515   18,663   24,506 

(Benefit)/provision for income taxes

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

 

 

  

 

 

  

 

 

  

 

 

 

Net (loss)/income

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

 

 

  

 

 

  

 

 

  

 

 

 

(Loss)/earnings per share:

     

Basic

   (0.03  0.04   0.47   0.24 

Diluted

   (0.03  0.04   0.44   0.23 

Weighted-average number of common shares outstanding:

     

Basic

   77,691   76,278   77,258   76,323 

Diluted

   77,691   79,548   82,717   79,401 

Cash dividends declared per share

  $0.03  $0.03  $0.09  $0.09 



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

See notes to unaudited condensed consolidated financial statements.


PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(LOSS)

(in thousands)

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

Net (loss)/income

  $(1,812 $3,301  $36,615   $18,237 

Other comprehensive income/(loss), net of tax

      

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

   22   (174  148    168 

Foreign currency translation adjustments

   549   (169  3,189    (1,400
  

 

 

  

 

 

  

 

 

   

 

 

 

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

   571   (343  3,337    (1,232
  

 

 

  

 

 

  

 

 

   

 

 

 

Comprehensive (loss)/income

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

 

 

  

 

 

  

 

 

   

 

 

 


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

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

   Nine Months Ended
September 30,
 
   2017  2016 

Operating activities:

   

Net income

  $36,615  $18,237 

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

   

Deferred income taxes

   (2,607  (2,841

Depreciation and amortization

   18,703   17,896 

Stock-based compensation expense

   39,929   30,634 

Foreign currency transaction loss/(gain)

   793   (2,764

Othernon-cash

   (89  153 

Change in operating assets and liabilities:

   

Trade accounts receivable

   80,580   3,940 

Income taxes receivable and other current assets

   (25,943  (11,904

Accounts payable and accrued expenses

   (8,546  (16,678

Deferred revenue

   (25,639  (17,698

Other long-term assets and liabilities

   130   1,581 
  

 

 

  

 

 

 

Cash provided by operating activities

   113,926   20,556 

Investing activities:

   

Purchases of marketable securities

   (25,687  (22,614

Proceeds from maturities and called marketable securities

   23,124   21,838 

Sales of marketable securities

   —     62,283 

Payments for acquisitions, net of cash acquired

   (297  (49,113

Investment in property and equipment

   (9,106  (15,253
  

 

 

  

 

 

 

Cash used in investing activities

   (11,966  (2,859

Financing activities:

   

Dividend payments to shareholders

   (6,941  (6,883

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

   (34,113  (10,398

Common stock repurchases under share repurchase programs

   (2,986  (25,750
  

 

 

  

 

 

 

Cash used in financing activities

   (44,040  (43,031

Effect of exchange rates on cash and cash equivalents

   2,054   (1,309
  

 

 

  

 

 

 

Net increase/(decrease) in cash and cash equivalents

   59,974   (26,643

Cash and cash equivalents, beginning of period

   70,594   93,026 
  

 

 

  

 

 

 

Cash and cash equivalents, end of period

  $130,568  $66,383 
  

 

 

  

 

 

 


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

 Common Stock 
Additional
Paid-In Capital
 Retained Earnings 
Accumulated Other Comprehensive (Loss) Income 
 
Total
Stockholders’ Equity
 Number
of Shares
 Amount    
December 31, 201778,081
 $781
 $152,097
 $509,697
 $(6,705) $655,870
Repurchase of common stock(101) (1) (5,688) 
 
 (5,689)
Issuance of common stock for share-based compensation plans566
 5
 (15,556) 
 
 (15,551)
Stock-based compensation
 
 15,109
 
 
 15,109
Cash dividends declared ($0.12 per share)
 
 
 (2,355) 
 (2,355)
Other comprehensive income
 
 
 
 4,262
 4,262
Net income
 
 
 12,200
 
 12,200
March 31, 201878,546
 785
 145,962
 519,542
 (2,443) 663,846
Repurchase of common stock(171) (2) (10,179) 
 
 (10,181)
Issuance of common stock for share-based compensation plans358
 4
 (11,395) 
 
 (11,391)
Issuance of common stock under Employee Stock Purchase Plan15
 
 849
 
 
 849
Stock-based compensation
 
 16,163
 
 
 16,163
Cash dividends declared ($0.12 per share)
 
 
 (2,364) 
 (2,364)
Other comprehensive (loss)
 
 
 
 (7,341) (7,341)
Net (loss)
 
 
 (10,409) 
 (10,409)
June 30, 201878,748
 787
 141,400
 506,769
 (9,784) 639,172
Repurchase of common stock(242) (2) (14,277) 
 
 (14,279)
Issuance of common stock for share-based compensation plans310
 3
 (8,399) 
 
 (8,396)
Stock-based compensation
 
 16,408
 

 
 16,408
Cash dividends declared ($0.12 per share)
 
 
 (2,367) 
 (2,367)
Other comprehensive (loss)
 
 
 
 (2,096) (2,096)
Net (loss)
 
 
 (7,587) 
 (7,587)
September 30, 201878,816
 $788
 $135,132
 $496,815
 $(11,880) $620,855
See notes to unaudited condensed consolidated financial statements.

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

 Common Stock 
Additional
Paid-In Capital
 Retained Earnings 
Accumulated Other Comprehensive (Loss) Income 
 
Total
Stockholders’ Equity
 Number
of Shares
 Amount    
December 31, 201878,526
 $785
 $123,205
 $510,863
 $(13,322) $621,531
Repurchase of common stock(144) (1) (7,586) 
 
 (7,587)
Issuance of common stock for share-based compensation plans514
 5
 (14,843) 
 
 (14,838)
Stock-based compensation
 
 18,406
 
 
 18,406
Cash dividends declared ($0.12 per share)
 
 
 (2,367) 
 (2,367)
Other comprehensive income
 
 
 
 2,001
 2,001
Net (loss)
 
 
 (28,717) 
 (28,717)
March 31, 201978,896
 789
 119,182
 479,779
 (11,321) 588,429
Repurchase of common stock(88) (1) (6,301) 
 
 (6,302)
Issuance of common stock for share-based compensation plans320
 3
 (11,217) 
 
 (11,214)
Issuance of common stock under Employee Stock Purchase Plan16
 
 1,103
 
 
 1,103
Stock-based compensation
 
 20,113
 
 
 20,113
Cash dividends declared ($0.12 per share)
 
 
 (2,375) 
 (2,375)
Other comprehensive (loss)
 
 
 
 (171) (171)
Net (loss)
 
 
 (32,296) 
 (32,296)
June 30, 201979,144
 791
 122,880
 445,108
 (11,492) 557,287
Repurchase of common stock(88) (1) (6,396) 
 
 (6,397)
Issuance of common stock for share-based compensation plans268
 3
 (8,804) 
 
 (8,801)
Stock-based compensation
 
 21,879
 
 
 21,879
Cash dividends declared ($0.12 per share)
 
 
 (2,381) 
 (2,381)
Other comprehensive (loss)
 
 
 
 (2,417) (2,417)
Net (loss)
 
 
 (30,338) 
 (30,338)
September 30, 201979,324
 $793
 $129,559
 $412,389
 $(13,909) $528,832

See notes to unaudited condensed consolidated financial statements.


PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

 Nine Months Ended
September 30,
 2019 2018
Operating activities   
Net (loss)$(91,351) $(5,796)
Adjustments to reconcile net (loss) to cash (used in) provided by operating activities   
Stock-based compensation60,242
 47,573
Amortization and depreciation50,622
 31,742
Deferred income taxes(40,531) (1,388)
Foreign currency transaction loss (gain)3,577
 (558)
Other non-cash(363) (1,377)
Change in operating assets and liabilities, net4,342
 (3,108)
Cash (used in) provided by operating activities(13,462) 67,088
Investing activities

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

See notes to unaudited condensed consolidated financial statements.
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.

2018.

In the opinion of management, the Company has prepared the accompanying unaudited condensed consolidated financial statements on the same basis as its audited financial statements, and these financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented.
The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year 2017.

2019.

2. NEW ACCOUNTING PRONOUNCEMENTS

Stock-Based Compensation

Leases
On January 1, 2019, the Company adopted Accounting Standards Codification 842 “Leases” (“ASC 842”) using the modified retrospective method, reflecting any cumulative effect as an adjustment to equity. Results for reporting periods beginning on or after January 1, 2019 are presented under ASC 842, while prior period amounts were not adjusted and continue to be reported in accordance with the Company’s historical accounting under ASC 840 “Leases”.
The Company elected the permitted practical expedients to not reassess the following related to leases that commenced before the effective date of ASC 842: (i) whether any expired or existing contracts contain leases; (ii) the lease classification for any expired or existing leases; and (iii) initial direct costs for any existing leases. Upon adoption, the Company recorded right of use assets of $41.8 million and lease liabilities of $54.2 million. The difference between the value of the right of use assets and lease liabilities is due to the reclassification of existing deferred rent, prepaid rent, and unamortized lease incentives as of January 1, 2019.
See Note 9. “Leases” for additional information.
Financial instruments
In May 2017,June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)No. 2017-09 “Stock Compensation (Topic 718), Scope of Modification Accounting” to clarify when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The effective date for the Company will be January 1, 2018. The Company does not expect the adoption of this standard to have a material effect on its financial position or results of operations.

Financial Instruments

In June 2016, the FASB issued 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.model. Credit losses relating toavailable-for-sale debt securities should be recorded through an allowance for credit losses when the fair value is below the amortized cost of the asset, removing the concept of “other-than-temporary” impairments. The effective date for the Company will be January 1, 2020, with early adoption permitted. The Company is currently evaluatingdoes not expect the effectadoption of this ASUstandard will have a material effect 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 itsposition or results of operations and cash flows.

Revenue

Inoperations.

3. MARKETABLE SECURITIES
 September 30, 2019
(in thousands)Amortized Cost Unrealized Gains Unrealized Losses Fair Value
Municipal bonds$10,680
 $69
 $
 $10,749
Corporate bonds9,611
 105
 
 9,716
 $20,291
 $174
 $
 $20,465
 December 31, 2018
(in thousands)Amortized Cost Unrealized Gains Unrealized Losses Fair Value
Municipal bonds$44,802
 $13
 $(110) $44,705
Corporate bonds48,499
 23
 (226) 48,296
 $93,301
 $36
 $(336) $93,001

As of September 30, 2019, maturities of marketable securities ranged from May 2014, the FASB issued ASUNo. 2014-09, “Revenue from Contracts2020 to August 2022, with Customers (Topic 606)”. This ASU amends the guidance for revenue recognition, creating the new Accounting Standards Codification Topic 606 (“ASC 606”). ASC 606 requires entities to apportion consideration from contracts to performance obligations on a relative standalone selling price basis, based on a five-step model. Under ASC 606, revenue is recognized when a customer obtains controlweighted-average remaining maturity of a promised good or service and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for the good or service. In addition, ASC 606 requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

The Company has elected the full retrospective adoption model, effective January 1, 2018. The Company’s quarterly results beginning with the quarter ending March 31, 2018 and comparative prior periods will be compliant with ASC 606. The Company’s Annual Report on Form10-K for the year ended December 31, 2018 will be the Company’s first Annual Report that will be issued in compliance with ASC 606.

approximately 1.5 years.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

The Company expects the following impacts:

Currently, the Company recognizes revenue from term licenses and perpetual licenses with extended payment terms over the term of the agreement as payments become due or earlier if prepaid, provided all other criteria


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

$419,320
 $504,765

Unbilled receivables are client committed amounts for which revenue recognition have been met,precedes billing, 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 termsbilling is recognized when control is transferredsolely subject to the customer. Any unrecognized licensepassage of time.
Unbilled receivables are expected to be billed in the future as follows:
(Dollars in thousands)September 30, 2019
1 year or less$172,090
59%
1-2 years84,045
28%
2-5 years39,917
13%
 $296,052
100%

Contract assets and deferred revenue from these arrangements,
(in thousands)September 30, 2019 December 31, 2018
Contract assets (1)
$5,046
 $3,711
Long-term contract assets (2)
2,381
 2,543
 $7,427
 $6,254
(1) Included in other current assets. (2) Included in other long-term assets.
(in thousands)September 30, 2019 December 31, 2018
Deferred revenue$159,849
 $185,145
Long-term deferred revenue (1)
4,029
 5,344
 $163,878
 $190,489
(1) Included in other long-term liabilities.
Contract assets are client committed amounts for which revenue recognized exceeds the amount billed to the client and the right to payment is subject to conditions other than the passage of time, such as the completion of a related performance obligation. Deferred revenue consists of billings and payments received in advance of revenue recognition. Contract assets and deferred revenue are netted at the contract level for each reporting period.
The change in deferred revenue in the nine months ended September 30, 2019 was primarily due to revenue recognized during the period that was included in deferred revenue at December 31, 2015, will2018, partially offset by new billings in advance of revenue recognition.
5. DEFERRED CONTRACT COSTS
The Company recognizes an asset for the incremental costs of obtaining a client contract, which relate to sales commissions. The Company expects to benefit from those costs for more than one year, as the Company generally only pays sales commissions on the initial contract and not be recognized in revenue in future periods but asany subsequent contract renewals. As a cumulative adjustment to retained earnings. Further, term license revenue from new arrangements executed in 2016 and 2017 will be recognized in full in the year that control of the license is transferred to the customer instead of over the term of the agreement. Revenue from the maintenance performance obligations is expected to be recognizedresult, there are no commensurate commissions paid on contract renewals. Deferred costs are amortized on a straight-line basis over the contractual term. Due to the revenue from term and perpetual licenses with extended payment terms being recognized prior to amounts being billed to the customer, the Company expects to recognize a net contract asset on the balance sheet.

Currently, the Company allocates revenue to licenses under the residual method when it has Vendor Specific Objective Evidence (“VSOE”) for the remaining undelivered elements, which allocates any future credits or significant discounts entirely to the license. The adoption of ASC 606 will result in future credits, significant discounts, and material rights under ASC 606, to be allocated to all performance obligations based upon their relative selling price. Under ASC 606, additional license revenue from the reallocation of such arrangement considerations will be recognized when control is transferred to the customer,benefit period, which is generally upon delivery of the license.on average 5 years.

Currently, the Company does not have VSOE for fixed price services, time
(in thousands)September 30, 2019 December 31, 2018
Deferred contract costs (1)
$67,182
 $64,367
(1) Included in other long-term assets.
 Three Months Ended
September 30,
 Nine Months Ended
September 30,
(in thousands)2019 2018 2019 2018
Amortization of deferred contract costs (1)
$8,193
 $4,208
 $22,372
 $11,806
(1)Included in selling and materials services in certain geographical areas, and unspecified future products, which results in revenue being deferred in such instances until such time as VSOE exists for all undelivered elements or recognized ratably over the longest performance period. The adoption of ASC 606 eliminates the requirement for VSOE and replaces it with the concept of a stand-alone selling price. Once the transaction price is allocated to each of the performance obligations, the Company can recognize revenue as the performance obligations are delivered, either at a point in time or over time. Under ASC 606, license revenue will be recognized when control is transferred to the customer, professional services revenue will be recognized over time based on input or output measures that reflect the Company’s performance on the contract. This will result in the acceleration of professional services revenue when compared to the current practice of ratable recognition for professional services when there is a lack of VSOE.marketing expenses.

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

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

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

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

3. MARKETABLE SECURITIES




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

(1) In May 2019, the Company acquired In the Chat Communications Inc., a privately-held software provider of digital customer service software, for $10.9 million, net of cash acquired. The Company also expects to issue up to approximately 15 thousand shares in retention-based bonus payments to a key employee upon the achievement of specified retention milestones. The principal assets and liabilities acquired as part of the business combination were additional goodwill and technology intangible assets of $6.2 million and $5.1 million.
Intangibles
Intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives as follows:

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

September 30, 2017

        

Municipal bonds

  $32,764   $12  ��$(17  $32,759 

Corporate bonds

   31,079    12    (38   31,053 
  

 

 

   

 

 

   

 

 

   

 

 

 
  $63,843   $24   $(55  $63,812 
  

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2016

        

Municipal bonds

  $36,746   $—     $(139  $36,607 

Corporate bonds

   26,610    1    (51   26,560 
  

 

 

   

 

 

   

 

 

   

 

 

 
  $63,356   $1   $(190  $63,167 
  

 

 

   

 

 

   

 

 

   

 

 

 

As

   September 30, 2019
(in thousands)Useful Lives Cost Accumulated
Amortization
 
Net Book Value (1)
Client-related4-10 years $63,089
 $(53,960) $9,129
Technology2-10 years 64,843
 (53,252) 11,591
Other1 - 5 years 5,361
 (5,361) 
   $133,293
 $(112,573) $20,720
(1) Included in other long-term assets.
   December 31, 2018
(in thousands)Useful Lives Cost Accumulated Amortization 
Net Book Value (1)
Client-related4-10 years $63,115
 $(51,224) $11,891
Technology2-10 years 59,742
 (50,398) 9,344
Other1 - 5 years 5,361
 (5,361) 
   $128,218
 $(106,983) $21,235
(1) Included in other long-term assets.
Amortization of September 30, 2017, the Company did not hold any investments with unrealized losses that are considered to be other-than-temporary.

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

4. DERIVATIVE INSTRUMENTS

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

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

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

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

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

Asset Derivatives

    

Foreign currency forward contracts

   Other current assets   $628 

Liability Derivatives

    

Foreign currency forward contracts

   Accrued expenses   $883 

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

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

(in thousands)    

Euro

  21,810 

British pound

  £5,919 

Australian dollar

  A$    19,515 

United States dollar

  $59,450 

intangible assets was:

(in thousands)Three Months Ended
September 30,
 Nine Months Ended
September 30,
2019 2018 2019 2018
Cost of revenue$647
 $1,232
 $2,854
 $3,695
Selling and marketing370
 1,603
 2,754
 4,813
 $1,017
 $2,835
 $5,608
 $8,508

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

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

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

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

  $—     $(1,237  $286   $(4,955

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

   (552   1,082    (793   2,764 
  

 

 

   

 

 

   

 

 

   

 

 

 
  $(552  $(155  $(507  $(2,191
  

 

 

   

 

 

   

 

 

   

 

 

 

5.




8. FAIR VALUE MEASUREMENTS

Assets and Liabilities Measuredliabilities measured at Fair Valuefair value on a Recurring Basis

recurring basis

The Company records its money market funds,cash equivalents, marketable securities, and forward contractsinvestments 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 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 partythird-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 allinvestments in privately-held companies are classified within Level 23 of the fair value hierarchy, are valued based on the notional amounts and rates under the contracts and observable market inputs such as currency exchange rates and credit risk. hierarchy.
If applicable, the Company will recognize transfers into and out of levels within the fair value hierarchy at the end of the reporting period in which the actual event or change in circumstance occurs. There were no transfers between Level 1 and Level 2levels during the nine months ended September 30, 2017.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

2019.

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

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

September 30, 2017

          

Fair Value Assets:

          

Money market funds

  $    655   $—         $655 

Marketable securities:

          

Municipal bonds

  $—     $32,759        32,759 

Corporate bonds

   —      31,053        31,053 
  

 

 

   

 

 

       

 

 

 
  $—     $63,812       $63,812 

December 31, 2016

          

Fair Value Assets:

          

Money market funds

  $458   $—         $458 

Marketable securities:

          

Municipal bonds

  $—     $36,607       $36,607 

Corporate bonds

   —      26,560        26,560 
  

 

 

   

 

 

       

 

 

 
  $—     $63,167       $63,167 

Foreign currency forward contracts

   —      628        628 

Fair Value Liabilities:

          

Foreign currency forward contracts

  $—     $883       $883 

were:

 September 30, 2019
(in thousands)Level 1 Level 2 Level 3 Total
Cash equivalents$88
 $
 $
 $88
Marketable securities:       
Municipal bonds$
 $10,749
 $
 $10,749
Corporate bonds
 9,716
 
 9,716
Total marketable securities$
 $20,465
 $
 $20,465
Investments in privately-held companies (1)
$
 $
 $4,583
 $4,583
(1) Included in other long-term assets.
 December 31, 2018
(in thousands)Level 1 Level 2 Level 3 Total
Cash equivalents$10,155
 $10,000
 $
 $20,155
Marketable securities:       
Municipal bonds$
 $44,705
 $
 $44,705
Corporate bonds
 48,296
 
 48,296
Total marketable securities$
 $93,001
 $
 $93,001
Investments in privately-held companies (1)
$
 $
 $3,390
 $3,390
(1) Included in other long-term assets.
For certain other financial instruments, including accounts receivable and accounts payable, the carrying value approximates their fair value due to the relatively short maturity of these items.

Assets Measured

9. LEASES
The Company’s leases are primarily for office space used in the ordinary course of business.
Accounting policy
All the Company’s leases are operating leases. The Company accounts for a contract as a lease when it has the right to control the asset for a period of time while obtaining substantially all of the asset’s economic benefits. The Company determines the initial classification and measurement of its operating right of use assets and lease liabilities at Fair Valuethe lease commencement date and thereafter if modified. Fixed lease costs are recognized on a Nonrecurring Basis

Assets recorded at fair value on a nonrecurringstraight-line basis such as property and equipment and intangible assets,over the term of the lease. Variable lease costs are recognized at fair value when they are impaired. Duringin the nine months ended September 30, 2017period in which the obligation for those payments is incurred. The Company combines lease and 2016,non-lease components in the determination of lease costs for its office space leases. The lease liability includes lease payments related to options to extend or renew the lease term if the Company did not recognize any impairments of its assets recorded at fair value on a nonrecurring basis.

6. TRADE ACCOUNTS RECEIVABLE, NET OF ALLOWANCE

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

Trade accounts receivable

  $164,530   $234,473 

Unbilled trade accounts receivable

   32,820    34,681 
  

 

 

   

 

 

 

Total trade accounts receivable

   197,350    269,154 

Allowance for sales credit memos

   (6,189   (4,126
  

 

 

   

 

 

 
  $191,161   $265,028 
  

 

 

   

 

 

 

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

7. GOODWILL AND OTHER INTANGIBLE ASSETS

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

(in thousands)    

Balance as of January 1,

  $73,164 

Purchase price adjustments to goodwill

   (354

Currency translation adjustments

   131 
  

 

 

 

Balance as of September 30,

  $72,941 
  

 

 

 

is

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Intangible




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

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

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

September 30, 2017

        

Customer related intangibles

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

Technology

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

Other intangibles

   —      5,361    (5,361   —   
    

 

 

   

 

 

   

 

 

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

 

 

   

 

 

   

 

 

 

December 31, 2016

        

Customer related intangibles

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

Technology

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

Other intangibles

   —      5,361    (5,361   —   
    

 

 

   

 

 

   

 

 

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

 

 

   

 

 

   

 

 

 

Amortization expense of intangibles assets is reflected inlease liabilities

(in thousands)September 30, 2019
Right of use assets (1)
$62,296
Lease liabilities (2)
$15,742
Long-term lease liabilities$56,904
(1) Represents the Company’s unaudited condensed consolidated statementsright to use the leased asset during the lease term. Included in other long-term assets. (2) Included in other current liabilities.
The weighted-average remaining lease term and discount rate for the Company’s leases were:
September 30, 2019
Weighted-average remaining lease term4.2 years
Weighted-average discount rate (1)
5.8%
(1) The rates implicit in most of operationsthe Company’s leases are not readily determinable, therefore the Company uses its incremental borrowing rate as follows:

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

Cost of revenue

  $1,232   $1,642   $3,871   $4,626 

Selling and marketing

   1,873    1,867    5,608    5,274 

General and administrative

   —      90    —      268 
  

 

 

   

 

 

   

 

 

   

 

 

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

 

 

   

 

 

   

 

 

   

 

 

 

Futurethe discount rate when measuring operating lease liabilities. The incremental borrowing rate represents an estimate of the interest rate the Company would incur to borrow an amount equal to the lease payments on a collateralized basis over the term of the lease.

Maturities of lease liabilities are:
(in thousands)September 30, 2019
Remainder of 2019$3,402
202021,061
202118,800
202217,642
2023 and thereafter21,375
Total lease payments82,280
Less: imputed interest (1)
(9,634)
Total short and long-term lease liabilities$72,646
(1) Lease liabilities are measured at the present value of the remaining lease payments using a discount rate determined at lease commencement unless the discount rate is updated as a result of a lease reassessment event.
As of December 31, 2018, the Company’s future minimum rental payments required under operating leases with noncancellable terms in excess of one year as determined before the adoption of ASC 842 were:
(in thousands)
Operating Leases (1)
2019$15,993
202014,807
202113,262
202212,279
202311,084
 $67,425
(1) Operating leases include future minimum rent payments, net of estimated amortization expense relatedsublease income for facilities that the Company has vacated pursuant to intangible assets as of September 30, 2017 is as follows:

(in thousands)    

Remainder of 2017

  $2,846 

2018

   11,347 

2019

   5,555 

2020

   2,659 

2021

   2,637 

2022 and thereafter

   9,711 
  

 

 

 
  $34,755 
  

 

 

 

8. ACCRUED EXPENSES

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

Outside professional services

  $13,447   $10,204 

Income and other taxes

   5,947    10,422 

Marketing and sales program expenses

   4,679    3,707 

Dividends payable

   2,336    2,298 

Employee related expenses

   4,715    3,806 

Other

   8,557    6,314 
  

 

 

   

 

 

 
  $39,681   $36,751 
  

 

 

   

 

 

 

its restructuring activities.

Cash flow information
(in thousands)Nine Months Ended
September 30, 2019
Cash paid for leases14,586
Right of use assets recognized for new leases and amendments (non-cash)31,126

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

9. DEFERRED




10. REVENUE

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

Term license

  $5,636   $15,843 

Perpetual license

   20,844    23,189 

Maintenance

   105,588    112,397 

Cloud

   18,805    13,604 

Professional Services

   10,058    10,614 
  

 

 

   

 

 

 

Current deferred revenue

   160,931    175,647 

Perpetual license

   4,085    7,909 

Maintenance

   828    1,802 

Cloud

   1,217    1,278 
  

 

 

   

 

 

 

Long-term deferred revenue

   6,130    10,989 
  

 

 

   

 

 

 
  $167,061   $186,636 
  

 

 

   

 

 

 

10.

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

Revenue streams
 Three Months Ended
September 30,
 Nine Months Ended
September 30,
(in thousands)2019 2018 2019 2018
Perpetual license$9,016
 $20,276
 $43,286
 $56,829
Term license48,989
 32,066
 122,257
 128,070
Revenue recognized at a point in time58,005
 52,342
 165,543
 184,899
Maintenance70,371
 66,017
 207,406
 196,448
Cloud35,153
 22,184
 94,610
 57,967
Consulting53,174
 62,720
 167,282
 195,910
Revenue recognized over time158,698
 150,921
 469,298
 450,325
 $216,703
 $203,263
 $634,841
 $635,224
(in thousands)Three Months Ended
September 30,
 Nine Months Ended
September 30,
2019 2018 2019 2018
Term license$48,989
 $32,066
 $122,257
 $128,070
Cloud35,153
 22,184
 94,610
 57,967
Maintenance70,371
 66,017
 207,406
 196,448
Subscription (1)
154,513
 120,267
 424,273
 382,485
Perpetual license9,016
 20,276
 43,286
 56,829
Consulting53,174
 62,720
 167,282
 195,910
 $216,703
 $203,263
 $634,841
 $635,224
(1) Reflects client arrangements (term license, cloud, and maintenance) that are subject to renewal.
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



Remaining performance obligations (“RPO”)
Expected future revenue on existing contracts:
 September 30, 2019
(Dollars in thousands)Perpetual license Term license Maintenance Cloud Consulting Total
1 year or less$7,689
 $25,948
 $158,220
 $133,785
 $13,145
 $338,787
56%
1-2 years853
 3,798
 18,590
 105,081
 863
 129,185
21%
2-3 years1,306
 591
 8,323
 72,915
 841
 83,976
14%
Greater than 3 years
 85
 4,959
 51,591
 
 56,635
9%
 $9,848
 $30,422
 $190,092
 $363,372
 $14,849
 $608,583
100%
 September 30, 2018
(Dollars in thousands)Perpetual license Term License Maintenance Cloud Consulting Total
1 year or less$25,343
 $44,283
 $140,591
 $88,529
 $14,107
 $312,853
60%
1-2 years6,490
 10,063
 8,877
 70,815
 1,830
 98,075
19%
2-3 years360
 1,598
 2,586
 54,646
 449
 59,639
11%
Greater than 3 years1,306
 218
 1,079
 49,110
 50
 51,763
10%
 $33,499
 $56,162
 $153,133
 $263,100
 $16,436
 $522,330
100%

Major clients
Clients accounting for 10% or more of the Company’s total revenue were:
 Three Months Ended
September 30,
 Nine Months Ended
September 30,
(in thousands)2019 2018 2019 2018
Total revenue$216,703
 $203,263
 $634,841
 $635,224
Client A*
 10% *
 *
*Client accounted for less than 10% of total revenue.
11. STOCK-BASED COMPENSATION

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

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

Cost of revenues

  $3,613   $3,117   $10,913   $8,711 

Selling and marketing

   3,976    3,468    11,482    9,395 

Research and development

   3,420    2,260    10,306    7,480 

General and administrative

   2,480    1,983    7,228    4,706 

Acquisition-related

   —      (10   —      342 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total stock-based compensation before tax

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

 

 

   

 

 

   

 

 

   

 

 

 

Income tax benefit

  $(4,129  $(3,227  $(12,231  $(8,917

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

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

The Company recognizes stock based compensation on the accelerated recognition method, treating each vesting tranche as if it were an individual grant.

Expense
 Three Months Ended
September 30,
 Nine Months Ended
September 30,
(in thousands)2019 2018 2019 2018
Cost of revenues$4,787

$4,319
 $14,216

$12,277
Selling and marketing8,317

6,198
 24,055

16,895
Research and development4,858

3,917
 13,990

11,356
General and administrative3,884

1,974
 7,981

7,045
 $21,846

$16,408
 $60,242

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

As of September 30, 2017,2019, the Company had approximately $56.8$95.6 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to all unvested RSUs and unvested stock options thatwhich is expected to be recognized over a weighted-average period of 2.12.2 years.

11.

Grants
The Company granted the following stock-based compensation awards:
 Nine Months Ended
September 30, 2019
(in thousands)Shares Total Fair Value
RSUs1,153
 $75,510
Non-qualified stock options2,165
 $41,260
Common stock11
 $800

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



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

During the nine months ended September 30, 2019, the Company’s effective income tax rate decreased primarily due to the Global Intangible Low-Taxed Income (“GILTI”) provision of the Tax Reform Act. The Company’s effective income tax rate was also affected by excess tax benefits from stock-based compensation and an increase in U.S. research and development tax credits.
13. EARNINGS PER SHARE

Basic earnings per share is computed using the weighted-average number of common shares outstanding during the applicable period. Diluted earnings per share is computed using the weighted-average number of common shares outstanding during the applicable period, plus the dilutive effect of outstanding stock options and RSUs, using the treasury stock method. Certain shares related to someIn periods of loss, all stock options and RSUs are excluded, as their inclusion would be anti-dilutive.
The calculation of the Company’sbasic and diluted earnings per share was:
 Three Months Ended
September 30,
 Nine Months Ended
September 30,
(in thousands, except per share amounts)2019 2018 2019 2018
Basic       
Net (loss)$(30,338) $(7,587) $(91,351) $(5,796)
Weighted-average common shares outstanding79,200

78,700

78,928

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

       
Outstanding anti-dilutive stock options and RSUs (1)
5,953
 6,119
 5,923
 6,380
(1) Certain outstanding stock options and RSUs were excluded from the computation of diluted earnings per share because they were anti-dilutive in the periods presented, but couldperiod presented. These awards may be dilutive in the future.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The calculation of




14. SUBSEQUENT EVENTS
On November 6, 2019, the Company’s basic and diluted earnings per share is as follows:

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
(in thousands, except per share amounts)  2017   2016   2017   2016 

Basic

        

Net (loss)/income

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

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average common shares outstanding

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

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/earnings per share, basic

  $(0.03  $0.04   $0.47   $0.24 
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

        

Net (loss)/income

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

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average effect of dilutive securities:

        

Stock options

   —      1,933    3,519    1,851 

RSUs

   —      1,337    1,940    1,227 
  

 

 

   

 

 

   

 

 

   

 

 

 

Effect of assumed exercise of stock options and RSUs

   —      3,270    5,459    3,078 
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average common shares outstanding, assuming dilution

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

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/earnings per share, diluted

  $(0.03  $0.04   $0.44   $0.23 
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   7,232    296    219    368 

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

12. GEOGRAPHIC INFORMATION AND MAJOR CLIENTS

Geographic Information

Operating segments are defined as components of an enterprise, about which separate financial information is available that is evaluated regularly by the chief operating decision makerCompany entered into a five-year $100 million, senior secured revolving credit agreement (the “Credit Agreement”) with PNC Bank, National Association (“CODM”PNC”) in deciding how to allocate resources and in assessing performance.

. The Company developsmay use borrowings to finance working capital needs and licenses software applications for customer engagementgeneral corporate purposes. Subject to specific circumstances, the Credit Agreement allows the Company to increase the aggregate commitment up to $200 million.

The Credit Agreement contains customary covenants, including, but not limited to, those relating to additional indebtedness, liens, asset divestures and its Pega® Platform, and provides consulting services, maintenance, and training related to its offerings.affiliate transactions. The Company derives substantially allis also required to comply with financial covenants that consist of its revenue from the sale and supporta maximum net consolidated leverage ratio 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 excellence3.5 (with a step-up in the enterprise applications market. To assess performance, the Company’s CODM, who is the chief executive officer, reviews financial informationevent of certain acquisitions) and a minimum consolidated interest coverage ratio of 3.5. The commitments expire on a consolidated basis. Therefore, the Company determined it has one reportable segment—Customer Engagement SolutionsNovember 4, 2024, and one reporting unit.

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

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

U.S.

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

Other Americas

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

U.K.

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

Other EMEA(1)

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

Asia Pacific

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

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

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

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

 

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

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Major Clients

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

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

Total revenue

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

Client A

   10.6  *    *    * 

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

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

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

Total trade accounts receivable

   197,350   269,154 

Client A

   12.4  * 

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

any outstanding loans will be payable on such date.


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

Forward-Looking Statements

ITEM 2.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form10-Q contains or incorporates forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, statements about our future financial performance and business plans, the adequacy of our liquidity and capital resources, the continued payment of quarterly dividends, by the Company, and the timing of revenue recognition, under license and cloud arrangements and are described more completely in Part I of our Annual Report on Form10-K for the year ended December 31, 2016.

2018.

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

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

Important factors that could cause actual future activities and results to differ materially from those expressed in such forward-looking statements include, among others, variation in demand for our products and services, and the difficulty in predicting the completion of product acceptance and other factors affecting the timing of license revenue recognition; reliance on third party relationships; the potential loss of vendor specific objective evidence for our consulting services;third-party relationships, reliance on key personnel, the inherent risks associated with international operations and the continued uncertainties in international economies; the Company’sglobal economy, our continued effort to market and sell both domestically and internationally;internationally, foreign currency exchange rates; the financial impact of any future acquisitions;rates, the potential legal and financial liabilities and reputation damage due to cyber-attacks and security breaches;breaches, and management of the Company’sour growth. These risks and other factors that could cause actual results to differ materially from those expressed in such forward-looking statements are described more completely in Part I of the Company’sour Annual Report on Form10-K for the year ended December 31, 2016 as well as2018 and other filings we make with the U.S. Securities and Exchange Commission

We have (“SEC”).

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

Business overview

otherwise.

BUSINESS OVERVIEW
We develop, market, license, and support enterprise software applications for marketing, sales, service,that help organizations transform the way they engage with their customers and operations. In addition, weprocess and complete work across their enterprise. We also license our no-code Pega® Platform Platform™ for rapid application development to clients that wish to build and extend their ownbusiness applications. TheOur cloud-architected portfolio of customer engagement and digital process automation applications leverages artificial intelligence (“AI”), case management, and robotic automation technology, built on our unified no-code Pega Platform, assists our clients in building, deploying,empowering businesses to quickly design, extend, and evolvingscale their enterprise applications creating an environment in whichto meet strategic business and IT can collaborate to manage back office operations, front office sales, marketing, and/or customer service needs. We also provide consulting services, maintenance, and training for our software.
Our software applications and Pega Platform can be deployed on Pega, partner, or customer-managed cloud architectures.

Ourtarget clients includeare Global 3000 companiesorganizations and government agencies that seekrequire applications to manage complex enterprise systemsdifferentiate themselves in the markets they serve. Our applications achieve and customer service issues with greaterfacilitate differentiation by increasing business agility, driving growth, improving productivity, attracting and cost-effectiveness. Our strategy isretaining customers, and reducing risk. We deliver applications tailored to sell a client a series of licenses, each focused on aour clients’ specific purpose or area of operations in support of longer term enterprise-wide digital transformation initiatives.

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

Financial and industry needs.

Performance Metrics

Management evaluates our financial performance, based a number of select financial and performance metrics. Themetrics

We utilize several performance metrics in analyzing and assessing our overall performance, making operating decisions, and forecasting and planning for future periods.
(Dollars in thousands,
except per share amounts)
Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
2019 2018  2019 2018 
Total revenue$216,703
 $203,263
 $13,440
7 % $634,841
 $635,224
 $(383) %
Subscription revenue (1)
$154,513
 $120,267
 $34,246
28 % $424,273
 $382,485
 $41,788
11 %
Net (loss)$(30,338) $(7,587) $(22,751)(300)% $(91,351) $(5,796) $(85,555)(1,476)%
(Loss) per share, diluted$(0.38) $(0.10) $(0.28)(280)% $(1.16) $(0.07) $(1.09)(1,557)%
(1)Reflects client arrangements (term license, cloud, and maintenance) that are periodically reviewed and revisedsubject to reflect any changes in our business. Historically, Recurring Revenue and License and Cloud Backlog have been our primary performance metrics. However, due to the change in the revenue recognition patterns of term license arrangements as a result of the expected implementation of the new revenue accounting standard (See Note 2) in the first quarter of 2018, we have started tracking renewal.


Annual Contract Valuecontract value (“ACV”), a new performance measure.

Select Financial Metrics

(Dollars in thousands,

except per share amounts)

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

Total revenue

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

Operating margin

   (8)%   3    3  5   

Diluted (loss)/earnings per share

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

Cash flow provided by operating activities

       113,926   20,556   93,370    454

Select Performance Metrics

Annual Contract Value (“ACV”)

(1) (2)

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

acvslideq3timesfor10qa02.jpg
 September 30, Change Constant Currency
Change
(Dollars in thousands)2019 2018  
Maintenance$281,484
 $264,068
 $17,416
7% 9%
Term207,317
 174,320
 $32,997
19% 20%
Client Cloud488,801
 438,388
 $50,413
11% 13%
Pega Cloud145,549
 98,373
 47,176
48% 51%
Total ACV$634,350
 $536,761
 $97,589
18% 20%
(1)Total ACV, as of a given date, is the sum of the following two components:

Term and Cloud
Client Cloud: the sum of (1) the annual value of each term license contract in effect on such date, which is equal to its total license value divided by the total number of years and (2) maintenance revenue reported for the quarter ended on such date, multiplied by four. We do not provide hosting services for Client Cloud arrangements.
Pega Cloud: the sum of the annual value of each cloud contract in effect on such date, which is equal to its total value divided by the total number of years.
(2)As foreign currency exchange rates are an important factor in understanding period to period comparisons, we believe the numberpresentation of committed contract years

Quarterly Maintenance revenue reported forACV growth rates on a constant currency basis enhances the current three months ended period multiplied by 4.

   September 30,     
(in thousands)  2017   2016   Change 

Term License and Cloud ACV

  $200,180   $163,408   $36,772    23

Maintenance ACV

   248,816    220,152   $28,664    13
  

 

 

   

 

 

     

Term License, Cloud and Maintenance ACV

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

 

 

   

 

 

     

LOGO

Recurring Revenue

A measure of the predictability and repeatabilityunderstanding of our revenue.

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

Recurring revenue

          

Term license

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

Maintenance

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

Cloud

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

 

 

  

 

 

    

 

 

  

 

 

    

Total recurring revenue

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

 

 

  

 

 

    

 

 

  

 

 

    

Recurring revenue as a percent of total revenue

   54  52    54  54   

Licenseresults and Cloud Backlog

A measure of the continued growthevaluation of our business as a result ofperformance in comparison to prior periods.

Remaining performance obligations (“RPO”)
Expected future contractual commitments by our clients.

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

Deferred license and cloud revenue as recorded on the Company’s balance sheet. (See Note 9 “Deferred Revenue”)existing contracts:
 September 30, 2019
(Dollars in thousands)Perpetual license Term license Maintenance Cloud Consulting Total
1 year or less$7,689
 $25,948
 $158,220
 $133,785
 $13,145
 $338,787
56%
1-2 years853
 3,798
 18,590
 105,081
 863
 129,185
21%
2-3 years1,306
 591
 8,323
 72,915
 841
 83,976
14%
Greater than 3 years
 85
 4,959
 51,591
 
 56,635
9%
 $9,848
 $30,422
 $190,092
 $363,372
 $14,849
 $608,583
100%
Change in RPO Since September 30, 2018           

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

(71)% (46)% 24% 38% (10)% 17% 

License and cloud contractual commitments, which are not recorded on our balance sheet because we have not yet invoiced our clients, nor have we recognized the associated revenue. (See “Future Cash Receipts from Committed License and Cloud Arrangements” which can be found in “Liquidity and Capital Resources” contained elsewhere in this Quarterly Report on Form10-Q for additional information)
 September 30, 2018
(Dollars in thousands)Perpetual license Term license Maintenance Cloud Consulting Total
1 year or less$25,343
 $44,283
 $140,591
 $88,529
 $14,107
 $312,853
60%
1-2 years6,490
 10,063
 8,877
 70,815
 1,830
 98,075
19%
2-3 years360
 1,598
 2,586
 54,646
 449
 59,639
11%
Greater than 3 years1,306
 218
 1,079
 49,110
 50
 51,763
10%
 $33,499
 $56,162
 $153,133
 $263,100
 $16,436
 $522,330
100%

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

   September 30,  Change 
(Dollars in thousands)  2017  2016  

Deferred license and cloud revenue on the balance sheet

        

Term license and cloud

  $25,658    51 $19,627    42  31

Perpetual license

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

 

 

    

 

 

    

Total deferred license and cloud revenue

   50,587    100  47,280    100  7
  

 

 

    

 

 

    

License and cloud contractual commitments not on the balance sheet

        

Term license and cloud

   450,535    91  352,804    94  28

Perpetual license

   46,459    9  23,483    6  98
  

 

 

    

 

 

    

Total license and cloud commitments

   496,994    100  376,287    100  32
  

 

 

    

 

 

    

Total license (term and perpetual) and cloud backlog

  $547,581    $423,567     29
  

 

 

    

 

 

    

Total term license and cloud backlog

   476,193    87  372,431    88  28
  

 

 

    

 

 

    

LOGO

Critical accounting policies


CRITICAL ACCOUNTING POLICIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“U.S.”) and the rules and regulations of the SEC for interim financial reporting. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and the related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, knowledge of current conditions, and expectations of what could occur in the future given available information.

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.

For more information regarding our critical accounting policies, we encourage you to read the discussion contained in Item 7 under the heading “Critical Accounting Estimates and Significant Judgments” and Note 2 “Significant Accounting Policies” included in the notes to the Consolidated Financial Statements containedfollowing locations in our Annual Report on Form10-K for the year ended December 31, 2016.

2018:

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

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

Total revenue

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

Gross profit

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

Total operating expenses

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

(Loss)/income from operations

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

Operating margin

   (8)%   3    3  5  

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

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

Operations”; and

Note 2. “Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary Data”.
There have been no significant changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018.
RESULTS OF OPERATIONS
Revenue

Software

(Dollars in thousands)Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
2019 2018  2019 2018 
Cloud$35,153
16% $22,184
11% $12,969
58 % $94,610
15% $57,967
9% $36,643
63 %
Term license48,989
23% 32,066
16% 16,923
53 % 122,257
19% 128,070
20% (5,813)(5)%
Maintenance70,371
32% 66,017
32% 4,354
7 % 207,406
33% 196,448
31% 10,958
6 %
Subscription (1)
154,513
71% 120,267
59% 34,246
28 % 424,273
67% 382,485
60% 41,788
11 %
Perpetual license9,016
4% 20,276
10% (11,260)(56)% 43,286
7% 56,829
9% (13,543)(24)%
Consulting53,174
25% 62,720
31% (9,546)(15)% 167,282
26% 195,910
31% (28,628)(15)%
 $216,703
100% $203,263
100% $13,440
7 % $634,841
100% $635,224
100% $(383) %
(1)Reflects client arrangements (term license, cloud, and maintenance) that are subject to renewal.
Our license revenue

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

Perpetual license

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

Term license

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

 

 

   

 

 

  

 

 

   

 

 

    

 

 

   

 

 

  

 

 

   

 

 

   

Total license revenue

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

 

 

   

 

 

  

 

 

   

 

 

    

 

 

   

 

 

  

 

 

   

 

 

   

The is derived from sales of our applications and Pega Platform. Our cloud revenue is derived from our hosted Pega Platform and software applications.

We expect our revenue mix between perpetual and term licenseto continue to shift in favor of our subscription offerings, particularly cloud arrangements, executedwhich could result in a particular period varies based on clients’ deployment preferences. A changeslower total revenue growth in the mix may cause our revenues to vary materiallynear term. Revenue from period to period. A higher proportion of term licensecloud arrangements executed willis generally result in license revenue being recognized over longer periods. Additionally, some of ourthe service period, while revenue from term and perpetual license arrangements include extended payment terms or additionalis generally recognized upfront when the license rights of use, which may also resultbecome effective.
Subscription revenue
The increases in the recognition of revenue over longer periods.

The decrease in perpetual licensecloud revenue in the three months ended September 30, 2017 was primarily due to a decrease in the average value of perpetual arrangements executed and a lower percentage of perpetual arrangements executed and recognized in revenue in the current period. The decrease in perpetual license revenue in the nine months ended September 30, 2017 was primarily due2019 reflect the shift in client preferences to a lower percentagecloud arrangements from other types of perpetual arrangements executed and recognized in revenue.

arrangements. The decreaseincrease in term license revenue in the three months ended September 30, 20172019 was primarily due to arevenue recognized from several large, multi-year term license renewal for which the second year of the term was recognized as revenuecontracts in the three months ended September 30, 2016. If the second year of this term license arrangement was not paid in advance in the three months ended September 30, 2016, term license revenue would have decreased 2%.2019. The increasedecrease in term license revenue in the nine months ended September 30, 20172019 was primarily dueattributable to broad based growth amongst new and existing customers offset by a largerevenue recognized from term license arrangementcontracts in the nine months ended September 30, 2019 with multi-year committed maintenance periods, which was prepaid and recognizedresulted in a greater portion of the contract value being allocated to maintenance. The increases in maintenance revenue in the three and nine months ended March 31, 2016. If this term license arrangement was not prepaid and recognized in revenue in the three months ended March 31, 2016 term license revenue would have increased 26%.

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

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

Maintenance revenue

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

Maintenance

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

The increases2019 were primarily due to the continued growth in the aggregate value of the installed base of our software and strong renewal rates significantly in excess of 90%.

Services

Perpetual license
The decreases in perpetual license revenue

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

Consulting services

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

Cloud

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

Training

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

 

 

   

 

 

  

 

 

   

 

 

    

 

 

   

 

 

  

 

 

   

 

 

   

Total services

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

 

 

   

 

 

  

 

 

   

 

 

    

 

 

   

 

 

  

 

 

   

 

 

   

Consulting services revenue is primarily generated from new in the three and nine months ended September 30, 2019 reflects the shift in client preferences in favor of our cloud offerings instead of our perpetual license implementations. arrangements.

Consulting
Our consulting services revenue may fluctuate in future periodsfluctuates depending onupon the mix of new implementation projects we perform as compared to those performed by our enabled clients or led by our partners.

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

Cloud revenue represents revenue from our Pega Cloud offerings. The increases in cloud revenue2019 were primarily due to continueddecreases in billable hours.


Gross profit
 Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
(Dollars in thousands)2019 2018  2019
2018 
Software license$57,329
99 % $51,087
98% $6,242
12% $162,561
98% $181,127
98% $(18,566)(10)%
Maintenance63,683
90 % 59,938
91% 3,745
6% 188,091
91% 178,413
91% 9,678
5 %
Cloud17,329
49 % 12,569
57% 4,760
38% 46,841
50% 31,853
55% 14,988
47 %
Consulting(2,536)(5)% 5,246
8% (7,782)*
 4,933
3% 19,977
10% (15,044)(75)%
 $135,805
63 % $128,840
63% $6,965
5% $402,426
63% $411,370
65% $(8,944)(2)%
* not meaningful
The recent shift in our revenue mix toward cloud arrangements has resulted in slower total gross profit growth ofas our cloud client base.

Gross profit

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

Software license

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

Maintenance

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

Services

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

 

 

  

 

 

    

 

 

  

 

 

   

Total gross profit

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

Software license gross profit %

   97  98    98  98  

Maintenance gross profit %

   89  88    88  88  

Services gross profit %

   19  11    20  14  
  

 

 

  

 

 

    

 

 

  

 

 

   

Total gross profit %

   61  67    66  68  

business continues to grow and scale. Revenue from cloud arrangements is generally recognized over the service period, while revenue from term and perpetual license arrangements is generally recognized upfront when the license rights become effective.

The decreaseincrease in total gross profit in the three months ended September 30, 20172019 was primarily due to a shift in the mix of license arrangements executed from perpetual to term licenses and an increase in lower margin services revenue.

term revenue recognized from several large, multi-year term license contracts in the three months ended September 30, 2019. It was also due to an increase in cloud revenue reflecting the shift in client preferences to cloud arrangements from other types of arrangements, an increase in maintenance revenue due to the continued growth in the aggregate value of the installed base of our software and strong renewal rates in excess of 90%.

The increasedecrease in total gross profit in the nine months ended September 30, 20172019 was primarily due to increaseda decrease in term and perpetual license revenue and a decrease in consulting revenue due to a decrease in billable hours.
The decrease in total revenue.

gross profit percent in the nine months ended September 30, 2019 was driven by the shift in client preferences in favor of cloud arrangements, which are lower margin than our term and perpetual license revenue streams and decreases in cloud and consulting gross profit percent.

The increasesdecreases in servicecloud gross profit percent in the three and nine months ended September 30, 2017 was2019 were driven by an increase in costs as we accelerated our investments in cloud infrastructure and service delivery to support future growth. The decreases in consulting gross profit percent in the three and nine months ended September 30, 2019 were driven by a decrease in billable hours as consulting resources were transitioning to new projects after completing a large project which beganand an increase in the second half of 2016consulting resource availability as we continue growing and several additional large projects for which costs were recognized in 2016 but whose associated revenue was not recognized until after September 30, 2016.

leveraging our partner network.

Operating expenses

Selling and marketing

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

Selling and marketing

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

As a percent of total revenue

   39  37     36  37   

Selling and marketing headcount, end of period

        934   875   59    7

Selling and marketing expenses include

 Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
(Dollars in thousands)2019 2018  2019 2018 
Selling and marketing (1)
$115,237
 $87,490
 $27,747
32% $341,064
 $269,845
 $71,219
26%
As a percent of total revenue53% 43%    54% 42%   
Selling and marketing headcount,
end of period
       1,532
 1,194
 338
28%
(1) Includes compensation, benefits, and other headcount-related expenses associated with our selling and marketing personnelactivities, as well as advertising, promotions, trade shows, seminars, and other programs. Selling and marketing expenses also include the amortization of customer relatedclient-related intangibles.

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

The increase in the nine months ended September 30, 2017 was2019 were primarily due to an increase in compensation and benefits of $12.7$22.6 million respectively, driven byand $58.1 million, attributable to increased headcount, and equity compensation, and an increaseincreases of $4.0 million and $10.6 million in employeedeferred contract cost amortization. Also, contributing to the increases were travel and entertainment partially offset by a decrease in brand marketing program expenses of $2.2$2.6 million and $4.5 million.

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

.

Research and development

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

Research and development

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

As a percent of total revenue

   23  21     20  20   

Research and Development headcount, end of period

        1,474   1,437   37    3

Research and development expenses include

 Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
(Dollars in thousands)2019 2018  2019 2018 
Research and development (1)
$52,492
 $46,504
 $5,988
13% $152,802
 $135,261
 $17,541
13%
As a percent of total revenue24% 23%    24% 21%   
Research and development headcount,
end of period
       1,631
 1,595
 36
2%
(1) Includes compensation, benefits, contracted services, and other headcount-related expenses associated with the creation and development of our products, as well as enhancements and design changes to existing products and the integration of acquired technologies.


The increases in the three and nine months ended September 30, 20172019 were primarily due to increases in compensation and benefits of $2.9$3.8 million and $12.6$10.5 million, respectively, attributable to increasedan increase in headcount and equity compensation.

compensation, and $1.2 million and $4.5 million in cloud hosting expenses as we expand our cloud-focused research and development activities.

General and administrative

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

General and administrative

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

As a percent of total revenue

   7  6     6  6   

General and administrative headcount, end of period

        407   371   36    10

General and administrative expenses include

 Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
(Dollars in thousands)2019 2018  2019 2018 
General and administrative (1)
$14,843
 $12,104
 $2,739
23% $41,693
 $38,749
 $2,944
8%
As a percent of total revenue7% 6%    7% 6%   
General and administrative headcount,
end of period (2)
       420
 326
 94
29%
(1) Includes compensation, benefits, and other headcount-related expenses associated with finance, legal, corporate governance, and other administrative headcount. TheyIt also includeincludes accounting, legal, and other professional consulting and administrative fees. (2)The general and administrative headcount includes employees in human resources, information technology, and corporate services departments, whose costs are partially allocated to other operating expense areas.

The increases in the three and nine months ended September 30, 20172019 were primarily due to increases in compensation and benefits of $0.4$3.2 million and $4$3.7 million, respectively, attributabledue to increased headcount and equity compensation. headcount.
Stock-based compensation
 Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
(Dollars in thousands)2019 2018  2019 2018 
Cost of revenues$4,787
 $4,319
 $468
11% $14,216
 $12,277
 $1,939
16%
Selling and marketing8,317
 6,198
 2,119
34% 24,055
 16,895
 7,160
42%
Research and development4,858
 3,917
 941
24% 13,990
 11,356
 2,634
23%
General and administrative3,884
 1,974
 1,910
97% 7,981
 7,045
 936
13%
 $21,846
 $16,408
 $5,438
33% $60,242
 $47,573
 $12,669
27%
The increaseincreases in the three and nine months ended September 30, 2017 was partially offset by a decrease of $1.5 million in legal fees.

Stock-based compensation

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

Cost of revenues

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

Selling and marketing

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

Research and development

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

General and administrative

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

Acquisition-related

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

 

 

  

 

 

    

 

 

  

 

 

   

Total stock-based compensation before tax

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

 

 

  

 

 

    

 

 

  

 

 

   

Income tax benefit

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

The increases2019 were primarily due to the increased value of our annual periodic equity awards granted in March 20162019 and 2017.2018 and increased headcount. These awards generally have a five-year vesting schedule.

Amortization of intangibles

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

Cost of revenue

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

Selling and marketing

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

General and administrative

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

 

 

   

 

 

     

 

 

   

 

 

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

 

 

   

 

 

     

 

 

   

 

 

    

Other income (expense), net
 Three Months Ended
September 30,
 Change Nine Months Ended
September 30,
 Change
(Dollars in thousands)2019 2018  2019 2018 
Foreign currency transaction (loss) gain$(1,970) $399
 $(2,369)*
 $(3,577) $558
 $(4,135)*
Interest income, net556
 683
 (127)(19)% 1,823
 2,076
 (253)(12)%
Other income, net323
 
 323
*
 378
 363
 15
4 %

$(1,091) $1,082
 $(2,173)*
 $(1,376) $2,997
 $(4,373)*
* not meaningful
The decreaseschanges in amortization of intangibles in the three and nine months ended September 30, 2017foreign currency transaction (loss) gain were primarily due to the amortization in fullimpact of certain intangibles acquired through past acquisitions.

Non-operating (expense)/income, net

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

Foreign currency transaction (loss)/gain

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

Interest income, net

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

Other (expense)/income, net

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

 

 

  

 

 

    

 

 

  

 

 

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

 

 

  

 

 

    

 

 

  

 

 

   

n/m - not meaningful

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

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

The total change in the fair value of our foreign currency forward contracts recorded in other

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

(Benefit)/provision for income taxes

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

(Benefit)/provision for income taxes

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

Effective income tax rate

   88  40     (96)%   26  

n/m - not meaningful

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

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

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

 Three Months Ended
September 30,
 Nine Months Ended
September 30,
(Dollars in thousands)2019 2018 2019 2018
(Benefit from) income taxes$(17,520) $(8,589) $(43,158) $(23,692)
Effective income tax rate    32% 80%
The inclusion of excess tax benefits as a component offrom stock-based compensation in the provision for income taxes may increase volatility inhas increased the variability of the effective tax rates ofin recent periods. This fluctuation may continue in future periods, as the amount of excess tax benefits from share-based compensation awards varies depending on our future stock price in relation to the fair value of awards, the timing of RSU vesting andvestings, the exercise behavior of our stock option holders, and the total value of future grants of share-basedstock-based compensation awards.

Liquidity

During the nine months ended September 30, 2019, the Company’s effective income tax rate changed primarily due to the Global Intangible Low-Taxed Income (“GILTI”) provision of the Tax Reform Act. The Company’s effective income tax rate was also affected by excess tax benefits from stock-based compensation and an increase in U.S. research and development tax credits.

LIQUIDITY AND CAPITAL RESOURCES
 Nine Months Ended
September 30,
 (in thousands)2019 2018
Cash provided by (used in):   
Operating activities$(13,462) $67,088
Investing activities53,448
 (49,595)
Financing activities(61,941) (71,664)
Effect of exchange rates on cash and cash equivalents(363) (1,913)
Net (decrease) in cash and cash equivalents$(22,318) $(56,084)
(in thousands)September 30, 2019 December 31, 2018
Held by U.S. entities$41,484
 $143,533
Held by foreign entities71,085
 63,890
Total cash, cash equivalents, and marketable securities$112,569
 $207,423
On November 6, 2019, we entered into a five-year $100 million senior secured revolving credit agreement (the “Credit Agreement”) with PNC Bank, National Association (“PNC”). We may use borrowings to finance working capital resources

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

Cash provided by (used in):

    

Operating activities

  $113,926   $20,556 

Investing activities

   (11,966   (2,859

Financing activities

   (44,040   (43,031

Effect of exchange rate on cash

   2,054    (1,309
  

 

 

   

 

 

 

Net increase/(decrease) in cash and cash equivalents

  $59,974   $(26,643
  

 

 

   

 

 

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

Total cash, cash equivalents, and marketable securities

  $194,380   $133,761 

needs and for general corporate purposes. Subject to specific circumstances, the Credit Agreement allows us to increase the aggregate commitment up to $200 million. See Item 5. “Other Information” for additional information.

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

As of September 30, 2017, approximately $61.1 million of Whether these resources are adequate to meet our cashliquidity needs beyond that period will depend on our growth, operating results, and cash equivalents was held inthe investments required to meet possible increased demand for our foreign subsidiaries. services. If we require additional capital resources to grow our business, we may seek to finance our operations from available funds or additional external financing.

If it becomesbecame necessary to repatriate theseforeign funds, we may be required to pay U.S. tax, net of any applicablestate and local taxes, as well as foreign tax credits,taxes, upon repatriation. We considerDue to the earningscomplexity of our foreign subsidiaries to be permanently reinvestedincome tax laws and as a result, U.S. taxes on such earnings are not provided. Itregulations, and the effects of the Tax Reform Act, it is impracticalimpracticable to estimate the amount of U.S. taxtaxes we may be requiredwould 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 (used in) provided by operating activities

As client preferences continue to shift in favor of cloud arrangements, we could continue to experience slower operating cash flow growth, or negative cash flow, in the near term. Cash from cloud arrangements is generally collected over an average service period of three years, while cash from perpetual license arrangements is generally collected upfront, shortly after the license rights become effective.
The primary drivers duringdriver of the decrease in the nine months ended September 30, 2017 were net income of $36.6 million and $80.6 million from trade accounts receivable, largely due to increased cash collections and2019 was the timing of billings.

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

Future Cash Receipts from Committed License and Cloud Arrangements

As of September 30, 2017, none of the amounts shownrecent shift in the table below had been billed and noour revenue had been recognized.

The below amounts for 2018 and subsequent periods may not be recognized in the periods shown below as a result of the adoption of the new revenue recognition standard (ASC 606). (See Note 2. New Accounting Pronouncements contained elsewhere in this Quarterly Report on Form10-Q for additional information)

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

Remainder of 2017

  $37,723   $13,274   $50,997 

2018

   150,629    21,213    171,842 

2019

   125,165    10,033    135,198 

2020

   85,939    1,572    87,511 

2021

   38,203    367    38,570 

2022 and thereafter

   12,876    —      12,876 
  

 

 

   

 

 

   

 

 

 

Total

  $450,535   $46,459   $496,994 
  

 

 

   

 

 

   

 

 

 

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

Total contractual future cash receipts due from our existing license andmix toward cloud arrangements, were approximately $376.3 millionwhich are generally collected over an average service period of three years, and increased costs as of September 30, 2016.

the Company accelerated investments in its cloud offerings and selling and marketing activities to support future growth.

Cash used inprovided by (used in) investing activities

During

The change in cash provided by (used in) investing activities was primarily driven by the nine months ended September 30, 2017, we purchased $25.7 millionpayment of marketable debt securities and made investmentsconsideration for the acquisition of $9.1 millionIn the Chat Communications Inc. in property and equipment, partially offset by proceeds received from maturities of marketable debt securities (including called marketable debt securities) of $23.1 million.

During the nine months ended September 30, 2016, we acquired OpenSpan for $48.8 million, net ofMay 2019.

Cash (used in) financing activities
We primarily used cash acquired, and invested $15.3 million primarily in internally developed software and leasehold improvements at our corporate headquarters, partially offset by proceeds received from the sales of marketable debt securities of $62.3 million.

Cash used in financing activities

We used cash primarily for repurchases of our common stock shareunder 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 program (1)
The changes in the remaining stock repurchase programs that have authorized the repurchase in the aggregate of up to $195 million of our common stock.authority were:
 Nine Months Ended
September 30,
(in thousands)2019
January 1,$6,620
Authorizations (2)
60,000
Repurchases(20,286)
September 30,$46,334
(1) Purchases under these programs have been made on the open market.

The following table is a summary(2) On March 15, 2019, we announced that our Board of ourDirectors extended the expiration date of the current stock repurchase activity:

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

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

Balance as of January 1,

     $39,385     $40,534 

Authorizations

   —      —     —     —      —     25,879 

Repurchase for net settlement of tax under stock-based compensation

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

Repurchases paid under authorized share repurchase program

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

Repurchases unsettled

   —      —     —     6    (177  (177
  

 

 

   

 

 

  

 

 

  

 

 

   

 

 

  

 

 

 

Activity in Period

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

 

 

     

 

 

 

Balance as of September 30,

     $36,399     $40,706 
     

 

 

     

 

 

 

In additionprogram to June 30, 2020 and increased the shareamount of common stock we are authorized to repurchase by $60 million .


Common stock repurchases made
 Nine Months Ended
September 30,
 2019 2018
(in thousands)Shares Amount Shares Amount
Tax withholdings for net settlement of equity awards514
 $34,871
 591
 $35,530
Stock repurchase program (1)
       
Repurchases paid318
 20,086
 512
 29,949
Repurchases unsettled at period end3
 200
 3
 200
Activity in period (2)
835
 $55,157
 1,106
 $65,679
(1) Represents activity under our publicly announced stock 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.

programs. (2)During the nine months ended September 30, 20172019 and 2016, option and RSU holders net settled a total of 2.4 million shares and 1.6 million shares, respectively, of which only 1.3 million shares and 0.8 million shares, respectively, were issued to the option and RSU holders. The balance of the shares were surrendered to us to pay for the exercise price with respect to options and the applicable taxes for both options and RSUs. During the nine months ended September 30, 2017 and 2016,2018, instead of receiving cash from the equity holders, we withheld shares with a value of $23.7$31.6 million and $10.1$28.2 million, respectively, for the exercise price of options.

These amounts have been excluded from the table above.

Dividends

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

Dividends Declared

  $0.09   $0.09 

Dividends Paid

  $0.09   $0.09 

 Nine Months Ended
September 30,
(in thousands)2019 2018
Dividend payments to shareholders$7,105
 $7,067
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 thisthe dividend program at any time without prior notice.

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURE

Market risk represents the risk of loss that may affect us due to adverse

ITEM 3.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in financial market prices and rates. Our market risk exposure is primarily related to fluctuations in foreign exchange rates.

As of September 30, 2017, we did not have any forward contracts outstanding. See Note 4 “Derivative Instruments” of this Quarterly Report on Form10-Q for further discussion.

Other than the item discussed above, there were no significant changes to our quantitative and qualitative disclosures about market risk during the first nine months ended September 30, 2017. See Part II, Item 7A. Quantitative and Qualitative Disclosures about Market Risk included2019 to the market risk exposure disclosed in our Annual Report on Form10-K for the year ended December 31, 2016 for a more complete discussion of our market risk exposure.

2018.
ITEM 4.CONTROLS AND PROCEDURES

ITEM 4.     CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controlsdisclosure controls and Procedures

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 September 30, 2017.2019. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of September 30, 2017.

2019.

(b) Changes in Internal Controlinternal control over Financial Reporting

financial reporting

There have been no changes in our internal control over financial reporting (as defined in Rules13a-15(f) and15d-15(f) under the Securities Exchange Act) during the quarter ended September 30, 20172019 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 below and in Part I, Item 1A. “Risk Factors” inof our Annual Report onForm 10-K for the year ended December 31, 2016.2018. These risk factors could materially affect our business, financial condition, and future results and they could cause our actual business and financial results to differ materially from those contained in forward-looking statements made in this Quarterly Report on Form10-Q or elsewhere by management from time to time. There
On November 6, 2019, we entered into a five-year $100 million, senior secured revolving credit agreement (the “Credit Agreement”) with PNC Bank, National Association (“PNC”). We may use borrowings to finance working capital needs and for general corporate purposes. Subject to specific circumstances, the Credit Agreement allows us to increase the aggregate commitment up to $200 million. See Item 5. “Other Information” for additional information.
Any failure to meet our debt obligations would damage our business.
Our ability to repay any amounts we borrow under our Credit Agreement will depend on market conditions and our future performance, which are subject to economic, financial, competitive, and other factors beyond our control. If we are not profitable in the future or if we use more cash than we generate in the future, our level of indebtedness at such time could adversely affect our operations by increasing our vulnerability to adverse changes in general economic and industry conditions and by limiting or prohibiting our ability to obtain additional financing for additional capital expenditures, acquisitions and general corporate and other purposes. If we incur significantly more debt, this could intensify the risks described above.
We are required to comply with certain financial and operating covenants under our revolving credit facility. Any failure to comply with those covenants could cause amounts borrowed to become immediately due and payable and/or prevent us from borrowing under the credit facility.
We are required to comply with certain financial and operating covenants under our Credit Agreement. Any failure to comply with those covenants could cause amounts borrowed to become immediately due and payable and/or prevent us from borrowing under the Credit Agreement. We are required to comply with specified financial and operating covenants under our Credit Agreement and to make payments, which limit our ability to operate our business as we otherwise might operate it. Our failure to comply with any of these covenants or to meet any debt payment obligations could result in an event of default which, if not cured or waived, would result in any amounts outstanding, including any accrued interest and/or unpaid fees, becoming immediately due and payable. We might not have been no material changes duringsufficient working capital or liquidity to satisfy any repayment obligations in the nine months ended September 30, 2017event of an acceleration of those obligations. In addition, if we are not in compliance with the financial and operating covenants under the Credit Agreement at the time we wish to borrow funds, we will be unable to borrow funds. The financial and operating covenants under the risk factors disclosed inCredit Agreement also may limit our Annual Report on Form10-Kability to borrow funds, including for the year ended December 31, 2016.

strategic acquisitions and share repurchases.
ITEM 2.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table sets forth information regarding our repurchases

ITEM 2.     UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of our commonEquity Securities
Common stock duringrepurchased in the three months ended September 30, 2017:

Period

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

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

July 1, 2017 - July 31, 2017

   12   $58.54    —     $36,399 

August 1, 2017 - August 31, 2017

   55    56.16    —      36,399 

September 1, 2017 - September 30, 2017

   108    56.56    —      36,399 
  

 

 

       

Total

   175   $56.57     
  

 

 

       

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

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 Rule10b-18 under the Exchange Act (the“10b5-1 Plan”). All share repurchases under the Current Program during closed trading window periods will be made pursuant to the10b5-1 Plan.

ITEM 6.EXHIBITS

2019 was:

(in thousands, except per share amounts)
Total Number of Shares Purchased (1) (2)
 
Average 
Price Paid
per Share (1) (2)
 
Total Number of Shares Purchased as Part of Publicly Announced Share Repurchase Program (2)
 
Approximate Dollar Value of Shares That May Yet Be Purchased at Period End Under Publicly Announced Share Repurchase Programs (2)  
July 1, 2019 - July 31, 201937
 $75.30
 29
 $50,532
August 1, 2019 - August 31, 201994
 $72.06
 31
 $48,333
September 1, 2019 - September 30, 2019199
 $71.12
 28
 $46,334

330
 $71.86
    
(1) Shares withheld to cover the option exercise price and tax withholding obligations under the net settlement provisions of our stock compensation awards have been included in these amounts.
(2) See “Liquidity and Capital Resources” in Item 2. “ Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information.
ITEM 5.     OTHER INFORMATION
On November 6, 2019, we entered into a five-year $100 million senior secured revolving credit agreement (the “Credit Agreement”) with PNC Bank, National Association (“PNC”). We may use borrowings to finance working capital needs and for general corporate purposes. Subject to specific circumstances, the Credit Agreement allows us to increase the aggregate commitment up to $200 million.
The following exhibits are filed or furnished, asCredit Agreement contains customary representations and warranties, affirmative and negative covenants, and events of default. Principal covenants include a maximum net consolidated leverage ratio of 3.5 (with a step-up in the caseevent of certain acquisitions) and a minimum consolidated interest coverage ratio of 3.5. Our obligations under the Credit Agreement may be accelerated upon the occurrence of an event of default under the Credit Agreement, which includes, among other things, payment defaults, defaults in the performance of

affirmative and negative covenants, the inaccuracy of representations or warranties, cross-defaults, bankruptcy and insolvency-related defaults, defaults relating to judgments, certain events resulting in a material adverse effect on us and a change of control of us.
The interest rates applicable to revolving loans under the Credit Agreement are, at our option, either:
the London Interbank Offered Rates (“LIBOR”) Rate plus an interest margin based on our net consolidated leverage ratio; or
a base rate (which is the highest of (1) PNC’s prime rate, (2) the Federal Funds open rate in effect on such day plus 0.5%, and (3) the daily LIBOR Rate plus 1%) plus an interest margin based on our net consolidated leverage ratio.
We are obligated to pay an unused commitment fee during the term of the Credit Agreement that varies between 0.15% and 0.225% depending on our net consolidated leverage ratio. The credit facility includes a provision for the replacement of the LIBOR rate in the event that such rate is no longer available. The replacement rate will be determined by PNC in consultation with us. The revolving credit facility may be prepaid before maturity in whole or in part at our option without penalty or premium. We may at any time reduce or terminate the commitments under the credit facility.
The description of the Credit Agreement contained herein is qualified in its entirety by reference to the Credit Agreement, a copy of which is filed as part ofExhibit 10.1 to this report.

EXHIBIT INDEX

Quarterly Report on Form 10-Q.
ITEM 6.     EXHIBITS

Exhibit No.

 

Description

10.1
31.1 
31.2 
3232+ 
101.INS XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.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.

++104Management contractsCover Page Interactive Data File (formatted as Inline XBRL and compensatory plan or arrangementscontained in Exhibit 101)

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

SIGNATURE


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

Pegasystems Inc.
Date: November 8, 2017Pegasystems Inc.
 By:
Dated:November 7, 2019By:/s/ KENNETH STILLWELL
  Kenneth Stillwell
  Chief Financial Officer and Chief Administrative Officer
  (Principal Financial Officer)



27