PEGA(PEGA) - 2020 Q4 - Annual Report

Part I Business Pegasystems develops enterprise software for customer engagement and digital process automation, transitioning to a subscription model - The company is transitioning its business to a subscription model, particularly Pega Cloud, which is anticipated to be substantially complete in early 2023, potentially causing lower interim revenue and operating cash flow growth[15] - As of December 31, 2020, the company's backlog of contracted revenue to be recognized in future periods was approximately $1.1 billion[50] - As of January 31, 2021, the company had 5,776 employees globally, with the majority based in the Americas and India[51] - On February 12, 2021, the company agreed to vacate its Cambridge, MA headquarters by October 1, 2021, for a payment of $18 million and plans to lease a new facility in the greater Boston area[20] Our Products and Capabilities Pega Infinity™ offers a software portfolio for customer engagement and intelligent automation, leveraging a unique "Center-out Business™ Architecture" - Pega Infinity™ is the latest software portfolio, designed to connect enterprises with customers in real-time and streamline business operations[23] - The Pega Customer Decision Hub™ acts as a real-time AI engine to predict customer behavior and recommend the 'next best action' across various channels[23] - The company's 'Center-out Business™ Architecture' is a key differentiator, enabling clients to centralize business logic and intelligence, separate from front-end channels and back-end systems, for greater agility and consistency[26] Our Markets and Competition Pegasystems targets Global 3000 and government clients in competitive markets, differentiating with its unified platform and industry expertise - Target clients are Global 3000 organizations and government agencies in industries like financial services, healthcare, insurance, and communications[37][39][46] - The company competes with some of the world's largest software companies, including Salesforce.com, Microsoft Corporation, Oracle Corporation, SAP SE, ServiceNow, and IBM[43] - Pega's competitive differentiation lies in its unified platform that allows business and IT users to build and evolve applications quickly, contrasting with the disjointed tools offered by many competitors[44] Our People Pegasystems employs 5,776 people globally, focusing on an inclusive, diverse culture, pay equity, and extensive employee development - The company has a strong focus on building an inclusive and diverse culture, with formal resource groups for women, veterans, and members of the black and LGBTQIA+ communities[54] - Pegasystems is committed to pay equity, regularly reviewing compensation practices to ensure fairness regardless of gender, race, or other personal characteristics[56] - In 2020, over 90% of employees participated in a formal education program, highlighting the company's investment in employee development[57] Risk Factors The company faces risks from its subscription model transition, intense competition, key personnel, cybersecurity, debt, and global economic uncertainties - The transition to a subscription-based business model poses risks of fluctuating revenues and cash flows, potentially decreased profitability, and challenges in maintaining client renewal rates[62][64] - The company faces significant competition from larger rivals like Salesforce.com, Microsoft, Oracle, and IBM, which have greater financial and marketing resources[84] - The CEO beneficially owned 49% of outstanding common stock as of December 31, 2020, giving him significant influence over stockholder matters, which could deter a change in control[86] - The company has $600 million in aggregate principal amount of Convertible Senior Notes due 2025, which introduces risks related to debt service, potential dilution, and financial covenants[93] - The global COVID-19 pandemic poses risks that could adversely affect sales cycles, client IT spending, and operational activities, with the full impact remaining uncertain[116][119] Unresolved Staff Comments The company reports no unresolved staff comments - None[127] Properties The company operates from leased facilities globally, with its Cambridge headquarters relocating by October 2021 for an $18 million payment - All of the company's properties are leased, with principal locations in Cambridge, MA and Hyderabad, India[128] - The company will vacate its Cambridge, MA headquarters on October 1, 2021, in exchange for an $18 million payment and intends to lease a new facility in the greater Boston area[128] Legal Proceedings The company is subject to ordinary course legal proceedings, which can materially impact operations due to costs and diverted resources - The company is subject to legal proceedings from time to time in the ordinary course of business[130] Mine Safety Disclosures This item is not applicable to the company - Not applicable[131] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities PEGA common stock trades on NASDAQ, with 48 stockholders of record, paying a $0.03 quarterly dividend, and conducting stock repurchases - The company paid a quarterly cash dividend of $0.03 per share in 2020, 2019, and 2018[134] Issuer Purchases of Equity Securities (Q4 2020) | Period | Total Shares Purchased (in thousands) | Average Price Paid per Share | Value of Shares Remaining for Repurchase ($ in thousands) | | :--- | :--- | :--- | :--- | | Oct 2020 | 37 | $125.97 | $43,873 | | Nov 2020 | 105 | $123.82 | $41,024 | | Dec 2020 | 138 | $128.76 | $37,726 | | Total | 280 | $126.54 | $37,726 | Stock Performance Comparison (2015-2020) | Year | Pegasystems Inc. | NASDAQ Composite | S&P NA Tech Software | | :--- | :--- | :--- | :--- | | 2015 | $100.00 | $100.00 | $100.00 | | 2016 | $131.46 | $108.87 | $106.20 | | 2017 | $172.58 | $141.13 | $151.66 | | 2018 | $175.44 | $137.12 | $170.83 | | 2019 | $292.66 | $187.44 | $229.93 | | 2020 | $490.22 | $271.64 | $349.26 | Selected Financial Data The company has omitted this section, consistent with new SEC rules eliminating Item 301 of Regulation S-K - The company has elected early adoption of the SEC's elimination of Item 301 of Regulation S-K, and therefore has not presented selected financial data[141] Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses financial performance, emphasizing the subscription transition, 12% revenue growth to $1.02 billion, strong ACV and Backlog, an operating loss, and enhanced liquidity Key Performance Metrics (as of Dec 31, 2020) | Metric | Value/Change | Note | | :--- | :--- | :--- | | Annual Contract Value (ACV) | Increased 21% since Dec 31, 2019 | Represents the annualized value of active contracts | | Backlog | Increased 28% since Dec 31, 2019 | Represents contracted revenue not yet recognized | | Pega Cloud Revenue | Increased 56% since 2019 | GAAP revenue for cloud contracts | Results of Operations Total revenue grew 12% to $1.02 billion in 2020, driven by subscription revenue growth and Pega Cloud, while operating expenses increased due to headcount Revenue by Type (2020 vs. 2019) | Revenue Type | 2020 ($ in thousands) | 2019 ($ in thousands) | % Change | | :--- | :--- | :--- | :--- | | Pega Cloud | $208,268 | $133,746 | 56% | | Maintenance | $296,709 | $280,580 | 6% | | Term license | $266,352 | $199,433 | 34% | | Subscription Total | $771,329 | $613,759 | 26% | | Perpetual license | $28,558 | $80,015 | (64)% | | Consulting | $217,630 | $217,609 | 0% | | Total Revenue | $1,017,517 | $911,383 | 12% | Gross Profit by Segment (2020 vs. 2019) | Segment | 2020 ($ in thousands) | 2019 ($ in thousands) | % Change | | :--- | :--- | :--- | :--- | | Software license | $291,982 | $275,792 | 6% | | Maintenance | $274,398 | $254,924 | 8% | | Pega Cloud | $131,693 | $67,918 | 94% | | Consulting | $8,531 | $2,727 | 213% | | Total Gross Profit | $706,604 | $601,361 | 18% | - Operating expenses increased across all categories in 2020, with Selling and marketing up 15%, Research and development up 15%, and General and administrative up 19%, primarily due to increased headcount and compensation[158][159] Liquidity and Capital Resources Liquidity significantly strengthened to $465.2 million in 2020, driven by $533.6 million from convertible notes, with minimal cash used in operations Cash Flow Summary (2020 vs. 2019) | Cash Flow Activity ($ in thousands) | 2020 | 2019 | | :--- | :--- | :--- | | Operating activities | $(563) | $(42,165) | | Investing activities | $(321,683) | $70,074 | | Financing activities | $423,448 | $(74,258) | - In February 2020, the company issued $600 million in convertible senior notes due 2025, receiving net proceeds of $533.6 million after issuance costs and the purchase of Capped Call Transactions[172][298] Contractual Obligations as of Dec 31, 2020 | Obligation Type ($ in thousands) | Total | Payments Due in 2021 | | :--- | :--- | :--- | | Convertible senior notes | $619,488 | $4,500 | | Purchase obligations | $125,281 | $59,685 | | Operating lease obligations | $87,624 | $22,164 | | Total | $837,573 | $86,849 | Critical Accounting Estimates and Significant Judgments Management identifies critical accounting estimates in revenue recognition, goodwill and intangible asset impairment, income taxes, and the complex accounting for convertible senior notes - Significant judgment is required for revenue recognition, including identifying distinct performance obligations and allocating transaction prices based on relative stand-alone selling prices, for which the company often uses the residual approach for software licenses and Pega Cloud arrangements[183][185] - Goodwill and intangible assets ($79.2 million and $15.7 million respectively as of Dec 31, 2020) are tested for impairment at least annually, requiring management to make assumptions about future performance[187][189] - Accounting for the convertible senior notes required separating the instrument into liability and equity components and valuing the related Capped Call Transactions as derivatives, which involved significant estimates for inputs like credit spreads and volatility[196][197] Quantitative and Qualitative Disclosures about Market Risk The company's primary market risk is foreign currency fluctuations, impacting financial results through translation and remeasurement risks Impact of a Hypothetical 10% Strengthening in the U.S. Dollar | Impact On | 2020 | 2019 | 2018 | | :--- | :--- | :--- | :--- | | Revenue | (4)% | (4)% | (4)% | | Net Income | 12% | (7)% | (1)% | - The company is primarily exposed to remeasurement risk from monetary assets and liabilities denominated in Australian dollars, Euros, and U.S. dollars held by its U.K. subsidiary, which has a British pound functional currency[203] Financial Statements and Supplementary Data This section presents the company's audited consolidated financial statements for 2018-2020, including balance sheets, income statements, and cash flow statements, with detailed notes Consolidated Balance Sheet Highlights (as of Dec 31) | Account ($ in thousands) | 2020 | 2019 | | :--- | :--- | :--- | | Total Assets | $1,604,262 | $984,812 | | Total Liabilities | $1,062,090 | $445,802 | | Total Stockholders' Equity | $542,172 | $539,010 | Consolidated Statement of Operations Highlights (Year Ended Dec 31) | Account ($ in thousands) | 2020 | 2019 | 2018 | | :--- | :--- | :--- | :--- | | Total Revenue | $1,017,517 | $911,383 | $891,581 | | Gross Profit | $706,604 | $601,361 | $589,816 | | (Loss) from Operations | $(143,527) | $(134,878) | $(17,032) | | Net (Loss) Income | $(61,373) | $(90,433) | $10,617 | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants on accounting and financial disclosure - None[369] Controls and Procedures Management, including the CEO and CFO, concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2020 - The CEO and CFO concluded that the company's disclosure controls and procedures were effective as of December 31, 2020[370] - Management concluded that the company's internal control over financial reporting was effective as of December 31, 2020[372] Other Information The company executed a Lease Termination Agreement for its Cambridge headquarters, effective October 1, 2021, for an $18 million payment - On February 12, 2021, the company executed an agreement to terminate its Cambridge, MA headquarters lease effective October 1, 2021, in exchange for an $18 million payment[374] Part III Directors, Executive Officers, Corporate Governance, Compensation, and Principal Accountant Fees Information for Items 10 through 14, covering governance, compensation, and related matters, is incorporated by reference from the 2021 proxy statement - Information for Part III (Items 10-14) is incorporated by reference from the company's 2021 proxy statement[377][379][380] Part IV Exhibits and Financial Statement Schedules This section lists financial statements and exhibits filed with the Form 10-K, with all financial statement schedules omitted - This section contains the list of financial statements and exhibits filed with the Form 10-K[384][385] - All financial statement schedules were omitted because the required information was not present or was included in the consolidated financial statements or notes[387] Form 10-K Summary The company has opted to omit the Form 10-K summary - Omitted at Registrant's option[388]