PEGA 10-Q Quarter ended Sept. 30, 2018

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2018

OR

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

Commission File Number: 1-11859

PEGASYSTEMS INC.

(Exact name of registrant as specified in its charter)

Massachusetts		04-2787865
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)
One Rogers Street, Cambridge, MA		02142-1209
(Address of principal executive offices)		(Zip Code)

(617) 374-9600

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files).     Yes  ☒        No  ☐

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

Large accelerated filer ☒		Accelerated filer ☐		Non-accelerated filer ☐		Smaller reporting company ☐		Emerging growth company ☐

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

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

There were 78,700,651 shares of the Registrant’s common stock, $0.01 par value per share, outstanding on November 1, 2018.

PEGASYSTEMS INC.

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

		Page
PART I - FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of September  30, 2018 and December 31, 2017			3
Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2018 and 2017			4
Unaudited Condensed Consolidated Statements of Comprehensive (Loss) Income for the three and nine months ended September 30, 2018 and 2017			5
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017			6
Notes to Unaudited Condensed Consolidated Financial Statements			7
Item  2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			19
Item 3. Quantitative and Qualitative Disclosures About Market Risk			26
Item 4. Controls and Procedures			27
PART II - OTHER INFORMATION
Item 1A. Risk Factors			28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			28
Item 6. Exhibits			28
Signature			29

2

PART I - FINANCIAL INFORMATION

ITEM 1.

UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS ⁽¹⁾

(in thousands)

		September 30, 2018				December 31, 2017
Assets
Current assets:
Cash and cash equivalents		$	106,195			$	162,279
Marketable securities			99,782				61,469
Total cash, cash equivalents, and marketable securities			205,977				223,748
Accounts receivable			150,733				222,735
Unbilled receivables			155,964				158,898
Other current assets			73,464				41,135
Total current assets			586,138				646,516
Long-term unbilled receivables			168,929				160,708
Goodwill			72,897				72,952
Other long-term assets			134,679				131,391
Total assets		$	962,643			$	1,011,567
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		$	12,926			$	17,370
Accrued expenses			39,829				45,508
Accrued compensation and related expenses			71,318				66,040
Deferred revenue			158,178				166,297
Total current liabilities			282,251				295,215
Deferred income tax liabilities			36,166				38,463
Other long-term liabilities			23,371				23,652
Total liabilities			341,788				357,330
Stockholders’ equity:
Preferred stock, 1,000 shares authorized; no shares issued and outstanding			—				—
Common stock, 200,000 shares authorized; 78,816 and 78,081 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively			788				781
Additional paid-in capital			135,132				152,097
Retained earnings			496,815				508,051
Accumulated other comprehensive loss			(11,880)				(6,692)
Total stockholders’ equity			620,855				654,237
Total liabilities and stockholders’ equity		$	962,643			$	1,011,567

(1)

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

See notes to unaudited condensed consolidated financial statements.

3

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS ⁽¹⁾

(in thousands, except per share amounts)

		Three Months Ended September 30,								Nine Months Ended September 30,
		2018				2017				2018				2017
Revenue
Software license		$	52,342			$	53,234			$	184,899			$	231,392
Maintenance			66,017				61,812				196,448				179,949
Services			84,904				75,911				253,877				222,521
Total revenue			203,263				190,957				635,224				633,862
Cost of revenue
Software license			1,255				1,276				3,772				3,826
Maintenance			6,079				6,716				18,035				20,945
Services			67,089				61,739				202,047				180,925
Total cost of revenue			74,423				69,731				223,854				205,696
Gross profit			128,840				121,226				411,370				428,166
Operating expenses
Selling and marketing			87,490				69,363				269,845				214,244
Research and development			46,504				41,031				135,261				121,089
General and administrative			12,104				13,133				38,749				38,174
Total operating expenses			146,098				123,527				443,855				373,507
(Loss) income from operations			(17,258)				(2,301)				(32,485)				54,659
Foreign currency transaction gain (loss)			399				(5,052)				558				(6,549)
Interest income, net			683				140				2,076				547
Other income, net			—				—				363				287
(Loss) income before benefit from income taxes			(16,176)				(7,213)				(29,488)				48,944
Benefit from income taxes			(8,589)				(8,501)				(23,692)				(9,009)
Net (loss) income		$	(7,587)			$	1,288			$	(5,796)			$	57,953
(Loss) earnings per share
Basic		$	(0.10)			$	0.01			$	(0.07)			$	0.75
Diluted		$	(0.10)			$	0.01			$	(0.07)			$	0.70
Weighted-average number of common shares outstanding
Basic			78,700				77,691				78,525				77,258
Diluted			78,700				83,323				78,525				82,717
Cash dividends declared per share		$	0.03			$	0.03			$	0.09			$	0.09

(1)

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

See notes to unaudited condensed consolidated financial statements.

4

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME ⁽¹⁾

(in thousands)

		Three Months Ended September 30,								Nine Months Ended September 30,
		2018				2017				2018				2017
Net (loss) income		$	(7,587)			$	1,288			$	(5,796)			$	57,953
Other comprehensive (loss) income, net of tax
Unrealized (loss) gain on available-for-sale marketable securities, net of tax			(162)				22				(277)				148
Foreign currency translation adjustments			(1,934)				2,576				(4,911)				8,848
Total other comprehensive (loss) income, net of tax			(2,096)				2,598				(5,188)				8,996
Comprehensive (loss) income		$	(9,683)			$	3,886			$	(10,984)			$	66,949

(1)

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

See notes to unaudited condensed consolidated financial statements.

5

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

Pegasystems Inc. (together with its subsidiaries, “the Company”) has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“U.S.”) for complete financial statements and should be read in conjunction with the Company’s audited financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2017.

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 2018.

On January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” using the full retrospective method which required that each prior reporting period presented be adjusted to reflect the application of this ASU. See Note 2. “New Accounting Pronouncements” for additional information.

2. NEW ACCOUNTING PRONOUNCEMENTS

Financial instruments

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-13, “Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which requires measurement and recognition of expected credit losses for financial assets measured at amortized cost, including accounts receivable, upon initial recognition of that financial asset using a forward-looking expected loss model, rather than an incurred loss model. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses when the fair value is below the amortized cost of the asset, removing the concept of “other-than-temporary” impairments. The effective date for the Company will be January 1, 2020, with early adoption permitted. The Company is currently evaluating the effect this ASU will have on its consolidated financial statements and related disclosures.

Leases

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842),” which requires lessees to record most leases on their balance sheets, recognizing a lease liability for the obligation to make lease payments and a right-of-use asset for the right to use the underlying asset for the lease term. The effective date for the Company will be January 1, 2019, with early adoption permitted. The Company expects that most of its operating lease commitments will be subject to this ASU and recognized as operating lease liabilities and right-of-use assets upon adoption with a material impact to the Company’s balance sheet but an immaterial impact to its results of operations and cash flows. The Company expects to elect the optional transition method to apply the new lease standard prospectively at the adoption date, as opposed to recasting prior reporting periods. As a result, the Company expects to recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption.

ASC 606 and ASC 340-40

On January 1, 2018, the Company adopted the ASC 606 revenue recognition standard and has adjusted prior periods to conform.

The most significant adoption impacts were as follows:

•

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

•

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

7

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

•

Deferred contract costs - Sales incentive programs and other incremental costs to obtain a contract were previously expensed when incurred. ASC 340-40 requires these costs be recognized as an asset when incurred and expensed over the period of expected benefit, which is on average five years. This change primarily impacts the Company’s contracts related to multi-year cloud offerings, maintenance on term and perpetual licenses, and long-term term and perpetual licenses with client usage rights that increase over time.

•

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

For additional information on the Company’s accounting policies as a result of the adoption of ASC 606 and ASC 340-40 see Note 4. “Receivables, Contract Assets, and Deferred Revenue”, Note 5. “Deferred Contract Costs”, and Note 9. “Revenue”.

The impact of the adoption of ASC 606 and ASC 340-40 on the Company’s unaudited condensed consolidated balance sheet and unaudited condensed consolidated statement of operations is:

		December 31, 2017
(in thousands)		Previously reported				Adjustments				As adjusted
Assets
Accounts receivable, unbilled receivables, and contract assets		$	248,331			$	134,216			$	382,547
Long-term unbilled receivables			—				160,708				160,708
Deferred income taxes			57,127				(42,887)				14,240
Deferred contract costs			—				37,924				37,924
Other assets (1)			416,148				—				416,148
Total assets		$	721,606			$	289,961			$	1,011,567
Liabilities and stockholders’ equity
Deferred revenue		$	195,073			$	(28,776)			$	166,297
Long-term deferred revenue			6,591				(2,885)				3,706
Deferred income tax liabilities			—				38,463				38,463
Other liabilities (2)			148,864				—				148,864
Total liabilities			350,528				6,802				357,330
Foreign currency translation adjustments			(3,494)				(2,966)				(6,460)
Retained earnings			221,926				286,125				508,051
Other equity (3)			152,646				—				152,646
Total stockholders’ equity			371,078				283,159				654,237
Total liabilities and stockholders’ equity		$	721,606			$	289,961			$	1,011,567

(1)

Includes cash, cash equivalents, marketable securities, income taxes receivable, other current assets, property and equipment, intangible assets, goodwill, and other long-term assets (as reflected in the consolidated balance sheets in the Annual Report on Form 10-K for the year ended December 31, 2017).

(2)

Includes accounts payable, accrued expenses, accrued compensation and related expenses, income taxes payable, and other long-term liabilities (as reflected in the consolidated balance sheets in the Annual Report on Form 10-K for the year ended December 31, 2017).

(3)

Includes common stock, additional paid-in capital, and net unrealized loss on available-for-sale marketable securities (as reflected in the consolidated balance sheets in the Annual Report on Form 10-K for the year ended December 31, 2017).

8

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

		September 30, 2017
		Three Months Ended												Nine Months Ended
(in thousands, except per share amounts)		Previously Reported				Adjustments				As Adjusted				Previously Reported				Adjustments				As Adjusted
Revenue:
Software license		$	41,793			$	11,441			$	53,234			$	195,220			$	36,172			$	231,392
Maintenance			62,204				(392)				61,812				180,759				(810)				179,949
Services			75,818				93				75,911				225,063				(2,542)				222,521
Total revenue			179,815				11,142				190,957				601,042				32,820				633,862
Cost of revenue:
Software license			1,276				—				1,276				3,826				—				3,826
Maintenance			6,716				—				6,716				20,945				—				20,945
Services			61,739				—				61,739				180,925				—				180,925
Total cost of revenue			69,731				—				69,731				205,696				—				205,696
Gross profit			110,084				11,142				121,226				395,346				32,820				428,166
Operating expenses:
Selling and marketing			70,209				(846)				69,363				217,384				(3,140)				214,244
Research and development			41,031				—				41,031				121,089				—				121,089
General and administrative			13,133				—				13,133				38,174				—				38,174
Total operating expenses			124,373				(846)				123,527				376,647				(3,140)				373,507
(Loss) income from operations			(14,289)				11,988				(2,301)				18,699				35,960				54,659
Foreign currency transaction loss			(552)				(4,500)				(5,052)				(793)				(5,756)				(6,549)
Interest income, net			144				(4)				140				470				77				547
Other income, net			—				—				—				287				—				287
(Loss) income before benefit from income taxes			(14,697)				7,484				(7,213)				18,663				30,281				48,944
Benefit from income taxes			(12,885)				4,384				(8,501)				(17,952)				8,943				(9,009)
Net (loss) income		$	(1,812)			$	3,100			$	1,288			$	36,615			$	21,338			$	57,953
(Loss) earnings per share:
Basic		$	(0.03)							$	0.01			$	0.47							$	0.75
Diluted		$	(0.03)							$	0.01			$	0.44							$	0.70
Weighted-average number of common shares outstanding:
Basic			77,691								77,691				77,258								77,258
Diluted			77,691								83,323				82,717								82,717

Adoption of ASC 606 and ASC 340-40 did not change the Company’s total cash provided by or used in operating, financing, or investing activities in the Company’s unaudited condensed consolidated statements of cash flows for the nine months ended September 30, 2017.

3. MARKETABLE SECURITIES

		September 30, 2018
(in thousands)		Amortized Cost				Unrealized Gains				Unrealized Losses				Fair Value
Municipal bonds		$	46,633			$	—			$	(267)			$	46,366
Corporate bonds			53,738				1				(323)				53,416
		$	100,371			$	1			$	(590)			$	99,782

		December 31, 2017
(in thousands)		Amortized Cost				Unrealized Gains				Unrealized Losses				Fair Value
Municipal bonds		$	32,996			$	—			$	(148)			$	32,848
Corporate bonds			28,757				1				(137)				28,621
		$	61,753			$	1			$	(285)			$	61,469

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

9

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

As of September 30, 2018, remaining maturities of marketable securities ranged from October 2018 to August 2021, with a weighted-average remaining maturity of approximately 1.5 years.

4. RECEIVABLES, CONTRACT ASSETS, AND DEFERRED REVENUE

Receivables

(in thousands)		September 30, 2018				December 31, 2017
Accounts receivable		$	150,733			$	222,735
Unbilled receivables			155,964				158,898
Long-term unbilled receivables			168,929				160,708
		$	475,626			$	542,341

Unbilled receivables are the amounts due from clients where the only condition to the right of payment is the passage of time. As of September 30, 2018 and December 31, 2017, the allowance for doubtful accounts was not material.

Unbilled receivables are expected to be billed in the future as follows:

(Dollars in thousands)		September 30, 2018
1 Year or Less		$	155,964				48%
1-2 Years			89,177				27%
2-5 Years			79,752				25%
		$	324,893				100%

Contract assets and deferred revenue

(in thousands)		September 30, 2018				December 31, 2017
Contract assets (1)		$	2,888			$	914
Long-term contract assets (2)			1,581				—
		$	4,469			$	914
Deferred revenue		$	158,178			$	166,297
Long-term deferred revenue (3)			5,840				3,706
		$	164,018			$	170,003

⁽¹⁾ Included in other current assets.

⁽²⁾ Included in other long-term assets.

⁽³⁾ Included in other long-term liabilities.

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

The change in deferred revenue in the nine months ended September 30, 2018 was primarily due to $225.1 million of revenue recognized, excluding the impact of netting contract assets and deferred revenue at the contract level, during the period that was included in deferred revenue at December 31, 2017, partially offset by new billings in advance of revenue recognition.

Major clients

No client represented 10% or more of the Company’s total receivables as of September 30, 2018 or December 31, 2017.

5. DEFERRED CONTRACT COSTS

The Company recognizes an asset for the incremental costs of obtaining a contract with a client if the Company expects the benefit of those costs to be longer than one year. Deferred costs are amortized on a straight-line basis over the benefit period, which is on average five years.

(in thousands)		September 30, 2018				December 31, 2017
Deferred contract costs (1)		$	50,799			$	37,924

⁽¹⁾ Included in other long-term assets.

10

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Amortization of deferred contract costs was as follows:

		Three Months Ended September 30,								Nine Months Ended September 30,
(in thousands)		2018				2017				2018				2017
Amortization of deferred contract costs (1)		$	4,208			$	3,034			$	11,806			$	8,529

⁽¹⁾ Included in selling and marketing expenses.

6. GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill

The change in the carrying amount of goodwill was as follows:

(in thousands)		Nine Months Ended September 30,
		2018
Balance as of January 1,		$	72,952
Currency translation adjustments			(55)
Balance as of September 30,		$	72,897

Intangibles

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

						September 30, 2018
(in thousands)		Useful Lives				Cost				Accumulated Amortization				Net Book Value (1)
Client-related intangibles			4-10 years			$	63,136			$	(49,633)			$	13,503
Technology			3-10 years				58,942				(49,067)				9,875
Other			1-5 years				5,361				(5,361)				—
						$	127,439			$	(104,061)			$	23,378

⁽¹⁾ Included in other long-term assets.

						December 31, 2017
(in thousands)		Useful Lives				Cost				Accumulated Amortization				Net Book Value (1)
Client-related intangibles			4-10 years			$	63,164			$	(44,835)			$	18,329
Technology			3-10 years				58,942				(45,372)				13,570
Other			1-5 years				5,361				(5,361)				—
						$	127,467			$	(95,568)			$	31,899

⁽¹⁾ Included in other long-term assets.

Amortization of intangible assets was as follows:

		Three Months Ended September 30,								Nine Months Ended September 30,
(in thousands)		2018				2017				2018				2017
Cost of revenue		$	1,232			$	1,232			$	3,695			$	3,871
Selling and marketing			1,603				1,873				4,813				5,608
		$	2,835			$	3,105			$	8,508			$	9,479

11

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

7. ACCRUED EXPENSES

(in thousands)		September 30, 2018				December 31, 2017
Outside professional services		$	11,638			$	14,468
Income and other taxes			3,971				7,420
Marketing and sales program expenses			4,623				6,444
Dividends payable			2,365				2,344
Employee-related expenses			5,212				4,065
Other			12,020				10,767
		$	39,829			$	45,508

8. FAIR VALUE MEASUREMENTS

Assets and liabilities measured at fair value on a recurring basis

The Company records its cash equivalents, marketable securities, and investments in privately-held companies at fair value on a recurring basis. Fair value is an exit price, representing the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants based on assumptions that market participants would use in pricing an asset or liability.

As a basis for classifying the fair value measurements, a three-tier fair value hierarchy, which classifies the fair value measurements based on the inputs used in measuring fair value, was established as follows:

•

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

•

Level 2 - significant other inputs that are observable either directly or indirectly; and

•

Level 3 - significant unobservable inputs on which there is little or no market data, which require the Company to develop its own assumptions. This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value.

The Company’s cash equivalents are composed of money market funds and time deposits, which are classified within Level 1 and Level 2, respectively, in the fair value hierarchy. The Company’s marketable securities, which are classified within Level 2 of the fair value hierarchy are valued based on a market approach using quoted prices, when available, or matrix pricing compiled by third party pricing vendors, using observable market inputs such as interest rates, yield curves, and credit risk. The Company’s investments in privately-held companies are classified within Level 3 of the fair value hierarchy and are valued using model-based techniques, including option pricing models and discounted cash flow models.

If applicable, the Company will recognize transfers into and out of levels within the fair value hierarchy at the end of the reporting period in which the actual event or change in circumstance occurs. There were no transfers between levels during the nine months ended September 30, 2018.

The Company’s assets and liabilities measured at fair value on a recurring basis were as follows:

		September 30, 2018
(in thousands)		Level 1				Level 2				Level 3				Total
Cash equivalents		$	10,212			$	15,212			$	—			$	25,424
Marketable securities:
Municipal bonds		$	—			$	46,366			$	—			$	46,366
Corporate bonds			—				53,416				—				53,416
Total marketable securities		$	—			$	99,782			$	—			$	99,782
Investments in privately-held companies (1)		$	—			$	—			$	2,890			$	2,890

⁽¹⁾ Included in other long-term assets.

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

		December 31, 2017
(in thousands)		Level 1				Level 2				Level 3				Total
Cash equivalents		$	2,720			$	40,051			$	—			$	42,771
Marketable securities:
Municipal bonds		$	—			$	32,848			$	—			$	32,848
Corporate bonds			—				28,621				—				28,621
Total marketable securities		$	—			$	61,469			$	—			$	61,469
Investments in privately-held companies (1)		$	—			$	—			$	1,030			$	1,030

⁽¹⁾ Included in other long-term assets.

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

Assets measured at fair value on a nonrecurring basis

Assets recorded at fair value on a nonrecurring basis, including property and equipment and intangible assets, are recognized at fair value when they are impaired. During the nine months ended September 30, 2018 and 2017, the Company did not recognize any impairments of its assets recorded at fair value on a nonrecurring basis.

9. REVENUE

Revenue policy

The Company’s revenue is primarily derived from:

•

Software license revenue is primarily derived from sales of the Company’s Pega Platform and software applications.

•

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

•

Services revenue is primarily derived from cloud revenue, which is sales of the Company’s hosted Pega Platform and software applications, and consulting revenue, which is primarily related to new license implementations.

Contracts with multiple performance obligations

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

Software licenses

The Company has concluded that its software licenses are distinct performance obligations, as the client can benefit from the software on its own. Software license revenue is typically recognized at a point in time when control is transferred to the client, which is defined as the point in time when the client can use and benefit from the license. The software license is delivered before related services are provided and is functional without services, updates, and technical support.

Stand-alone selling price for software licenses is determined using the residual approach. The Company utilizes the residual approach as license performance obligations are sold for a broad range of amounts (the selling price is highly variable) and a stand-alone selling price is not discernible from past transactions or other observable evidence. Periodically, the Company reevaluates whether the residual approach is appropriate for its license performance obligations when sold with other performance obligations. If the standalone selling price analysis illustrates that software license performance obligations are no longer highly variable, the Company will utilize the relative allocation method for such arrangements.

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PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Geographic revenue

		Three Months Ended September 30,																Nine Months Ended September 30,
(Dollars in thousands)		2018								2017								2018								2017
U.S.		$	103,075				51%			$	105,059				55%			$	327,409				51%			$	376,819				59%
Other Americas			10,424				5%				9,307				5%				37,766				6%				32,890				5%
United Kingdom (“U.K.”)			19,277				9%				18,537				10%				68,450				11%				67,403				11%
Europe (excluding U.K.), Middle East, and Africa			42,254				21%				31,109				16%				101,150				16%				81,557				13%
Asia-Pacific			28,233				14%				26,945				14%				100,449				16%				75,193				12%
Total revenue		$	203,263				100%			$	190,957				100%			$	635,224				100%			$	633,862				100%

Revenue streams

		Three Months Ended September 30,								Nine Months Ended September 30,
(in thousands)		2018				2017				2018				2017
Perpetual license		$	20,276			$	12,623			$	56,829			$	81,819
Term license			32,066				40,611				128,070				149,573
Revenue recognized at a point in time			52,342				53,234				184,899				231,392
Maintenance			66,017				61,812				196,448				179,949
Cloud			22,184				13,280				57,967				36,207
Consulting			62,720				62,631				195,910				186,314
Revenue recognized over time			150,921				137,723				450,325				402,470
Total revenue		$	203,263			$	190,957			$	635,224			$	633,862
		Three Months Ended September 30,								Nine Months Ended September 30,
(in thousands)		2018				2017				2018				2017
Term license		$	32,066			$	40,611			$	128,070			$	149,573
Cloud			22,184				13,280				57,967				36,207
Maintenance			66,017				61,812				196,448				179,949
Subscription (1)			120,267				115,703				382,485				365,729
Perpetual license			20,276				12,623				56,829				81,819
Consulting			62,720				62,631				195,910				186,314
Total revenue		$	203,263			$	190,957			$	635,224			$	633,862

⁽¹⁾ Subscription revenue reflects client arrangements (term license, cloud, and maintenance) which may be subject to a renewal.

During the nine months ended September 30, 2018 and 2017, there were no material changes in the Company’s estimate of variable fees.

Remaining performance obligations (formerly reported as “committed not yet recognized revenue”)

Revenue for the remaining performance obligations on existing contracts is expected to be recognized in the future as follows:

		September 30, 2018
(Dollars in thousands)		Perpetual license				Term license				Maintenance				Cloud				Consulting				Total
1 year or less		$	25,343			$	44,283			$	140,591			$	88,529			$	14,107			$	312,853				60%
1-2 years			6,490				10,063				8,877				70,815				1,830				98,075				19%
2-3 years			360				1,598				2,586				54,646				449				59,639				11%
Greater than 3 years			1,306				218				1,079				49,110				50				51,763				10%
		$	33,499			$	56,162			$	153,133			$	263,100			$	16,436			$	522,330				100%

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