Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended June 30, 2015

or

 

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

For the transition period from                      to                     

Commission File Number: 1-11859

 

 

PEGASYSTEMS INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Massachusetts   04-2787865

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

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

(617) 374-9600

(Registrant’s telephone number including area code)

 

 

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

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

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

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if smaller reporting company)    Smaller reporting company   ¨

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

There were 76,523,015 shares of the Registrant’s common stock, $.01 par value per share, outstanding on July 17, 2015.

 

 

 


Table of Contents

PEGASYSTEMS INC.

Index to Form 10-Q

 

          Page  
Part I—Financial Information   

Item 1.

  

Financial Statements (Unaudited):

  
  

Condensed Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014

     3   
  

Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2015 and 2014

     4   
  

Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2015 and 2014

     5   
  

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2015 and 2014

     6   
  

Notes to Condensed Consolidated Financial Statements

     7   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     15   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     24   

Item 4.

  

Controls and Procedures

     25   
Part II—Other Information   

Item 1A.

  

Risk Factors

     25   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     25   

Item 6.

  

Exhibits

     26   

SIGNATURE

     27   

 

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Table of Contents

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

     As of
June 30,

2015
    As of
December 31,
2014
 

 

ASSETS

    

 

Current assets:

    

 

Cash and cash equivalents

   $     120,864      $ 114,585   

 

Marketable securities

     106,068        96,631   
  

 

 

   

 

 

 

Total cash, cash equivalents, and marketable securities

     226,932        211,216   

 

Trade accounts receivable, net of allowance of $1,752 and $1,540

     135,585        154,844   

 

Deferred income taxes

     12,948        12,974   

 

Income taxes receivable

     8,429        4,502   

 

Other current assets

     12,536        9,544   
  

 

 

   

 

 

 

Total current assets

     396,430        393,080   

 

Property and equipment, net

     33,855        30,156   

 

Long-term deferred income taxes

     70,765        69,258   

 

Long-term other assets

     3,016        2,783   

 

Intangible assets, net

     39,419        45,664   

 

Goodwill

     46,882        46,860   
  

 

 

   

 

 

 

Total assets

   $ 590,367      $ 587,801   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

 

Current liabilities:

    

 

Accounts payable

   $ 8,330      $ 4,752   

 

Accrued expenses

     40,326        42,958   

 

Accrued compensation and related expenses

     37,249        47,250   

 

Deferred revenue

     143,001        134,672   
  

 

 

   

 

 

 

Total current liabilities

     228,906        229,632   

 

Income taxes payable

     24,919        24,896   

 

Long-term deferred revenue

     16,214        20,859   

 

Other long-term liabilities

     16,751        17,709   
  

 

 

   

 

 

 

Total liabilities

     286,790        293,096   
  

 

 

   

 

 

 

Stockholders’ equity:

    

 

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

     —          —     

 

Common stock, 200,000 shares authorized; 76,627 shares and 76,357 shares issued and outstanding

     766        764   

 

Additional paid-in capital

     147,257        141,495   

 

Retained earnings

     157,495        153,058   

 

Accumulated other comprehensive loss

     (1,941     (612
  

 

 

   

 

 

 

Total stockholders’ equity

     303,577        294,705   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 590,367      $ 587,801   
  

 

 

   

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

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PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2015     2014     2015     2014  

 

Revenue:

        

 

Software license

   $ 63,497      $ 54,012      $   121,472      $   106,626   

 

Maintenance

     49,329        45,393        98,081        90,274   

 

Services

     49,193        43,580        96,384        86,549   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     162,019        142,985        315,937        283,449   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenue:

        

 

Software license

     1,030        1,177        2,106        2,756   

 

Maintenance

     5,476        5,044        10,656        9,708   

 

Services

     48,275        40,470        92,078        80,140   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue

     54,781        46,691        104,840        92,604   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     107,238        96,294        211,097        190,845   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

 

Selling and marketing

     60,389        56,342        116,124        102,149   

 

Research and development

     31,372        27,323        61,216        51,932   

 

General and administrative

     10,214        10,250        16,559        19,552   

 

Acquisition-related

     13        157        39        363   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     101,988        94,072        193,938        173,996   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     5,250        2,222        17,159        16,849   

 

Foreign currency transaction (loss) gain

     (968     (4     (3,930     318   

 

Interest income, net

     216        163        529        287   

 

Other income (expense), net

     3        6        3        (526
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before provision for income taxes

     4,501        2,387        13,761        16,928   

 

Provision for income taxes

     1,397        883        4,722        5,659   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 3,104      $ 1,504      $ 9,039      $ 11,269   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share:

        

 

Basic

   $ 0.04      $ 0.02      $ 0.12      $ 0.15   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 0.04      $ 0.02      $ 0.11      $ 0.14   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average number of common shares outstanding:

        

 

Basic

     76,626        76,286        76,514        76,385   

 

Diluted

     78,950        78,280        78,771        78,563   

 

Cash dividends declared per share

   $ 0.03      $ 0.03      $ 0.06      $ 0.045   
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

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PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2015     2014     2015     2014  

 

Net income

   $     3,104      $     1,504      $   9,039      $   11,269   

 

Other comprehensive income (loss):

        

 

Unrealized (loss) gain on securities, net of tax

     (86     (3     5        28   

 

Foreign currency translation adjustments

     1,762        891        (1,334     1,276   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive income (loss), net

     1,676        888        (1,329     1,304   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 4,780      $ 2,392      $ 7,710      $ 12,573   
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

     Six Months Ended
June 30,
 
     2015     2014  

 

Operating activities:

    

 

Net income

   $ 9,039      $ 11,269   

 

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

    

 

Excess tax benefits from exercise or vesting of equity awards

     (2,280     (2,526

 

Deferred income taxes

     (1,525     (899

 

Depreciation and amortization

     11,258        11,412   

 

Stock-based compensation expense

     14,914        8,453   

 

Foreign currency transaction loss (gain)

     3,930        (318

 

Other non-cash items

     550        495   

 

Change in operating assets and liabilities:

    

 

Trade accounts receivable

     16,645        51,155   

 

Income taxes receivable and other current assets

     (4,853     (3,836

 

Accounts payable and accrued expenses

     (10,507     94   

 

Deferred revenue

     2,378        (214

 

Other long-term assets and liabilities

     (150     (1,150
  

 

 

   

 

 

 

Cash provided by operating activities

     39,399        73,935   
  

 

 

   

 

 

 

Investing activities:

    

 

Purchases of marketable securities

     (31,504     (29,547

 

Proceeds from maturities and called marketable securities

     21,120        15,996   

 

Payments for acquisitions

     (535     (1,593

 

Investment in property and equipment

     (7,293     (2,864
  

 

 

   

 

 

 

Cash used in investing activities

     (18,212     (18,008
  

 

 

   

 

 

 

Financing activities:

    

 

Issuance of common stock for share-based compensation plans

     587        338   

 

Excess tax benefits from exercise or vesting of equity awards

     2,280        2,526   

 

Dividend payments to shareholders

     (4,594     (2,290

 

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

     (4,432     (3,402

 

Common stock repurchases under share repurchase programs

     (7,075     (8,459
  

 

 

   

 

 

 

Cash used in financing activities

     (13,234     (11,287
  

 

 

   

 

 

 

Effect of exchange rates on cash and cash equivalents

     (1,674     2,240   
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     6,279        46,880   

 

Cash and cash equivalents, beginning of period

     114,585        80,231   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $   120,864      $   127,111   
  

 

 

   

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1. ACCOUNTING POLICIES

Basis of Presentation

Pegasystems Inc. (together with its subsidiaries, “the Company”) has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“U.S.”) for complete financial statements and should be read in conjunction with the Company’s audited financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2014.

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 2015.

 

2. NEW ACCOUNTING PRONOUNCEMENTS

Revenue from Contracts with Customers: In May 2014, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. This ASU amends the guidance for revenue recognition to replace numerous, industry-specific requirements, and converges areas under this topic with those of the International Financial Reporting Standards. This ASU implements a five-step process for customer contract revenue recognition that focuses on transfer of control, as opposed to transfer of risk and rewards. This ASU also requires enhanced disclosures regarding the nature, amount, timing, and uncertainty of revenues and cash flows from contracts with customers. Other major provisions include ensuring the time value of money is considered in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. The amendments in this ASU were originally scheduled to become effective for reporting periods beginning after December 15, 2016. On July 9, 2015, the FASB delayed the effective date of this ASU by one year so that the amendments in this ASU will be effective for reporting periods beginning after December 15, 2017, with early adoption permitted for reporting periods beginning on December 15, 2016. The proposed new effective date for the Company will be January 1, 2018. Management is currently assessing the impact the adoption of this ASU will have on the Company’s consolidated financial statements.

 

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3. MARKETABLE SECURITIES

 

     June 30, 2015  
(in thousands)    Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
     Fair Value  

 

Municipal bonds

   $ 35,493       $ 20       $ (43    $ 35,470   

 

Corporate bonds

     66,520         14         (72      66,462   

 

Certificates of deposit

     4,131         6         (1      4,136   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $   106,144       $ 40       $ (116    $   106,068   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2014  
(in thousands)    Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
     Fair Value  

 

Municipal bonds

   $ 27,820       $ 52       $ (17    $ 27,855   

 

Corporate bonds

     65,487         5         (144      65,348   

 

Certificates of deposit

     3,428         2         (2      3,428   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $     96,735       $ 59       $ (163    $     96,631   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company considers debt securities with maturities of three months or less from the purchase date to be cash equivalents. Interest is recorded when earned. All of the Company’s investments are classified as available-for-sale and are carried at fair value with unrealized gains and losses recorded as a component of accumulated other comprehensive loss, net of related income taxes.

As of June 30, 2015, remaining maturities of marketable debt securities ranged from July 2015 to June 2017, with a weighted-average remaining maturity of approximately 13 months.

 

4. DERIVATIVE INSTRUMENTS

The Company has historically used foreign currency forward contracts (“forward contracts”) to manage its exposure to changes in foreign currency exchange rates associated with its foreign currency denominated cash, accounts receivable, and intercompany receivables and payables held by its U.S. operating company.

Effective on April 1, 2015, the Company restructured its operations with its clients based outside the Americas. These clients began transacting with Pegasystems Limited, a United Kingdom (“U.K.”) subsidiary of Pegasystems Inc., which has the British pound as its functional currency. This reorganization resulted in increased cash, accounts receivable, and intercompany receivables and payables held by Pegasystems Limited in currencies other than the British pound. As a result, the Company’s exposure to foreign currency exchange rate fluctuations in the U.S. dollar, the Euro, and the Australian dollar relative to the British pound increased, while its exposure to foreign currency exchange rate fluctuations in the British pound, the Euro, and the Australian dollar relative to the U.S. dollar decreased.

In July 2015, as a result of this operational reorganization, the Company implemented its revised hedging program under which it fully or partially hedges its non-functional currency exposures for Pegasystems Inc. and Pegasystems Limited, utilizing forward contracts with terms not greater than 180 days. The Company executed forward contracts in July 2015 to hedge its exposures to Euro and British pound denominated cash, accounts receivable, and intercompany receivables and payables held by Pegasystems Inc., and to Euro, U.S. dollar, and Australian dollar denominated cash, accounts receivable, and intercompany receivables and payables held by Pegasystems Limited.

The forward contracts utilized by the Company, both prior to March 2014 and under its revised hedging program, are not designated as hedging instruments. As a result, the Company records the fair value of these contracts at the end of each reporting period in its consolidated balance sheet as other current assets for unrealized gains and accrued expenses for unrealized losses, with any fluctuations in the value of these contracts recognized in other income (expense), net, in its consolidated statement of operations. However, the fluctuations in the value of these foreign currency forward contracts partially offset the gains and losses from the remeasurement or settlement of the foreign currency denominated cash, accounts receivable, and intercompany receivables and payables held by Pegasystems Inc. and Pegasystems Limited, thus partly mitigating the volatility.

The Company did not enter into any forward contracts between March 2014 and June 2015, and as of June 30, 2015 and December 31, 2014, the Company did not have any forward contracts outstanding.

 

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During the six months ended June 30, 2014, the Company entered into forward contracts with an aggregate notional value of $87.9 million, and the total change in fair value recorded in other income (expense), net, was $0.5 million.

 

5. FAIR VALUE MEASUREMENTS

Assets Measured at Fair Value on a Recurring Basis

The Company records its marketable securities at fair value on a recurring basis. Fair value is an exit price, representing the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants based on assumptions that market participants would use in pricing an asset or liability. As a basis for classifying the fair value measurements, a three-tier fair value hierarchy, which classifies the fair value measurements based on the inputs used in measuring fair value, was established as follows: (Level 1) observable inputs such as quoted prices in active markets for identical assets or liabilities; (Level 2) significant other inputs that are observable either directly or indirectly; and (Level 3) significant unobservable inputs on which there is little or no market data, which require the Company to develop its own assumptions. This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value.

The Company’s money market funds are classified within Level 1 of the fair value hierarchy and are valued using quoted market prices in active markets for identical assets. The Company’s investments 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. 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 significant transfers between Level 1 and Level 2 during the three and six months ended June 30, 2015.

The fair value hierarchy of the Company’s cash equivalents and marketable securities is as follows:

 

            Fair Value Measurements at
Reporting Date Using
 
(in thousands)    June 30, 2015      Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
 

 

Money market funds (1)

   $ 2,497       $ 2,497       $ —     
  

 

 

    

 

 

    

 

 

 

Marketable securities:

        

 

Municipal bonds

   $ 35,470       $ —         $ 35,470   

 

Corporate bonds

     66,462         —           66,462   

 

Certificates of deposit

     4,136         —           4,136   
  

 

 

    

 

 

    

 

 

 

Total marketable securities

   $ 106,068       $ —         $ 106,068   
  

 

 

    

 

 

    

 

 

 

 

(1)  Included in “cash and cash equivalents” in the accompanying unaudited condensed consolidated balance sheet as of June 30, 2015, in addition to $118.4 million of cash.

 

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            Fair Value Measurements at
Reporting Date Using
 
(in thousands)    December 31,
2014
     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
 

 

Money market funds (1)

   $ 2,295       $ 2,295       $ —     
  

 

 

    

 

 

    

 

 

 

Marketable securities:

        

 

Municipal bonds

   $ 27,855       $ —         $ 27,855   

 

Corporate bonds

     65,348         —           65,348   

 

Certificates of deposit

     3,428         —           3,428   
  

 

 

    

 

 

    

 

 

 

Total marketable securities

   $ 96,631       $ —         $ 96,631   
  

 

 

    

 

 

    

 

 

 

 

(1)  Included in “cash and cash equivalents” in the accompanying unaudited condensed consolidated balance sheet as of December 31, 2014, in addition to $112.3 million of cash.

Assets Measured at Fair Value on a Nonrecurring Basis

Assets recorded at fair value on a nonrecurring basis, such as property and equipment, and intangible assets, are recognized at fair value when they are impaired. During the first six months of 2015 and 2014, the Company did not recognize any impairments on its assets measured at fair value on a nonrecurring basis.

 

6. TRADE ACCOUNTS RECEIVABLE, NET OF ALLOWANCE

 

(in thousands)    June 30,
2015
     December 31,
2014
 

 

Trade accounts receivable

   $ 122,210       $ 128,757   

 

Unbilled trade accounts receivable

     15,127         27,627   
  

 

 

    

 

 

 

Total accounts receivable

     137,337         156,384   
  

 

 

    

 

 

 

Allowance for sales credit memos

     (1,752      (1,540
  

 

 

    

 

 

 
   $         135,585       $ 154,844   
  

 

 

    

 

 

 

Unbilled trade accounts receivable primarily relate to services revenue earned under time and materials arrangements and to maintenance and license arrangements which have commenced or been delivered but have not been invoiced.

 

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7. GOODWILL AND OTHER INTANGIBLE ASSETS

Changes in the carrying amount of goodwill:

 

(in thousands)    2015  

 

Balance as of January 1,

   $     46,860   

 

Translation adjustments

     22   
  

 

 

 

Balance as of June 30,

   $ 46,882   
  

 

 

 

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

 

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

 

As of June 30, 2015

           

 

Customer related intangibles

     4-9 years       $ 49,601       $ (27,402    $ 22,199   

 

Technology

     3-9 years         48,342         (31,580      16,762   

 

Other intangibles

     3 years         5,361         (4,903      458   
     

 

 

    

 

 

    

 

 

 

Total

      $     103,304       $ (63,885    $     39,419   
     

 

 

    

 

 

    

 

 

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

 

As of December 31, 2014

           

 

Customer related intangibles

     4-9 years       $ 49,590       $ (24,338    $ 25,252   

 

Technology

     3-9 years         48,342         (28,890      19,452   

 

Other intangibles

     1-3 years         5,361         (4,401      960   
     

 

 

    

 

 

    

 

 

 

Total

      $ 103,293       $ (57,629    $ 45,664   
     

 

 

    

 

 

    

 

 

 

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

 

     Three Months Ended
June 30,
     Six Months Ended June
30,
 
(in thousands)    2015      2014      2015      2014  

 

Cost of revenue

   $ 1,347       $ 1,444       $ 2,690       $ 3,284   

 

Selling and marketing

     1,534         1,499         3,065         2,995   

 

General and administrative

     238         481         502         901   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total amortization expense

   $ 3,119       $ 3,424       $     6,257       $     7,180   
  

 

 

    

 

 

    

 

 

    

 

 

 

Amortization of intangibles is estimated to be recorded over their remaining useful lives as follows:

 

(in thousands) as of June 30, 2015

   Future estimated
amortization
expense
 

 

Remainder of 2015

   $ 5,954   

 

2016

     11,524   

 

2017

     9,826   

 

2018

     8,826   

 

2019

     3,034   

 

2020 and thereafter

     255   
  

 

 

 
   $ 39,419   
  

 

 

 

 

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8. ACCRUED EXPENSES

 

(in thousands)    June 30,
2015
     December 31,
2014
 

 

Partner commissions

   $ 3,003       $ 2,441   

 

Other taxes

     9,144         10,970   

 

Employee reimbursable expenses

     2,589         1,474   

 

Dividends payable

     2,302         2,294   

 

Professional services contractor fees

     3,760         2,297   

 

Self-insurance health and dental claims

     1,519         2,115   

 

Professional fees

     1,989         2,444   

 

Short-term deferred rent

     1,564         1,446   

 

Income taxes payable

     885         8,966   

 

Acquisition-related expenses and merger consideration

     2,176         2,702   

 

Restructuring

     401         461   

 

Marketing and sales program expenses

     4,737         1,914   

 

Cloud hosting expenses

     1,654         516   

 

Leasehold improvements in process

     1,653         —     

 

Other

     2,950         2,918   
  

 

 

    

 

 

 
   $           40,326       $ 42,958   
  

 

 

    

 

 

 

 

9. DEFERRED REVENUE

 

(in thousands)    June 30,
2015
     December 31,
2014
 

 

Software license

   $ 36,429       $ 38,961   

 

Maintenance

     89,474         83,467   

 

Cloud

     8,996         4,209   

 

Services and other

     8,102         8,035   
  

 

 

    

 

 

 

Current deferred revenue

     143,001         134,672   
  

 

 

    

 

 

 

Software license

     15,914         19,878   

 

Maintenance and services

     300         981   
  

 

 

    

 

 

 

Long-term deferred revenue

     16,214         20,859   
  

 

 

    

 

 

 
   $         159,215       $ 155,531   
  

 

 

    

 

 

 

 

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10. STOCK-BASED COMPENSATION

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

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
(in thousands)    2015      2014      2015      2014  

Cost of revenues

   $     2,281       $     1,387       $     4,234       $     2,398   

Operating expenses

     6,364         3,771         10,680         6,055   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation before tax

   $ 8,645       $ 5,158       $ 14,914       $ 8,453   

Income tax benefit

   $ (2,328    $ (1,591    $ (4,111    $ (2,582

During the first six months of 2015, the Company issued approximately 592,000 shares of common stock to its employees and 25,000 shares to its non-employee directors under the Company’s share-based compensation plans.

During the first six months of 2015, the Company granted approximately 1,620,000 restricted stock units (“RSUs”) and 2,048,000 non-qualified stock options to its employees with total fair values of approximately $32 million and $15.3 million, respectively. Approximately 250,000 RSUs were granted in connection with the election by employees to receive 50% of their 2015 target incentive compensation under the Company’s Corporate Incentive Compensation Plan (the “CICP”) in the form of RSUs instead of cash. Stock-based compensation of approximately $4.3 million associated with this RSU grant will be recognized over a one-year period beginning on the grant date.

The Company recognizes stock based compensation on the accelerated recognition method, while treating each vesting tranche as if it were an individual grant. As of June 30, 2015, the Company had approximately $41.6 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to all unvested RSUs and unvested stock options that is expected to be recognized over a weighted-average period of 2.2 years.

 

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11. EARNINGS PER SHARE

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

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
(in thousands, except per share amounts)    2015      2014      2015      2014  

 

Basic

           

 

Net income

   $     3,104       $     1,504       $     9,039       $   11,269   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted-average common shares outstanding

     76,626         76,286         76,514         76,385   
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per share, basic

   $ 0.04       $ 0.02       $ 0.12       $ 0.15   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted

           

 

Net income

   $ 3,104       $ 1,504       $ 9,039       $ 11,269   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted-average common shares outstanding, basic

     76,626         76,286         76,514         76,385   

 

Weighted-average effect of dilutive securities:

           

 

Stock options

     1,525         1,607         1,517         1,766   

 

RSUs

     799         387         740         412   
  

 

 

    

 

 

    

 

 

    

 

 

 

Effect of assumed exercise of stock options and RSUs

     2,324         1,994         2,257         2,178   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted-average common shares outstanding, diluted

     78,950         78,280         78,771         78,563   
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per share, diluted

   $ 0.04       $ 0.02       $ 0.11       $ 0.14   
  

 

 

    

 

 

    

 

 

    

 

 

 

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

     223         166         141         112   

 

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12. GEOGRAPHIC INFORMATION AND MAJOR CLIENTS

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

The Company develops and licenses its strategic software applications and Pega 7 platform, and provides consulting services, maintenance, and training related to its offerings. The Company derives substantially all of its revenue from the sale and support of one group of similar products and services – software that provides business process solutions in the enterprise applications market. To assess performance, the Company’s CODM reviews financial information on a consolidated basis. Therefore, the Company determined it has one reportable segment — Digital Enterprise Business Solutions, and one reporting unit.

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

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
(Dollars in thousands)    2015      2014      2015      2014  

 

U.S.

   $ 87,867         54%       $ 70,411         49%       $ 178,031         56%       $ 152,428         54%   

 

Other Americas

     27,380         17%         5,464         4%         39,677         13%         9,304         3%   

 

United Kingdom

     21,149         13%         24,643         17%         41,376         13%         53,557         19%   

 

Other EMEA

     15,835         10%         34,008         24%         34,703         11%         50,308         18%   

 

Asia Pacific

     9,788         6%         8,459         6%         22,150         7%         17,852         6%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $   162,019         100%       $   142,985         100%       $   315,937         100%       $   283,449         100%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

There were no clients accounting for 10% or more of the Company’s total revenue during the second quarter and first six months of 2015 and 2014. Clients accounting for 10% or more of the Company’s total outstanding trade receivables, net of allowance, were as follows:

 

    

As of

June 30,

     As of
December 31,
 
(Dollars in thousands)    2015      2014  

Trade receivables, net of allowance

   $         135,585       $ 154,844   

Client A

     13%         n/a   

 

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

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains or incorporates forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, statements about our future financial performance and business plans, the adequacy of our liquidity and capital resources, the continued payment of quarterly dividends by the Company, and the timing of recognizing revenue under existing term license agreements. 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,” 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 include, among others, variation in demand for our products and services and the difficulty in predicting the completion of product acceptance and other factors affecting the timing of license revenue recognition; the ongoing consolidation in the financial services, insurance, healthcare, and communications markets; reliance on third party relationships; the potential loss of vendor specific objective evidence for our consulting services; the inherent risks associated with international operations and the continued weakness in international economies; foreign currency exchange rates; the financial impact of the Company’s past acquisitions and any future acquisitions; and management of the Company’s growth. These risks are described more completely in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2014. We do not intend to update any forward-looking statements publicly, whether as a result of new information, future events, or otherwise.

 

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Table of Contents

Business overview

We develop, market, license, and support strategic software applications for marketing, sales and onboarding, customer service, and operations. In addition, we license our Pega 7 platform for clients that wish to build and extend their own applications. Pega 7 assists our clients in building, deploying, and evolving enterprise applications, creating an environment in which business and IT can collaborate to manage back office operations, front office sales, marketing, and/or customer service needs. We also provide consulting services, maintenance, and training for our software and our applications. Our applications and Pega 7 can be deployed in the Cloud or on-premises.

Pega 7 and our related applications are used by our clients in the financial services, healthcare, insurance, communications and media, public sector, manufacturing, life sciences, and other markets. We sell our software directly and also through a network of business and technology alliances. Our partners include major systems integrators, management consulting firms, technology providers, and application developers.

Our clients include Global 500 companies and government agencies that seek to manage complex enterprise systems and customer service issues more nimbly and cost-effectively. Our strategy is to sell a client a series of licenses, each focused on a specific purpose or area of operations. As we have found meaningful interest from smaller companies, we are expanding our sales force to extend coverage beyond our traditional Global 500 focus. We license our products and render consulting and training services to clients domestically and internationally, including in Canada, Europe, the Middle East, Latin America, Asia, and Australia. In the second quarter of 2015 and 2014, revenue from clients based outside of the United States of America (“U.S.”) represented 46% and 51% of our total revenue, respectively. In the first six months of 2015 and 2014, revenue from clients based outside of the U.S. represented 44% and 46% of our total revenue, respectively.

Our license revenue is primarily derived from sales of our applications in the areas of marketing, sales and onboarding, customer service and support, and operations, as well as our Pega 7 platform. Our consulting services revenue is primarily related to new license implementations. Our consulting services revenue may be lower in future periods as more of our clients become enabled and our partners lead more projects. We offer training for our staff, clients, and partners at our regional training facilities and at third-party facilities, including client sites. Our online training through Pega Academy provides an alternative way to learn our software in a virtual environment. We believe that this online training will continue to expand the number of trained experts at a faster pace.

We continue to invest heavily in research and development to improve our software. Our research and development operations are primarily located in the U.S. and India. We also regularly evaluate acquisitions or investment opportunities in complementary businesses, services and technologies, and intellectual property rights in an effort to expand and enhance our product offerings.

 

(Dollars in thousands, except per share
amounts)

   Three Months Ended
June 30,
     Increase      Six Months Ended
June 30,
     Increase (Decrease)  
   2015      2014                    2015      2014               

Total revenue

   $   162,019       $   142,985       $     19,034         13%       $ 937       $   283,449       $     32,488        11%   

License revenue

   $ 63,497       $ 54,012       $ 9,485         18%       $   121,472       $ 106,626       $ 14,846        14%   

Diluted earnings per share

   $ 0.04       $ 0.02       $ 0.02         100%       $ 0.11       $ 0.14       $ (0.03     (21)%   

Cash flow provided by operating activities

               $ 39,399       $ 73,935       $ (34,536     (47)%   

The increase in diluted earnings per share during the second quarter of 2015 was primarily due to the significant increase in income from operations, partially offset by the $1 million increase in foreign currency transaction loss. The decrease in diluted earnings per share for the first six months of 2015 was primarily due to the $4.2 million increase in foreign currency transaction loss. The decrease in cash provided by operating activities was primarily due to the larger outstanding billings at June 30, 2015 compared to June 30, 2014.

 

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Table of Contents

In addition to the above key financial metrics, management also focuses on license and Cloud backlog. We compute license and Cloud backlog by adding billed deferred license and Cloud revenue as recorded on the balance sheet and license and Cloud contractual commitments, which are not billed and not recorded on our balance sheet. License and Cloud backlog may vary in any given period depending on the amount and timing of when arrangements are executed, as well as the mix between perpetual and term license arrangements.

 

     As of June 30,      % Change  
(Dollars in thousands)    2015      2014         

Total billed deferred license and Cloud revenue

   $ 61,339       $ 54,938         12%   

Total off-balance sheet license and Cloud commitments

     330,043         298,658         11%   
  

 

 

    

 

 

    

 

 

 

Total license and Cloud Backlog

   $   391,382       $   353,596         11%   
  

 

 

    

 

 

    

 

 

 

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 of America (“U.S. GAAP”) and with 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 beliefs of what could occur in the future given available information.

There have been no changes in our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014. For more information regarding our critical accounting policies, we encourage you to read the discussion contained in Item 7 under the heading “Critical Accounting Estimates and Significant Judgments” and Note 2 “Significant Accounting Policies” included in the notes to the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2014.

 

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Table of Contents

Results of Operations

 

     Three Months Ended
June 30,
     Increase      Six Months Ended June 30,      Increase (Decrease)  
(Dollars in thousands)    2015      2014                    2015      2014               

 

Total revenue

   $   162,019       $   142,985       $   19,034         13%       $   315,937       $   283,449       $   32,488        11%   

 

Gross profit

   $ 107,238       $ 96,294       $ 10,944         11%       $ 211,097       $ 190,845       $ 20,252        11%   

 

Total operating expenses

   $ 101,988       $ 94,072       $ 7,916         8%       $ 193,938       $ 173,996       $ 19,942        11%   

 

Income from operations

   $ 5,250       $ 2,222       $ 3,028         136%       $ 17,159       $ 16,849       $ 310        2%   

 

Income before provision for income taxes

   $ 4,501       $ 2,387       $ 2,114         89%       $ 13,761       $ 16,928       $ (3,167     (19)%   

Revenue

 

     Three Months Ended
June 30,
     Increase      Six Months Ended
June 30,
     Increase  
(Dollars in thousands)    2015      2014                    2015      2014                

 

License revenue

                                   

 

Perpetual licenses

   $ 35,166         55%       $ 33,272         62%       $   1,894          $ 63,092         52%       $ 56,657         53%       $ 6,435      

 

Term licenses

     26,423         42%         19,040         35%         7,383            54,222         45%         45,866         43%         8,356      

 

Subscription

     1,908         3%         1,700         3%         208            4,158         3%         4,103         4%         55      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

       

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Total license revenue

   $ 63,497         100%       $ 54,012         100%       $ 9,485         18%       $ 121,472         100%       $ 106,626         100%       $   14,846         14%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

       

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

The aggregate value of new license arrangements executed during the first six months of 2015 significantly increased compared to the first six months of 2014 primarily due to a higher number and higher value of arrangements executed in the first six months of 2015. The higher value was due to two arrangements, each greater than $10 million, executed in the first six months of 2015. The aggregate value of new license arrangements executed fluctuates quarter to quarter. During the first six months of 2015 and 2014, approximately 56% and 84%, respectively, of the value of new license arrangements were executed with existing clients.

The mix between perpetual and term license arrangements executed in a particular period varies based on client needs. A change in the mix between perpetual and term license arrangements executed may cause our revenues to vary materially from period to period. A higher proportion of term license arrangements executed would result in more license revenue being recognized over longer periods as payments become due or earlier if prepaid. Additionally, some of our perpetual license arrangements include extended payment terms or additional rights of use, which also result in the recognition of revenue over longer periods.

The increase in perpetual license revenue during the second quarter of 2015 compared to the second quarter of 2014 was primarily due to revenue recognized on an arrangement greater than $10 million executed in the first quarter of 2015. The increase in perpetual license revenue during the first six months of 2015 compared to the first six months of 2014 was primarily due to revenue associated with a large arrangement effective in the third quarter of 2014 that has been recognized ratably over the past year due to the revenue recognition criteria. The aggregate value of payments due under noncancellable perpetual licenses was $58.3 million as of June 30, 2015 compared to $46.7 million as of June 30, 2014. We expect to recognize $28.2 million of the $58.3 million as revenue during the remainder of 2015.

The increases in term license revenue during the second quarter and first six months of 2015 compared to the same periods in 2014 were primarily due to revenue recognized from arrangements executed in the first half of 2015. The aggregate value of payments due under noncancellable term licenses and our Cloud arrangements grew to $271.7 million as of June 30, 2015 compared to $252 million as of June 30, 2014. We expect to recognize $36.6 million of the $271.7 million as revenue during the remainder of 2015 in addition to new term license and Cloud arrangements we may complete or prepayments we may receive from existing term license agreements. See the table of future cash receipts in Liquidity and Capital Resources - Cash Provided by Operating Activities.

Subscription revenue primarily consists of the ratable recognition of license, maintenance, and bundled services revenue on license arrangements that include a right to successor products or unspecified future products. Subscription revenue does not include revenue from our Cloud arrangements, which is included in services revenue. The timing of scheduled payments under client arrangements may limit the amount of revenue recognized in a reporting period. Consequently, our subscription revenue may vary materially quarter to quarter.

 

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             Three Months Ended        
June 30,
             Increase                     Six Months Ended        
June 30,
         Increase      
(Dollars in thousands)    2015      2014                   2015      2014                

 

Maintenance revenue

                      

 

Maintenance

   $ 49,329       $ 45,393       $ 3,936         9   $ 98,081       $ 90,274       $   7,807         9

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

 

     Three Months Ended
June 30,
     Increase      Six Months Ended
June 30,
     Increase  
(Dollars in
thousands)
   2015      2014                    2015      2014                

 

Services revenue

                                   

 

Consulting services

   $   40,827         83%       $   38,835         89%       $     1,992         5%       $   80,338         83%       $   76,911         89%       $     3,427         4%   

 

Cloud

     7,279         15%         3,727         9%         3,552         95%         13,456         14%         7,585         9%         5,871         77%   

 

Training

     1,087         2%         1,018         2%         69         7%         2,590         3%         2,053         2%         537         26%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

       

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Total services

   $ 49,193         100%       $ 43,580         100%       $ 5,613         13%       $ 96,384         100%       $ 86,549         100%       $ 9,835         11%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

       

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Consulting services represents revenue primarily from new license implementations. Our consulting services revenue may fluctuate in future periods depending on the mix of new implementation projects we perform as compared to those performed by our enabled clients or led by our partners. The increases in consulting services revenue were due to the higher number of projects and billable hours in the second quarter and first six months of 2015 compared to the same periods in 2014.

Cloud represents revenue from our Cloud offerings. The increase in Cloud revenue was primarily due to continued growth of our Cloud client base.

Gross profit

 

     Three Months Ended
June 30,
     Increase (Decrease)      Six Months Ended
June 30,
     Increase (Decrease)  
(Dollars in thousands)    2015      2014                   2015      2014               

 

Gross Profit

          

 

Software license

   $ 62,467       $ 52,835       $ 9,632        18%       $ 119,366       $ 103,870       $ 15,496        15%   

 

Maintenance

     43,853         40,349         3,504        9%         87,425         80,566         6,859        9%   

 

Services

     918         3,110         (2,192     (70)%         4,306         6,409         (2,103     (33)%   
  

 

 

    

 

 

    

 

 

      

 

 

    

 

 

    

 

 

   

Total gross profit

   $   107,238       $     96,294       $ 10,944        11%       $   211,097       $   190,845       $   20,252        11%   
  

 

 

    

 

 

    

 

 

      

 

 

    

 

 

    

 

 

   

Total gross profit %

     66%         67%              67%         67%        

 

Software license gross profit %

     98%         98%              98%         97%        

 

Maintenance gross profit %

     89%         89%              89%         89%        

 

Services gross profit %

     2%         7%              4%         7%        

The increases in total gross profit were primarily due to the increases in software license and maintenance revenue.

The decreases in services gross profit percent were primarily due to increased employee-related expenses associated with higher headcount, increased software license costs, lower realization rates on two North American projects, and increased subcontractor usage.

 

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Operating expenses

 

     Three Months Ended
June 30,
     Increase (Decrease)      Six Months Ended
June 30,
     Increase (Decrease)  
(Dollars in thousands)    2015      2014                   2015      2014               

 

Amortization of intangibles:

          

 

Cost of revenue

   $ 1,347       $ 1,444       $ (97     (7)%       $ 2,690       $ 3,284       $ (594     (18)%   

 

Selling and marketing

     1,534         1,499         35        2%         3,065         2,995         70        2%   

 

General and administrative

     238         481         (243     (51)%         502         901         (399     (44)%   
  

 

 

    

 

 

    

 

 

      

 

 

    

 

 

    

 

 

   
   $ 3,119       $ 3,424       $ (305     (9)%       $   6,257       $   7,180       $ (923     (13)%   
  

 

 

    

 

 

    

 

 

      

 

 

    

 

 

    

 

 

   

The decreases were primarily due to the full amortization in 2014 of certain technology and other intangibles acquired from Chordiant and Antenna, respectively.

 

     Three Months Ended
June 30,
     Increase      Six Months Ended
June 30,
     Increase  
(Dollars in thousands)    2015      2014                    2015      2014                

Selling and marketing

           

Selling and marketing

   $     60,389       $     56,342       $     4,047         7%       $   116,124       $   102,149       $     13,975         14%   

As a percent of total revenue

     37%         39%               37%         36%         

Selling and marketing headcount at June 30,

                 678         614         64         10%   

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

The increase in selling and marketing expenses during the second quarter of 2015 was primarily due to a $2.9 million increase in marketing and sales program expenses and a $1.7 million increase in compensation and benefits associated with higher headcount.

The increase in selling and marketing expenses during the first six months of 2015 was primarily due to a $5.7 million increase in compensation and benefits associated with higher headcount, a $5.5 million increase in marketing and sales program expenses, and a $2.4 million increase in sales commissions associated with the higher value of new license arrangements executed during the first six months of 2015 compared to the first six months of 2014.

 

     Three Months Ended
June 30,
     Increase      Six Months Ended
June 30,
     Increase  
(Dollars in thousands)    2015      2014                    2015      2014                

Research and development

           

Research and development

   $   31,372       $   27,323       $   4,049         15%       $   61,216       $   51,932       $   9,284         18%   

As a percent of total revenue

     19%         19%               19%         18%         

Research and development headcount at June 30,

                 1,128         1,020         108         11%   

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

The increase in headcount reflects the growth in our India research facility. The increase in offshore headcount lowered our average compensation expense per employee.

The increase in research and development expenses during the second quarter of 2015 compared to the same period in 2014 was primarily due to a $2.3 million increase in compensation and benefit expenses associated with higher headcount, a $0.5 million increase in outsourced hosting services, a $0.4 million increase in software license costs, and a $0.3 million increase in rent and rent-related costs.

 

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The increase in research and development expenses during the first six months of 2015 compared to the same period in 2014 was primarily due to a $5.8 million increase in compensation and benefit expenses associated with higher headcount, a $0.8 million increase in equipment and software license costs, a $0.7 million increase in contracted professional services, an $0.7 million increase in outsourced hosting services, and a $0.6 million increase in rent and rent-related costs.

 

     Three Months Ended
June 30,
             (Decrease)              Six Months Ended
June 30,
     Increase (Decrease)  
(Dollars in thousands)    2015      2014                   2015      2014               

 

General and administrative

 

                     

General and administrative

   $   10,214       $   10,250       $ (36     —  %       $   16,559       $   19,552       $ (2,993     (15 )% 

 

As a percent of total revenue

     6%         7%              5%         7%        

 

General and administrative headcount at June 30,

                314         286         28        10%   

General and administrative expenses include compensation, benefits, and other headcount-related expenses associated with finance, legal, corporate governance, and other administrative headcount. It also includes accounting, legal, and other administrative fees. The general and administrative headcount includes employees in human resources, information technology, and corporate services departments whose costs are allocated to our other functional departments.

The decrease in general and administrative expenses during the first six months of 2015 compared to the same period in 2014 was primarily due to the recognition in the first quarter of 2015 of the $1.8 million benefit from the settlement of the Antenna indemnification claims and the $1.6 million benefit from the settlement of indirect tax liabilities.

Stock-based compensation

The following table summarizes stock-based compensation expense included in our unaudited condensed consolidated statements of operations:

 

     Three Months Ended
June 30,
    Increase      Six Months Ended
June 30,
    Increase  
(Dollars in thousands)    2015     2014                   2015     2014               

 

Cost of revenues

   $     2,281      $     1,387      $ 894         64%       $ 4,234      $     2,398      $     1,836         77%   

 

Operating expenses

     6,364        3,771        2,593         69%         10,680        6,055        4,625         76%   
  

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

    

Total stock-based compensation before tax

   $   8,645      $ 5,158      $   3,487         68%       $     14,914      $ 8,453      $ 6,461         76%   

 

Income tax benefit

   $ (2,328   $ (1,591         $ (4,111   $ (2,582     

The increases were primarily due to the higher value of the 2014 annual periodic equity grant compared to the 2013 grant, which occurred in March 2015 and 2014, respectively.

Non-operating income and expenses, net

 

     Three Months Ended
June 30,
    Increase (Decrease)     Six Months Ended
June 30,
    Increase (Decrease)  
(Dollars in thousands)        2015             2014                           2015                 2014                    

 

Foreign currency transaction (loss) gain

   $ (968   $ (4   $ (964     n/m      $ (3,930   $ 318      $ (4,248     n/m   

 

Interest income, net

     216        163        53        33%        529        287        242        84%   

 

Other income (expense), net

     3        6        (3     (50 )%      3        (526     529        (101 )% 
  

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

Non-operating (loss) income

   $ (749   $ 165      $ (914     n/m      $ (3,398   $ 79      $ (3,477     n/m   
  

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

n/m - not meaningful

We have historically used foreign currency forward contracts (“forward contracts”) to manage our exposure to changes in foreign currency exchange rates associated with cash, accounts receivable, and intercompany receivables and payables held by Pegasystems Inc., our U.S. operating company, in currencies other than the U.S. dollar.

 

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Effective on April 1, 2015, our clients based outside the Americas began transacting with Pegasystems Limited, a U.K. subsidiary, which has the British pound as its functional currency. This reorganization resulted in increased cash, accounts receivable, and intercompany receivables and payables held by Pegasystems Limited in currencies other than the British pound.

We did not enter into any forward contracts between March 2014 and June 2015. In July 2015, as a result of this operational reorganization, we implemented our revised hedging program, under which we fully or partially hedge our non-functional currency exposures for Pegasystems Inc. and Pegasystems Limited, utilizing forward contracts with terms not greater than 180 days. We executed forward contracts in July 2015 to hedge our exposures to Euro and British pound denominated cash, accounts receivable and intercompany receivables and payables held by Pegasystems Inc. and Euro, U.S. dollar, and Australian dollar denominated cash, accounts receivable, and intercompany receivables and payables held by Pegasystems Limited.

These forward contracts, executed both prior to March 2014 and under our revised hedging program, are not designated as hedging instruments. As a result, we record the fair value of the outstanding contracts at the end of the reporting period in our consolidated balance sheet, with any fluctuations in the value of these contracts recognized in other income (expense), net.

See Note 4 “Derivative Instruments” in the notes to the accompanying unaudited condensed consolidated financial statements for discussion of our use of forward contracts.

Provision for income taxes

We account for income taxes at each interim period using our estimated annual effective tax rate and adjust for discrete tax items recorded in the same period. The provision for income taxes represents current and future amounts owed for federal, state, and foreign taxes. During the second quarter of 2015 and 2014, we recorded tax provisions of $1.4 million and $0.9 million, respectively, which resulted in an effective tax rate of 31.0% and 37.0%, respectively. During the first six months of 2015 and 2014, we recorded a provision of $4.7 million and $5.7 million, respectively, which resulted in an effective tax rate of 34.3% and 33.4%, respectively. Our effective tax rate during the second quarter of 2015 compared to the second quarter of 2014 was lower, primarily due to higher income in lower tax rate jurisdictions, partially offset by a slight decrease in our anticipated domestic production activities deduction. Our effective tax rate during the first six months of 2015 compared to the second quarter of 2014 was higher, primarily due to a decrease in our anticipated domestic production activities deduction.

Liquidity and capital resources

 

     Six Months Ended
June 30,
 
(in thousands)    2015      2014  

 

Cash provided by (used in):

     

 

Operating activities

   $ 39,399       $ 73,935   

 

Investing activities

     (18,212      (18,008

 

Financing activities

     (13,234      (11,287

 

Effect of exchange rate on cash

     (1,674      2,240   
  

 

 

    

 

 

 

Net increase in cash and cash equivalents

   $ 6,279       $ 46,880   
  

 

 

    

 

 

 
     As of
      June 30, 2015      
     As of
December 31, 2014
 

Total cash, cash equivalents, and marketable securities

   $ 226,932       $ 211,216   
  

 

 

    

 

 

 

The increase in cash and cash equivalents during the first six months of 2015 was primarily due to cash provided by operating activities during the period. We believe that our current cash, cash equivalents, marketable securities, and cash flow from operations will be sufficient to fund our operations, our dividend payments, and our share repurchase program for at least the next 12 months.

We evaluate acquisition opportunities from time to time, which if pursued, could require use of our funds. During the first six months of 2014, we paid $0.8 million of the remaining merger consideration related to the final working capital adjustment for our October 2013 acquisition of Antenna Software, Inc. and $0.8 million in cash consideration to acquire Meshlabs Software Private Limited. During the first quarter of 2015, we paid $0.5 million in additional cash consideration to the selling shareholders of one of the three companies acquired in 2014 based on the achievement of certain performance milestones. We may be required to pay an additional $1.2 million in cash to the same selling shareholders based on the achievement of certain performance milestones through the end of 2016. In July 2015, we paid $1.1 million of additional cash consideration to the selling shareholders of another of the three companies acquired in 2014.

 

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As of June 30, 2015, approximately $41.7 million of our cash and cash equivalents was held in our foreign subsidiaries. If it becomes necessary to repatriate these funds, we may be required to pay U.S. tax, net of any applicable foreign tax credits, upon repatriation. We consider the earnings of our foreign subsidiaries to be permanently reinvested and, as a result, U.S. taxes on such earnings are not provided. It is impractical to estimate the amount of U.S. tax we could 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.

Cash provided by operating activities

The primary drivers of cash provided by operating activities during the first six months of 2015 were net income of $9 million, and a $16.6 million decrease in trade accounts receivable as a result of collections, partially offset by a $10.5 million decrease in accounts payable and accrued expenses primarily due to the timing of payments for compensation-related accruals.

The primary drivers of cash provided by operating activities during the first six months of 2014 were net income of $11.3 million and the $46 million net change in assets and liabilities. The net change in assets and liabilities primarily consisted of a decrease in trade accounts receivable due to our significant collections, partially offset by an increase in income taxes receivable due to estimated tax payments and the tax benefits associated with domestic stock-based compensation expense.

Future Cash Receipts from License and Cloud Arrangements

Total contractual future cash receipts due from our existing license and Cloud arrangements was approximately $330 million as of June 30, 2015 compared to $298.7 million as of June 30, 2014. The future cash receipts due are summarized as follows:

 

(in thousands) as of June 30, 2015

   Contractual
payments for term
licenses and Cloud
arrangements
not recorded
on the balance sheet (1)
     Other contractual
license payments not
recorded on the
balance
sheet (2)
                 Total              

 

Remainder of 2015

   $ 36,631       $ 28,228       $ 64,859   

 

2016

     99,794         23,103         122,897   

 

2017

     59,862         4,168         64,030   

 

2018

     42,932         2,111         45,043   

 

2019 and thereafter

     32,513         701         33,214   
  

 

 

    

 

 

    

 

 

 

Total

   $   271,732       $     58,311       $   330,043   
  

 

 

    

 

 

    

 

 

 

 

(1)  These amounts include contractual future cash receipts related to our on-premises term licenses and hosted Cloud service offerings. The timing of future revenue recognition and future cash receipts may not coincide.
(2)  These amounts include contractual future cash receipts related to perpetual licenses with extended payment terms and/or additional rights of use.

Cash used in investing activities

During the first six months of 2015, cash used in investing activities was primarily for purchases of marketable debt securities of $31.5 million, partially offset by the proceeds received from the maturities of marketable debt securities of $21.1 million. We also invested $7.3 million primarily in leasehold improvements for the build-out of our new office in Hyderabad, India.

During the first six months of 2014, cash used in investing activities was primarily for purchases of marketable debt securities of $29.5 million, partially offset by the proceeds received from the maturities of marketable debt securities of $16 million.

Cash used in financing activities

Cash used in financing activities during the first six months of 2015 and 2014 was primarily for repurchases of our common stock. Since 2004, our Board of Directors has approved annual stock repurchase programs that have authorized the repurchase in the aggregate of up to $169 million of our common stock. On June 4, 2015, we announced that our Board of Directors extended the expiration date of the current stock repurchase program to June 30, 2016 and authorized the Company to repurchase an additional $50 million of our stock between June 4, 2015 and June 30, 2016. Purchases under these programs have been made on the open market.

 

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The following table is a summary of our repurchase activity under all of our repurchase programs during the first six months of 2015 and 2014:

 

     Six Months Ended
June 30,
 
     2015      2014  
(Dollars in thousands)        Shares              Amount              Shares              Amount      

 

Prior year authorization as of January 1,

      $ 13,284          $ 14,433   

 

Authorizations

     —           50,000         —           —     

 

Repurchases paid

     314,949         (6,780      419,000         (8,305

 

Repurchases unsettled

     32,372         (749      —           —     
     

 

 

       

 

 

 

Authorization remaining as of June 30,

      $ 55,755          $ 6,128   
     

 

 

       

 

 

 

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

During the first six months of 2015 and 2014, option and RSU holders net settled a total of 944,000 shares and 700,000 shares, respectively, of which only 536,000 shares and 394,000 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 and the applicable taxes. During the first six months of 2015 and 2014, instead of receiving cash from the equity holders, we withheld shares with a value of $4.4 million and $3.4 million, respectively, for withholding taxes, and $4.2 million and $2.9 million, respectively, for the exercise price. The value of share repurchases and shares withheld for net settlement of our employee stock option exercises and vesting of RSUs offset the proceeds received under our various share-based compensation plans during the first six months of 2015 and 2014.

Dividends

On May 27, 2014, we announced an increase in our quarterly cash dividend from $0.015 to $0.03 per share. We declared a cash dividend of $0.06 and $0.045 in the first six months of 2015 and 2014, respectively. We paid cash dividends of $4.6 million and $2.3 million in the first six months of 2015 and 2014, respectively. It is our current intention to pay a quarterly cash dividend of $0.03 per share; however, the Board of Directors may terminate or modify this dividend program at any time without notice.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

We have historically used foreign currency forward contracts (“forward contracts”) to manage our exposure to changes in foreign currency exchange rates associated with cash, accounts receivable, and intercompany receivables and payables held by Pegasystems Inc., our U.S. operating company, in currencies other than the U.S. dollar.

Effective on April 1, 2015, our clients based outside the Americas began transacting with Pegasystems Limited, a U.K. subsidiary, which has the British pound as its functional currency. This reorganization resulted in increased cash, accounts receivable, and intercompany receivables and payables held by Pegasystems Limited in currencies other than the British pound.

We did not enter into any forward contracts between March 2014 and June 2015. In July 2015, as a result of this operational reorganization, we executed forward contracts, which are not designated as hedging instruments, to hedge our exposures to Euro and British pound denominated cash, accounts receivable, and intercompany receivables and payables held by Pegasystems Inc. and Euro, U.S. dollar, and Australian dollar denominated cash, accounts receivable, and intercompany receivables and payables held by Pegasystems Limited.

See Note 4 “Derivative Instruments” in the notes to the accompanying unaudited condensed consolidated financial statements for further discussion.

 

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There were no significant changes to our quantitative and qualitative disclosures about market risk during the first six months of 2015. Please refer to Part II, Item 7A. Quantitative and Qualitative Disclosures about Market Risk included in our Annual Report on Form 10-K for the year ended December 31, 2014 for a more complete discussion of our market risk exposure.

 

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures.

Our management, with the participation of our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of June 30, 2015. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of June 30, 2015.

(b) Changes in Internal Control over Financial Reporting.

There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act) during the quarter ended June 30, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II—Other Information:

 

Item 1A. Risk Factors

We encourage you to carefully consider the risk factors identified in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2014. These risk factors could materially affect our business, financial condition, and future results and could cause our actual business and financial results to differ materially from those contained in forward-looking statements made in this Quarterly Report on Form 10-Q or elsewhere by management from time to time. There have been no material changes during the first six months of 2015 to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014.

 

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

The following table sets forth information regarding our repurchases of our common stock during the second quarter of 2015:

 

Period

   Total Number
of Shares
Purchased
     Average Price
Paid per
Share
     Total Number
of Shares
Purchased as Part
of Publicly
Announced Share
Repurchase
Programs (1)
     Approximate Dollar
Value of Shares That
May Yet Be Purchased
Under Publicly
Announced Share
Repurchase Programs (1)
(in thousands)
 

 

4/1/2015 - 4/30/2015

     43,706       $ 21.45         43,706       $ 10,206   

 

5/1/2015 - 5/31/2015

     60,133       $ 21.56         60,133       $ 8,909   

 

6/1/2015 - 6/30/2015

     136,792       $ 23.06         136,792       $ 55,755   
  

 

 

          

Total

     240,631       $ 22.39      
  

 

 

          

 

(1)  Since 2004, our Board of Directors has approved stock repurchase programs that have authorized the repurchase, in the aggregate, of up to $169 million of our common stock. On June 4, 2015, we announced that our Board of Directors extended the expiration date of the current stock repurchase program (the “Current Program”) to June 30, 2016 and authorized the Company to repurchase an additional $50 million of our stock between June 4, 2015 and June 30, 2016. Under the Current Program, purchases may be made from time to time on the open market or in privately negotiated transactions. Shares may be repurchased in such amounts as market conditions warrant, subject to regulatory and other considerations. We have established a pre-arranged stock repurchase plan, intended to comply with the requirements of Rule 10b5-1 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Rule 10b-18 under the Exchange Act (the “10b5-1 Plan”). All share repurchases under the Current Program during closed trading window periods will be made pursuant to the 10b5-1 Plan.

 

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Item 6. Exhibits

The exhibits listed in the Exhibit Index immediately preceding such exhibits are filed or furnished, as the case may be, as part of this report and such Exhibit Index is incorporated herein by reference.

 

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SIGNATURE

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

 

      Pegasystems Inc.
Date:   July 29, 2015     By:  

/s/    RAFEAL E. BROWN        

        Rafeal E. Brown
        Chief Financial Officer, Chief Administrative Officer and Senior Vice President
        (Principal Financial Officer)

 

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PEGASYSTEMS INC.

Exhibit Index

 

Exhibit
No.

  

Description

  31.1    Certification pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief Executive Officer.
  31.2    Certification pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief Financial Officer.
  32    Certification pursuant to 18 U.S.C. Section 1350 of the Chief Executive Officer and the Chief Financial Officer.
101    The following materials from Pegasystems Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015 formatted in XBRL (Extensible Business Reporting Language): (i) the Unaudited Condensed Consolidated Balance Sheets, (ii) the Unaudited Condensed Consolidated Statements of Operations, (iii) the Unaudited Condensed Consolidated Statements of Comprehensive Income, (iv) the Unaudited Condensed Consolidated Statements of Cash Flows, and (v) the Notes to Unaudited Condensed Consolidated Financial Statements.

 

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