Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2019
OR
☐
Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number: 1-11859
____________________________
PEGASYSTEMS INC.
(Exact name of Registrant as specified in its charter)
____________________________
Massachusetts04-2787865
(State or other jurisdiction of incorporation or organization) (IRS Employer Identification No.)
One Rogers Street, Cambridge, MA02142-1209
(Address of principal executive offices) (Zip Code)
(617) 374-9600
(Registrant’s telephone number, including area code)
____________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading symbol(s)
Name of each exchange on which registered
Common Stock, $.01 par value per share
PEGA
NASDAQ 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. Yesx No ¨
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files). Yesx No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
☒
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
☐
Emerging growth company
☐
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐No ☒
There were 79,131,665 shares of the Registrant’s common stock, $0.01 par value per share, outstanding on July 30, 2019.
Common stock, 200,000 shares authorized; 79,144 and 78,526 shares issued and outstanding at
June 30, 2019 and December 31, 2018, respectively
791
785
Additional paid-in capital
122,880
123,205
Retained earnings
445,108
510,863
Accumulated other comprehensive (loss)
(11,492
)
(13,322
)
Total stockholders’ equity
557,287
621,531
Total liabilities and stockholders’ equity
$
940,617
$
982,553
See notes to unaudited condensed consolidated financial statements.
3
PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Three Months Ended June 30,
Six Months Ended June 30,
2019
2018
2019
2018
Revenue
Software license
$
44,274
$
44,784
$
107,538
$
132,557
Maintenance
69,329
65,906
137,035
130,431
Services
91,989
86,089
173,565
168,973
Total revenue
205,592
196,779
418,138
431,961
Cost of revenue
Software license
928
1,262
2,306
2,517
Maintenance
6,292
5,874
12,627
11,956
Services
69,860
66,681
136,584
134,958
Total cost of revenue
77,080
73,817
151,517
149,431
Gross profit
128,512
122,962
266,621
282,530
Operating expenses
Selling and marketing
116,962
93,972
225,827
182,355
Research and development
49,714
41,972
100,310
88,757
General and administrative
14,174
10,181
26,850
26,645
Total operating expenses
180,850
146,125
352,987
297,757
(Loss) from operations
(52,338
)
(23,163
)
(86,366
)
(15,227
)
Foreign currency transaction gain (loss)
2,105
1,244
(1,607
)
159
Interest income, net
544
629
1,267
1,393
Other income, net
55
—
55
363
(Loss) before (benefit from) income taxes
(49,634
)
(21,290
)
(86,651
)
(13,312
)
(Benefit from) income taxes
(17,338
)
(10,881
)
(25,638
)
(15,103
)
Net (loss) income
$
(32,296
)
$
(10,409
)
$
(61,013
)
$
1,791
(Loss) earnings per share
Basic
$
(0.41
)
$
(0.13
)
$
(0.77
)
$
0.02
Diluted
$
(0.41
)
$
(0.13
)
$
(0.77
)
$
0.02
Weighted-average number of common shares outstanding
Basic
78,987
78,635
78,787
78,436
Diluted
78,987
78,635
78,787
83,247
See notes to unaudited condensed consolidated financial statements.
4
PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS)
(in thousands)
Three Months Ended June 30,
Six Months Ended June 30,
2019
2018
2019
2018
Net (loss) income
$
(32,296
)
$
(10,409
)
$
(61,013
)
$
1,791
Other comprehensive (loss) income, net of tax
Unrealized gain (loss) on available-for-sale marketable securities
238
73
612
(115
)
Foreign currency translation adjustments
(409
)
(7,414
)
1,218
(2,964
)
Total other comprehensive (loss) income, net of tax
(171
)
(7,341
)
1,830
(3,079
)
Comprehensive (loss)
$
(32,467
)
$
(17,750
)
$
(59,183
)
$
(1,288
)
See notes to unaudited condensed consolidated financial statements.
5
PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except per share amounts)
Common Stock
Additional
Paid-In
Capital
Retained Earnings
Accumulated Other Comprehensive (Loss) Income
Total
Stockholders’ Equity
Number of Shares
Amount
December 31, 2017
78,081
$
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 plans
566
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, 2018
78,546
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 plans
358
4
(11,395
)
—
—
(11,391
)
Issuance of common stock under Employee Stock Purchase Plan
15
—
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, 2018
78,748
$
787
$
141,400
$
506,769
$
(9,784
)
$
639,172
December 31, 2018
78,526
$
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 plans
514
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, 2019
78,896
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 plans
320
3
(11,217
)
—
—
(11,214
)
Issuance of common stock under Employee Stock Purchase Plan
16
—
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, 2019
79,144
$
791
$
122,880
$
445,108
$
(11,492
)
$
557,287
See notes to unaudited condensed consolidated financial statements.
6
PEGASYSTEMS INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Six Months Ended June 30,
2019
2018
Operating activities
Net (loss) income
$
(61,013
)
$
1,791
Adjustments to reconcile net (loss) income to cash provided by operating activities
Stock-based compensation
38,397
31,165
Amortization and depreciation
33,788
20,921
Foreign currency transaction loss (gain)
1,607
(159
)
Other non-cash
(230
)
(846
)
Change in operating assets and liabilities, net
(4,829
)
22,560
Cash provided by operating activities
7,720
75,432
Investing activities
Purchases of investments
(10,497
)
(51,395
)
Proceeds from maturities and called investments
13,545
11,546
Sales of investments
29,965
—
Payments for acquisitions, net of cash acquired
(10,921
)
—
Investment in property and equipment
(4,882
)
(6,520
)
Cash provided by (used in) investing activities
17,210
(46,369
)
Financing activities
Dividend payments to shareholders
(4,730
)
(4,702
)
Common stock repurchases
(39,637
)
(41,123
)
Cash (used in) financing activities
(44,367
)
(45,825
)
Effect of exchange rate changes on cash and cash equivalents
515
(1,226
)
Net (decrease) in cash and cash equivalents
(18,922
)
(17,988
)
Cash and cash equivalents, beginning of period
114,422
162,279
Cash and cash equivalents, end of period
$
95,500
$
144,291
See notes to unaudited condensed consolidated financial statements.
7
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
Pegasystems Inc. (together with its subsidiaries, “the Company”) has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all the information required by accounting principles generally accepted in the United States of America (“U.S.”) for complete financial statements and should be read in conjunction with the Company’s audited financial statements included in the Annual Report on Form 10-K for the year ended December 31, 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 2019.
2. NEW ACCOUNTING PRONOUNCEMENTS
Financial instruments
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which requires measurement and recognition of expected credit losses for financial assets measured at amortized cost, including accounts receivable, upon initial recognition of that financial asset using a forward-looking expected loss model, rather than an incurred loss model. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses when the fair value is below the amortized cost of the asset, removing the concept of “other-than-temporary” impairments. The effective date for the Company will be January 1, 2020, with early adoption permitted. The Company does not expect the adoption of this standard will have a material effect on its financial position or results of operations.
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 historic 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.
3. MARKETABLE SECURITIES
June 30, 2019
(in thousands)
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
Municipal bonds
$
29,495
$
156
$
(5
)
$
29,646
Corporate bonds
29,620
291
(8
)
29,903
$
59,115
$
447
$
(13
)
$
59,549
December 31, 2018
(in thousands)
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
Municipal bonds
$
44,802
$
13
$
(110
)
$
44,705
Corporate bonds
48,499
23
(226
)
48,296
$
93,301
$
36
$
(336
)
$
93,001
As of June 30, 2019, maturities of marketable securities ranged from January 2020 to August 2022, with a weighted-average remaining maturity of approximately 1.5 years.
8
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE
Receivables
(in thousands)
June 30, 2019
December 31, 2018
Accounts receivable
$
134,965
$
180,872
Unbilled receivables
169,554
172,656
Long-term unbilled receivables
117,889
151,237
$
422,408
$
504,765
Unbilled receivables are client committed amounts for which revenue recognition precedes billing, and billing is solely subject to the passage of time.
Unbilled receivables are expected to be billed in the future as follows:
(Dollars in thousands)
June 30, 2019
1 year or less
$
169,554
59
%
1-2 years
79,128
28
%
2-5 years
38,761
13
%
$
287,443
100
%
Contract assets and deferred revenue
(in thousands)
June 30, 2019
December 31, 2018
Contract assets (1)
$
3,770
$
3,711
Long-term contract assets (2)
2,190
2,543
$
5,960
$
6,254
(1) Included in other current assets. (2) Included in other long-term assets.
(in thousands)
June 30, 2019
December 31, 2018
Deferred revenue
$
169,009
$
185,145
Long-term deferred revenue (1)
4,342
5,344
$
173,351
$
190,489
(1) Included in other long-term liabilities.
Contract assets are amounts under client contracts where revenue recognized exceeds the amount billed to the client and the right to payment is subject to conditions other than the passage of 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 six months ended June 30, 2019 was primarily due to $135.8 million of revenue recognized, excluding the impact of netting contract assets and deferred revenue at the contract level, during the period that was included in deferred revenue at December 31, 2018, 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 primarily relate to sales commissions. The Company expects to benefit from those costs for more than one year, as the Company generally only pays sales commissions on the initial contract, and not any subsequent contract renewals. As a result, there are no commensurate commissions paid on contract renewals. Deferred costs are amortized on a straight-line basis over the benefit period, which is on average 5 years.
(in thousands)
June 30, 2019
December 31, 2018
Deferred contract costs (1)
$
64,809
$
64,367
(1) Included in other long-term assets.
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2019
2018
2019
2018
Amortization of deferred contract costs (1)
$
5,878
$
3,809
$
14,179
$
7,598
(1)Included in selling and marketing expenses.
9
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
6. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
The change in the carrying amount of goodwill was:
(in thousands)
Six Months Ended June 30, 2019
Balance as of January 1,
$
72,858
Acquisition (1)
6,179
Currency translation adjustments
—
Balance as of June 30,
$
79,037
(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 intangibles assets of $6.2 million and $5.1 million. The allocation of the purchase price is preliminary for income taxes as the Company is still gathering information.
Intangibles
Intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives as follows:
June 30, 2019
(in thousands)
Useful Lives
Cost
Accumulated Amortization
Net Book Value (1)
Client-related intangibles
4-10 years
$
63,115
$
(53,608
)
$
9,507
Technology
2-10 years
64,843
(52,605
)
12,238
Other
1 - 5 years
5,361
(5,361
)
—
$
133,319
$
(111,574
)
$
21,745
(1) Included in other long-term assets.
December 31, 2018
(in thousands)
Useful Lives
Cost
Accumulated Amortization
Net Book Value (1)
Client-related intangibles
4-10 years
$
63,115
$
(51,224
)
$
11,891
Technology
2-10 years
59,742
(50,398
)
9,344
Other
1 - 5 years
5,361
(5,361
)
—
$
128,218
$
(106,983
)
$
21,235
(1) Included in other long-term assets.
Amortization of intangible assets was:
(in thousands)
Three Months Ended June 30,
Six Months Ended June 30,
2019
2018
2019
2018
Cost of revenue
$
875
$
1,231
$
2,207
$
2,463
Selling and marketing
781
1,605
2,385
3,210
$
1,656
$
2,836
$
4,592
$
5,673
7. ACCRUED EXPENSES
(in thousands)
June 30, 2019
December 31, 2018
Outside professional services expenses
$
8,513
$
10,367
Income and other taxes
6,401
10,387
Marketing and sales program expenses
12,115
5,860
Dividends payable
2,375
2,363
Employee-related expenses
5,378
3,536
Cloud hosting expenses
11,978
4,604
Other
3,612
8,389
$
50,372
$
45,506
10
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
8. FAIR VALUE MEASUREMENTS
Assets and liabilities measured at fair value on a recurring basis
The Company records its cash equivalents, marketable securities, and investments in privately-held companies at fair value on a recurring basis. Fair value is an exit price, representing the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants based on assumptions that market participants would use in pricing an asset or liability.
As a basis for classifying the fair value measurements, a three-tier fair value hierarchy, which classifies the fair value measurements based on the inputs used in measuring fair value, was established as follows:
•
Level 1 - observable inputs such as quoted prices in active markets for identical assets or liabilities;
•
Level 2 - significant other inputs that are observable either directly or indirectly; and
•
Level 3 - significant unobservable inputs on which there is little or no market data, which require the Company to develop its own assumptions. This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value.
The Company’s cash equivalents are composed of money market funds and time deposits, which are classified within Level 1 and Level 2, respectively, in the fair value hierarchy. The Company’s marketable securities, which are classified within Level 2 of the fair value hierarchy are valued based on a market approach using quoted prices, when available, or matrix pricing compiled by third party pricing vendors, using observable market inputs such as interest rates, yield curves, and credit risk. The Company’s investments in privately-held companies are classified within Level 3 of the fair value hierarchy.
If applicable, the Company will recognize transfers into and out of levels within the fair value hierarchy at the end of the reporting period in which the actual event or change in circumstance occurs. There were no transfers between levels during the six months ended June 30, 2019.
The Company’s assets and liabilities measured at fair value on a recurring basis were:
June 30, 2019
(in thousands)
Level 1
Level 2
Level 3
Total
Cash equivalents
$
5,653
$
—
$
—
$
5,653
Marketable securities:
Municipal bonds
$
—
$
29,646
$
—
$
29,646
Corporate bonds
—
29,903
—
29,903
Total marketable securities
$
—
$
59,549
$
—
$
59,549
Investments in privately-held companies (1)
$
—
$
—
$
3,890
$
3,890
(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 fair value due to the relatively short maturity of these items.
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 the lease commencement date and thereafter if modified. Fixed lease costs are recognized on a straight-line basis over the term of the lease. Variable lease costs are recognized in the period in which the obligation for those payments is incurred. The Company combines lease and 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 is
11
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
reasonably certain it will exercise those options. The Company’s leases do not contain any material residual value guarantees or restrictive covenants.
Expense
(in thousands)
Three Months Ended June 30, 2019
Six Months Ended June 30, 2019
Operating lease costs (1)
$
4,281
$
8,581
Variable lease costs
1,362
2,683
$
5,643
$
11,264
(1) Lease costs that are fixed.
Right of use assets and lease liabilities
(in thousands)
June 30, 2019
Right of use assets (1)
$
57,772
Lease liabilities (2)
$
14,576
Long-term lease liabilities
$
54,292
(1) An asset that represents the Company’s right to use the leased asset during the lease term. Included in other long-term assets. (2) Included in other current liabilities.
The weighted-average remaining lease term and discount rate for the Company’s leases were:
June 30, 2019
Weighted-average remaining lease term
4.3 years
Weighted-average discount rate (1)
5.7
%
(1) The rates implicit in most of the Company’s leases are not readily determinable, and therefore the Company uses its incremental borrowing rate as the discount rate when measuring operating lease liabilities. The incremental borrowing rate represents an estimate of the interest rate the Company would incur to borrow an amount equal to the lease payments on a collateralized basis over the term of the lease.
Maturities of lease liabilities are:
(in thousands)
June 30, 2019
Remainder of 2019
$
8,290
2020
18,976
2021
17,099
2022
16,166
2023 and thereafter
17,393
Total lease payments
77,924
Less: imputed interest (1)
(9,056
)
$
68,868
(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 prior to the adoption of ASC 842 were:
(in thousands)
Operating Leases (1)
2019
$
15,993
2020
14,807
2021
13,262
2022
12,279
2023
11,084
$
67,425
(1) Operating leases include future minimum rent payments, net of estimated sublease income for facilities that the Company has vacated pursuant to its restructuring activities.
12
PEGASYSTEMS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Cash flow information
(in thousands)
Six Months Ended June 30, 2019
Cash paid for leases
9,638
Right of use assets recognized for new leases and amendments (non-cash)