Pegasystems
Annual Report 2009

Plain-text annual report

PEGASYSTEMS INC FORM 10-K (Annual Report) Filed 02/22/10 for the Period Ending 12/31/09 Address ONE ROGERS STREET Telephone CAMBRIDGE, MA 02142-1209 6173749600 CIK 0001013857 Symbol PEGA SIC Code 7374 - Computer Processing and Data Preparation and Processing Services Industry Software Sector Technology Fiscal Year 12/31 http://www.edgar-online.com © Copyright 2016, EDGAR Online, Inc. All Rights Reserved. Distribution and use of this document restricted under EDGAR Online, Inc. Terms of Use. Table of Contents UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K For the fiscal year ended December 31, 2009 Commission File No. 1-11859 PEGASYSTEMS INC. (Exact name of Registrant as specified in its charter) Massachusetts (State or other jurisdiction of incorporation or organization) (IRS Employer Identification No. 04-2787865) (617) 374-9600 (Registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value per share Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933. Yes (cid:1) No  Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes (cid:1) No  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 (cid:1) 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 (cid:1) No (cid:1) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  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. (Check one): Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes (cid:1) No  The aggregate market value of the Registrant’s common stock held by non-affiliates of the Registrant based on the closing price (as reported by NASDAQ) of such common stock on the last business day of the Registrant’s most recently completed second fiscal quarter (June 30, 2009) was approximately $383 million. There were 36,818,677 shares of the Registrant’s common stock, $0.01 par value per share, outstanding on February 9, 2010. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant’s definitive proxy statement for the annual meeting of stockholders to be held June 4, 2010 are incorporated by     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT of 1934 (cid:1) (cid:1) (cid:1) (cid:1) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT of 1934 101 Main Street Cambridge, MA 02142-1590 (Address of principal executive offices) (zip code) Large accelerated filer (cid:1) Accelerated filer  Non-accelerated filer (cid:1) Smaller reporting company (cid:1) (Do not check if a smaller reporting company) reference into Part III of this report. Table of Contents TABLE OF CONTENTS 2 Item Page PART I 1 Business 3 1A Risk Factors 9 1B Unresolved Staff Comments 14 2 Properties 14 3 Legal Proceedings 14 4 Submission of Matters to a Vote of Security Holders 14 PART II 5 Market for Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities 15 6 Selected Financial Data 18 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations 19 7A Quantitative and Qualitative Disclosure about Market Risk 37 8 Financial Statements and Supplementary Data 38 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 67 9A Controls and Procedures 67 9B Other Information 69 PART III 10 Directors, Executive Officers, and Corporate Governance 69 11 Executive Compensation 70 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 70 13 Certain Relationships and Related Transactions, and Director Independence 70 14 Principal Accountant Fees and Services 70 PART IV 15 Exhibits and Financial Statement Schedules 71 Signatures 72 Table of Contents PART I Forward-looking statements This Annual Report on Form 10-K contains or incorporates forward-looking statements within the meaning of section 27A of the Securities Act of 1933 and section 21E of the Securities Exchange Act of 1934. 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,” “project,” 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. We have identified certain risk factors included in Item 1A of this Annual Report on Form 10-K that we believe could cause our actual results to differ materially from the forward-looking statements we make. We do not intend to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Pegasystems Inc. was incorporated in Massachusetts in 1983. Our stock is traded on the NASDAQ Global Select Market under the symbol PEGA. Our Website address is www.pega.com. We are not including the information contained on our Website as part of, or incorporating it by reference into, this Annual Report on Form 10-K. Unless the context otherwise requires, references in this Annual Report on Form 10-K to “the Company,” “we,” “us” or “our” refer to Pegasystems Inc. and its subsidiaries. Our Company We develop, market, license, and support software to automate complex, changing business processes. Our software enables organizations to build, deploy, and change enterprise applications easily and quickly by directly capturing business objectives, automating programming, and automating work. It also allows organizations to avoid the time and expense required to create lengthy policy manuals and system specifications by unifying business rules with business processes in the software and automating the creation of system documentation. Our software is standards-based and can leverage existing technology investments to reduce implementation time. Our customers use our software and services to improve their customer service, manage new business, and facilitate case management. Our PegaRULES Process Commander (“PRPC”) software is the primary component of our SmartBPM Suite, which is complemented by software solutions that we refer to as frameworks. These frameworks provide purpose or industry-specific functionality that allows our customers to quickly implement our software. We provide implementation, consulting, training, and technical support services to help our customers maximize the business value they obtain from the use of our software. We also maintain alliances with systems integrators and technology consulting firms that also provide consulting services to our customers. Our business strategy We lead the Business Process Management (“BPM”) software market by leveraging our patented technology that unifies business processes and business rules. We focus our sales efforts on accounts within target customer organizations, which are typically large organizations that are among the leaders in their industry. We frequently sell initial licenses to these target accounts that are focused on a specific purpose or area of operations, rather than selling large enterprise licenses. A primary objective of this strategy is to have our customers quickly realize business value from our software. Once a customer has realized this initial value, we 3 ITEM 1. Business ® Table of Contents work with that customer to identify opportunities for follow-on sales. The sales process for follow-on sales is often shorter as a result of our established relationship with the customer. We invest resources in professional services, customer support, and customer and partner enablement to help our customers achieve success. Strategic partnerships with consultants and systems integrators are important to our sales efforts because they influence buying decisions, help us to identify engagements, and complement our software with their domain expertise and services capabilities. These partners may deliver strategic business planning, consulting, project management, and implementation services to our customers. Currently, our partners include Accenture Ltd., Capgemini SA, Computer Sciences Corporation (“CSC”), Cognizant Technology Solutions Inc., Infosys Technologies Limited, International Business Machines Corporation (“IBM”), and Wipro Ltd. Our products We provide a comprehensive rules-based BPM suite intended to help our customers plan, build, and manage business process management solutions. PegaRULES Process Commander PRPC provides capabilities designed to model, execute, monitor, and analyze results. PRPC includes an application profiler that allows a business process application to be defined based on business goals and objectives, with simplified “fill in the blank” forms. The product also simplifies process modeling, allowing business users to graphically describe and test an intended business process within the system itself. The software uses the results of the application profiler and the process modeling to create the new business solution, including the user interface and executable business models. PRPC also provides a browser-based graphical development environment, execution engine, and management dashboard for rapid business application and solution development. This product helps solve a wide range of BPM problems, including acquiring new business, providing customer service, creating a servicing backbone for enterprise-wide processing, and managing risk, fraud and compliance with regulatory requirements. PRPC also allows our customers to leverage previous technology investments by integrating software applications across a common platform. Pegasystems SmartBPM Suite and Solution Frameworks Pegasystems SmartBPM Suite adds process analysis, process simulation, enterprise integration, portal integration, content management, and case management to the PRPC capabilities. Pegasystems also offers purpose- or industry -specific solution frameworks built on the capabilities of our PRPC software. These frameworks allow organizations to quickly implement new customer-facing practices and processes, bring new offerings to market, and provide customized or specialized processing to meet the needs of different customers, departments, geographies or regulatory requirements. Some of these frameworks include: 4 • Customer Process Manager • Product Configuration • Financial Services Industry Foundation Framework • Financial Crimes Management • Healthcare Industry Framework • Insurance Industry Framework ® Table of Contents We also offer other frameworks that address exceptions management — transactions that are not automatically processed by existing systems. By automating not only research and decision making, but also the business processes necessary to execute the decisions, our exceptions management frameworks can reduce the costs and risks associated with manual processing, while improving quality and efficiency. Some of these frameworks include: Pegasystems SmartPaaS SmartPaaS is Pegasystems’ platform-as-a service offering that allows customers to create PRPC applications using an internet-based infrastructure. This offering enables Pegasystems’ customers to immediately build their applications in a secure environment while minimizing their infrastructure and hardware costs. Our services and support We offer services and support through our professional services group, customer support group, and our training services group. We also utilize third party contractors to assist us in providing services. Professional services Our professional services group helps companies and partners implement our software. This enables us to guide our customers through deployment of our software. Many of our customers choose to engage our professional services group to expand their use of our software to additional business or product lines or automate additional processes within existing solutions. In addition, systems integrators and consulting firms, with which we have alliances, help our customers deploy our products. Customer support Our customer support group is responsible for support of our software deployed at customer sites when customer support has been purchased. Support services include automated problem tracking, prioritization and escalation procedures, periodic preventive maintenance, documentation updates, new software releases, and regularly scheduled meetings with our staff. Training services The success of our sales strategy for multiple follow-on sales to target customers depends on our ability to train a larger number of partners and customers to implement our technology. We offer training for our staff, customers, and partners. Training is offered at our regional training facilities in Cambridge, Massachusetts, London, England, Hyderabad, India, Sydney, Australia, at third party facilities in numerous other locations, or at customer sites. Courses are designed to meet the specific requirements of process architects, system architects, and system administrators. Our markets and representative customers The market for BPM software is driven by businesses that seek to close the execution gaps that may exist between their business objectives and their existing business processes. Our target customers are large, industry-leading organizations faced with managing transaction intensive, complex and changing processes that seek the 5 • Smart Dispute • Smart Investigate for Payments • Smart Investigate for Securities • Smart Adjust • Healthcare Claims Automation Suite ® Table of Contents agility needed for growth, productivity, customer retention, and compliance. Our customers are typically large companies in the financial services, healthcare and insurance markets. With PRPC, we are also able to offer solutions to a broader range of companies as well as a broader range of industries, such as life sciences, communications, travel and entertainment, and government. Financial services Financial services organizations require software to improve the quality, accuracy, and efficiency of customer interactions and transactions processing. Pegasystems’ customer process and exceptions management products allow customers to be responsive to changing business requirements. Representative financial services customers of ours include: BBVA Bancomer S.A., BNP Paribas, Citigroup Inc., HSBC Holdings Plc, ING Bank, MasterCard Worldwide, National Australia Bank Limited, and RBC Financial Group. Healthcare Healthcare organizations seek products that integrate their front and back office initiatives and help drive customer service, efficiency, and productivity. Representative healthcare customers of ours include: Aetna Inc., Blue Cross Blue Shield of Massachusetts, Blue Cross Blue Shield of Minnesota, CSC, Group Health Cooperative, HealthNow New York Inc., United Healthcare Services, Inc., and ViPS/WebMD. Insurance Insurance companies, whether competing globally or nationally for customers and channels, need software to automate the key activities of policy rating, quoting, customization, underwriting, and servicing as well as products that improve customer service and the overall customer experience. Representative insurance industry customers of ours include: American National Insurance Group, CARDIF, Farmers Insurance Group of Companies, John Hancock Life Insurance Co., Manulife Financial Corporation, and Zurich North America. Other industries PRPC offers solutions to a broad range of companies and industries. We sell rules-based BPM technology to customers in telecommunications, government, life sciences, manufacturing, and travel services. Customers include: Advanced Micro Devices, Inc. (“AMD”), Novartis International AG, Starwood Hotels & Resorts Worldwide Inc., The British Airport Authority, and The ServiceMaster Company. Competition The BPM software market is intensely competitive, rapidly changing, and highly fragmented, as current competitors expand their product offerings and new companies enter the market. Competitors vary in size and in the scope and breadth of the products and services offered. We encounter competition from: 6 • Service-Oriented Architecture (“SOA”) middleware vendors including IBM, Oracle Corporation, Software AG, and Tibco Software Inc.; • BPM vendors such as Appian Corporation, Global360, Inc. the Lombardi Software division of IBM, Metastorm Inc., and the Savvion division of Progress Software; • Business Rules Engine vendors such as Corticon Technologies Inc., Fair Isaac Corporation, and the ILOG division of IBM; • Customer Relationship Management (“CRM”) application vendors including Chordiant Software, the Microsoft Dynamics CRM division of Microsoft, Salesforce.com, and the Siebel division of Oracle; • Enterprise Content Management-based vendors such as the Documentum division of EMC Corporation, and the FileNet division of IBM’s Information Management Group; Table of Contents We are the leading company in the overall BPM software market, and have a strong presence in the financial services, insurance and healthcare markets. We have been most successful competing for customers whose businesses are characterized by a high degree of change, complexity and size. We believe that the principal competitive factors within our market include: We believe we compete favorably with our competitors on the basis of most of these competitive factors as our Build for Change technology includes a comprehensive set of business rules that are unified with business processes, can be developed quickly by both client business and IT staff, and incorporates a single, Web-based user interface. We believe we also compete favorably due to our expertise in our target industries and our long-standing customer relationships. We believe we compete less favorably on the basis of some of these factors with respect to our larger competitors, many of which have greater sales, marketing and financial resources, more extensive geographical presence and greater name recognition than we do. In addition, we may be at a disadvantage with respect to our ability to provide expertise outside our target industries. Sales and marketing We market our software and services primarily through a direct sales force. Strategic partnerships with consultants and systems integrators are important to our sales efforts because they influence buying decisions, help us to identify engagements, and complement our software with their domain expertise and services capabilities. To support our sales efforts, we conduct a broad range of marketing programs, including targeted solution campaigns, industry trade shows, industry seminars, meetings with industry analysts, and other direct and indirect marketing efforts. Our consulting staff, business partners, and other third parties also generate sales leads. Sales by geography In 2009, 2008, and 2007, sales to customers based outside of the United States of America (“U.S.”) represented approximately 34%, 38%, and 35%, respectively, of our total revenue. We currently operate in one operating segment — rules-based BPM software. We derive substantially all of our operating revenue from the 7 • Companies that provide application specific software for the financial services, healthcare, insurance and other specific markets such as Norkom Group Plc, SmartStream Technologies Ltd., SunGard, and The TriZetto Group, Inc.; and • Current customers’ information technology departments, which may seek to modify existing systems or develop proprietary systems. • Product adaptability, scalability, functionality, and performance; • Proven success in delivering cost-savings and efficiency improvements; • Ease-of-use for developers, business units, and end-users; • Timely development and introduction of new products and product enhancements; • Establishment of a significant base of reference customers; • Ability to integrate with other products and technologies; • Customer service and support; • Product price; • Vendor reputation; and • Relationships with systems integrators. ® Table of Contents sale and support of one group of similar products and services. Substantially all of our assets are located within the U.S. See Note 16 “Geographic Information and Major Customers” included in the notes to the accompanying consolidated financial statements for further detail. Research and development Our development organization is responsible for product architecture, core technology development, product testing, and quality assurance. Our product development priority is to continue expanding the capabilities of our rules-based BPM technology. We intend to maintain and extend the support of our existing solution frameworks, and we may choose to invest in additional frameworks which incorporate the latest business innovations. We also intend to maintain and extend the support of popular hardware platforms, operating systems, databases, and connectivity options to facilitate easy and rapid deployment in diverse information technology infrastructures. Our goal with all of our products is to enhance product capabilities, ease of implementation, long-term flexibility, and the ability to provide improved customer service. During 2009, 2008, and 2007, research and development expenses were approximately $38.9 million, $31.5 million, and $26.2 million, respectively. We expect that we will continue to commit significant resources to our product research and development in the future to maintain our leadership position. Employees As of January 31, 2010, we had 1,076 employees worldwide, of which 740 were based in the U.S., 185 were based in Europe, 96 were based in India, 32 were based in Canada, 15 were based in Australia and 8 were based in Asia. Our total headcount includes 425 consulting and customer support employees, 274 sales and marketing employees, 228 research and development employees, and 149 administrative employees. In addition, we supplemented our research and development and professional services employees with 178 contractors. Backlog of license, maintenance, and professional services As of December 31, 2009, we had software license, maintenance, and professional services agreements with customers expected to result in approximately $192 million of future revenue, of which we expect approximately $128 million to be recognized in 2010. As of December 31, 2008, we had backlog of software license, maintenance, and professional services agreements with customers of approximately $172 million. Under some of these agreements, we must fulfill certain conditions prior to recognizing revenue, and there can be no assurance when, if ever, we will be able to satisfy all such conditions in each instance. Business conditions could change and, therefore, backlog may not be a reliable indicator of future financial performance. Available Information We make available free of charge through our Website www.pegasystems.com our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission (“SEC”). The SEC maintains a Website that contains reports, proxy, and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov . We make available on our Website reports filed by our executive officers and Directors on Forms 3, 4, and 5 regarding their ownership of our securities. Our Code of Conduct, and any amendments to our Code of Conduct, is also available on our Website. 8 Table of Contents The following important factors could cause our actual business and financial results to differ materially from those contained in forward-looking statements made in this Annual Report on Form 10-K or elsewhere by management from time to time. Factors relating to our revenues The number of our license arrangements has been increasing, and we may not be able to sustain this growth unless we can provide sufficient high quality professional services, training, and maintenance resources to enable our customers to realize significant business value from our software. Our customers typically request professional services and training to assist them in implementing our products. Our customers also purchase maintenance on our products in almost all cases. As a result, an increase in the number of license arrangements is likely to increase demand for professional services, training, and maintenance relating to our products. Given that the number of our license arrangements has been increasing, we will need to provide our customers with more professional services, training, and maintenance to enable our customers to realize significant business value from our software. Accordingly, we have been hiring additional personnel in these areas and improving our “on-boarding” process to ramp up new personnel in a shorter period of time. We have also been increasingly enabling our partners and our customers through training and the creation of “centers of excellence” to create an expanded universe of people that are skilled in the implementation of our products. However, if we are unable to provide sufficient high quality professional services, training, or maintenance resources to our customers, our customers may not realize sufficient business value from our products to justify follow-on sales, which could impact our future financial performance. In addition, the growth required to meet the increased demand for our professional services could strain our ability to deliver our services engagements at desired levels of profitability, thereby impacting our overall profitability and financial results. We frequently enter into limited scope initial licenses with new customers, which could adversely affect our financial performance if we are not successful in obtaining follow-on business from these customers. We frequently enter into initial licenses with our new customers that are focused on a specific purpose or area of operations, rather than selling large enterprise licenses, to allow these new customers to realize business value from our software quickly and for a limited initial investment. Once a customer has realized this initial value, we work with the customer to identify opportunities for follow-on sales. However, we may not be successful in demonstrating this initial value to some customers, for reasons relating to the performance of our products, the quality of the services and support we provide for our products, or external reasons. For these customers, we may not obtain follow-on sales or the follow-on sales may be delayed, and our license revenue will be limited to the smaller initial sale. This could lower average transaction size and adversely affect our financial performance. Our professional services revenue is dependent to a significant extent on closing new license transactions with customers. We derive a substantial portion of our professional services revenue from implementation of new software licenses with our customers. Accordingly, it is imperative that we close more license transactions with our customers if we are to maintain or grow our services revenue. If we are unable to maintain vendor specific objective evidence (“VSOE”) of fair value of our professional services arrangements, we may be required to delay a portion of our revenue to future periods . We have established VSOE of fair value of our professional services in all geographic areas, except for in Australia and one European country, based on the price charged when these services are sold separately. The weakened economy and significant competition within our industry have created pricing pressure on professional services provided by technology companies. If we elect to discount our professional services pricing or otherwise introduce variability in our professional services arrangements to attract or retain customers, this could lead to an insufficient number of consistent pricing examples for us to measure and maintain VSOE. If we do not have VSOE of fair value of our professional services, we may be required to recognize all revenue for these professional services arrangements, including any related license, maintenance, and other services revenue if the professional services are bundled in an arrangement, ratably over the longer of the software maintenance period or the service period. 9 ITEM 1A. RISK FACTORS Table of Contents Factors relating to fluctuations in our financial results The timing of our license revenue is difficult to predict accurately, which may cause our quarterly operating results to vary considerably. A change in the number or size of high value license arrangements, or a change in the mix between perpetual and term licenses, can cause our revenues to fluctuate materially from quarter to quarter. Our decision to enter into term licenses that require the term license revenue to be recognized over the license term as payments become due or earlier if prepaid may adversely affect our profitability in any period due to sales commissions being paid at the time of signing and the corresponding revenue being recognized over time. We plan selling and marketing expenses, product development, and other expenses based on anticipated future revenue. If the timing or amount of revenue fails to meet our expectations in any given quarter, our financial performance is likely to be adversely affected because only small portions of expenses vary with revenue. As a result, period-to-period comparisons of operating results are not necessarily meaningful and should not be relied upon to predict future performance. Our financial results may be adversely affected if we are required to change certain estimates, judgments, and positions relative to our income taxes. In the ordinary course of conducting a global business enterprise, there are many transactions and calculations undertaken whose ultimate tax outcome cannot be certain. Some of these uncertainties arise as a consequence of positions we have taken regarding valuation of deferred tax assets, transfer pricing for transactions with our subsidiaries, and potential challenges to nexus and tax credit estimates. We estimate our exposure to unfavorable outcomes related to these uncertainties and estimate the probability for such outcomes. Although we believe our estimates are reasonable, no assurance can be given that the final tax outcome of these matters or our current estimates regarding these matters will not be different from what is reflected in our historical income tax provisions, returns, and accruals. Such differences, or changes in estimates relating to potential differences, could have a material impact, unfavorable or favorable, on our income tax provisions, require us to change the recorded value of deferred tax assets, and adversely affect our financial results. We are investing heavily in sales and marketing and professional services in anticipation of a continued increase in license arrangements, and we may experience decreased profitability or losses if we are unsuccessful in increasing the value of our license arrangements in the future. We have been increasing our investment in sales and marketing to meet increasing demand by hiring additional sales and marketing personnel. We anticipate that we will need to provide our customers with more professional services, training, and maintenance as a result of this increase in demand, and have been hiring additional personnel in these areas. These investments have resulted in increased fixed costs that do not vary with the level of revenue. If the increased demand for our products does not continue, we could experience decreased profitability or losses as a result of these increased fixed costs. Factors relating to our products and markets The adverse changes in the global capital markets and economy may negatively impact our sales to, and the collection of receivables from, our financial services and insurance customers and possibly our customers in other industries. The recent financial crisis in the global capital markets and the current negative global economic trends could impact the ability and willingness of our financial services and insurance customers, and possibly our customers in other industries, to make investments in technology, which may delay or reduce the amount of purchases of our software and professional services. These factors could also impact the ability and willingness of these customers to pay their trade obligations and honor their contractual commitments under their non-cancellable term licenses. These customers may also become subject to increasingly restrictive regulatory requirements, which could limit or delay their ability to proceed with new technology purchases. Our financial services and insurance customers as a group represent a significant amount of our revenues and receivables. Accordingly, their potential financial instability could negatively impact our business, operating results, and financial condition. We will need to acquire or develop new products, evolve existing ones, and adapt to technology change . Technical developments, customer requirements, programming languages, and industry standards change 10 Table of Contents frequently in our markets. As a result, success in current markets and new markets will depend upon our ability to enhance current products, to acquire or develop and introduce new products that meet customer needs, keep pace with technology changes, respond to competitive products, and achieve market acceptance. Product development requires substantial investments for research, refinement, and testing. There can be no assurance that we will have sufficient resources to make necessary product development investments. We may experience difficulties that will delay or prevent the successful development, introduction, or implementation of new or enhanced products. Inability to introduce or implement new or enhanced products in a timely manner would adversely affect future financial performance. The market for our offerings is increasingly and intensely competitive, rapidly changing, and highly fragmented. The market for BPM software and related implementation, consulting, and training services is intensely competitive, rapidly changing and highly fragmented. We currently encounter significant competition from internal information systems departments of potential or existing customers that develop custom software. We also compete with large technology companies such as IBM, Oracle and SAP, companies that target the customer interaction and workflow markets, companies focused on business rules engines or enterprise application integration, “pure play” BPM companies, and professional service organizations that develop custom software in conjunction with rendering consulting services. Competition for market share and pressure to reduce prices and make sales concessions are likely to increase. Many competitors have far greater resources and may be able to respond more quickly and efficiently to new or emerging technologies, programming languages or standards or to changes in customer requirements or preferences. Competitors may also be able to devote greater managerial and financial resources to develop, promote, and distribute products and provide related consulting and training services. There has been recent consolidation in the BPM market whereby larger companies such as IBM, Oracle, SAP and Progress Software have acquired companies that provide BPM software, which we expect will further increase competition. There can be no assurance that we will be able to compete successfully against current or future competitors or that the competitive pressures faced by us will not materially adversely affect our business, operating results, and financial condition. We have historically sold to the financial services, insurance and healthcare markets, and rapid changes or consolidation in these markets could affect the level of demand for our products. We have historically derived a significant portion of our revenue from customers in the financial services, insurance, and healthcare markets, and sales to these markets are important for our future growth. Competitive pressures, industry consolidation, decreasing operating margins, regulatory changes, and privacy concerns affect the financial condition of our customers and their willingness to buy. In addition, customers’ purchasing patterns in these industries for large technology projects are somewhat discretionary. The financial services and insurance markets are undergoing intense domestic and international consolidation and financial turmoil, and consolidation has been occurring in the healthcare market. Consolidation may interrupt normal buying behaviors and increase the volatility of our operating results. In recent years, several of our customers have been merged or consolidated, and we expect this to continue in the near future. Future mergers or consolidations may cause a decline in revenues and adversely affect our future financial performance. All of these factors affect the level of demand for our products from customers in these industries, and could adversely affect our business, operating results and financial condition. We rely on certain third-party relationships. We have a number of relationships with third parties that are significant to sales, marketing and support activities, and product development efforts. We rely on software and hardware vendors, large system integrators, and technology consulting firms to provide marketing and sales opportunities for the direct sales force and to strengthen our products through the use of industry-standard tools and utilities. We also have relationships with third parties that distribute our products. There can be no assurance that these companies, most of which have significantly greater financial and marketing resources, will not develop or market products that compete with ours in the future or will not otherwise end or limit their relationships with us. We face risks from operations and customers based outside of the U.S. Sales to customers headquartered outside of the U.S. represented approximately 34% of our total revenue in 2009, 38% in 2008 and 35% in 2007. 11 Table of Contents We, in part through our wholly-owned subsidiaries based in the United Kingdom, Germany, Spain, the Netherlands, Switzerland, Canada, and Australia, market products and render consulting and training services to customers based in Canada, the United Kingdom, France, Germany, Spain, the Netherlands, Belgium, Switzerland, Austria, Ireland, Sweden, Mexico, Australia, Hong Kong, and Singapore. We have established offices in Canada, Europe, Asia and Australia. We believe that growth will necessitate expanded international operations, requiring a diversion of managerial attention and increased costs. We anticipate hiring additional personnel to accommodate international growth, and we may also enter into agreements with local distributors, representatives, or resellers. If we are unable to do one or more of these things in a timely manner, our growth, if any, in our foreign operations may be restricted, and our business, operating results, and financial condition could be materially and adversely affected. In addition, there can be no assurance that we will be able to maintain or increase international market demand for our products. Several of our international sales are denominated in U.S. dollars. Accordingly, any appreciation of the value of the U.S. dollar relative to the currencies of those countries in which we sell our products may place us at a competitive disadvantage by effectively making our products more expensive as compared to those of our competitors. Additional risks inherent in our international business activities generally include unexpected changes in regulatory requirements, increased tariffs and other trade barriers, the costs of localizing products for local markets and complying with local business customs, longer accounts receivable patterns and difficulties in collecting foreign accounts receivable, difficulties in enforcing contractual and intellectual property rights, heightened risks of political and economic instability, the possibility of nationalization or expropriation of industries or properties, difficulties in managing international operations, potentially adverse tax consequences (including restrictions on repatriating earnings and the threat of “double taxation”), increased accounting and internal control expenses, and the burden of complying with a wide variety of foreign laws. There can be no assurance that one or more of these factors will not have a material adverse effect on our foreign operations, and, consequentially, our business, operating results, and financial condition. We are exposed to fluctuations in currency exchange rates that could negatively impact our financial results and cash flows. Because a significant portion of our business is conducted outside the U.S., we face exposure to adverse movements in foreign currency exchange rates. These exposures may change over time as business practices evolve, and they could have a material adverse impact on our financial results and cash flows. Our international sales have increasingly become denominated in foreign currencies. The operating expenses of our foreign operations are primarily denominated in foreign currencies, which partially offset our foreign currency exposure. A decrease in the value of foreign currencies, particularly the British pound sterling and the Euro relative to the U.S. dollar, could adversely impact our financial results and cash flows. Factors relating to our internal operations and potential liabilities We depend on certain key personnel, and must be able to attract and retain qualified personnel in the future. The business is dependent on a number of key, highly skilled technical, managerial, consulting, sales, and marketing personnel, including our Chief Executive Officer. The loss of key personnel could adversely affect financial performance. We do not have any significant key-man life insurance on any officers or employees and do not plan to obtain any. Our success will depend in large part on the ability to hire and retain qualified personnel. The number of potential employees who have the extensive knowledge of computer hardware and operating systems needed to develop, sell, and maintain our products is limited, and competition for their services is intense, and there can be no assurance that we will be able to attract and retain such personnel. If we are unable to do so, our business, operating results, and financial condition could be materially adversely affected. We may experience significant errors or security flaws in our product and services, and could face privacy, product liability and warranty claims as a result. Despite testing prior to their release, software products frequently contain errors or security flaws, especially when first introduced or when new versions are released. Errors in our software products could affect the ability of our products to work with other hardware or 12 Table of Contents software products, or could delay the development or release of new products or new versions of products. The detection and correction of any security flaws can be time consuming and costly. Errors or security flaws in our software could result in the inadvertent disclosure of confidential information or personal data relating to our customers, employees, or third parties. Software product errors and security flaws in our products or services could expose us to privacy, product liability and warranty claims as well as harm our reputation, which could impact our future sales of products and services. Our license agreements typically contain provisions intended to limit the nature and extent of our risk of product liability and warranty claims. There is a risk that a court might interpret these terms in a limited way or could hold part or all of these terms to be unenforceable. Also, there is a risk that these contract terms might not bind a party other than the direct customer. Furthermore, some of our licenses with our customers are governed by non-U.S. law, and there is a risk that foreign law might give us less or different protection. Although we have not experienced any material product liability claims to date, a product liability suit or action claiming a breach of warranty, whether or not meritorious, could result in substantial costs and a diversion of management’s attention and our resources. We face risks related to intellectual property claims or appropriation of our intellectual property rights. We rely primarily on a combination of copyright, trademark and trade secrets laws, as well as confidentiality agreements to protect our proprietary rights. We have obtained patents from the U.S. Patent and Trademark Office relating to the architecture of our systems. We cannot assure that such patents will not be invalidated or circumvented or that rights granted thereunder or the claims contained therein will provide us with competitive advantages. Moreover, despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain the use of information that we regard as proprietary. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the U.S. There can be no assurance that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop similar technology. We are not aware that any of our products infringe the proprietary rights of third parties. There can be no assurance, however, that third parties will not claim infringement by us with respect to current or future products. Although we attempt to limit the amount and type of our contractual liability for infringement of the proprietary rights of third parties, these limitations often contain certain exclusions, and we cannot be assured that these limitations will be applicable and enforceable in all cases. Even if these limitations are found to be applicable and enforceable, our liability to our customers for these types of claims could be material in amount given the size of certain of our transactions. We expect that software product developers will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Any such claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays, or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could have a material adverse effect upon our business, operating results, and financial condition. The acquisition of other businesses and technologies may present new risks. We have undertaken an acquisition during the past two years and may continue to evaluate and consider other potential strategic transactions, including acquisitions of businesses, technologies, services, products and other assets in the future. These acquisitions, if undertaken, may involve significant new risks and uncertainties, including distraction of management attention away from our current business operations, insufficient new revenue to offset expenses, inadequate return on capital, integration challenges, new regulatory requirements, and issues not discovered in our due diligence process. No assurance can be given that such acquisitions will be successful and will not adversely affect our profitability or operations. Ongoing medical and dental claims expenses could significantly affect our earnings and cash flows. Beginning in 2010, we will self-insure for U.S. employee medical and dental claims (“claims”). We will accrue amounts for liabilities based on our assessment of claims that arise and we will evaluate and revise these accruals from time to time based on additional information. We maintain insurance with licensed insurance carriers above the amounts for which we self-insure. Our future claims expenses may exceed our expectations, which could reduce our earnings and negatively impact our cash flow. 13 Table of Contents None. Our principal administrative, sales, marketing, support, and research and development operations are located at 101 Main Street, Cambridge, Massachusetts in an approximately 105,000 square foot leased facility. The lease for this facility expires in 2013, subject to our option to extend for two additional five-year periods. We also lease space for our other offices in the U.S., Australia, Canada, India, the United Kingdom and in other European countries. These leases expire at various dates through 2014. We believe that additional or alternative space will be available as needed in the future on commercially reasonable terms. None. During the fourth quarter of 2009, there were no matters submitted to a vote of our security holders. 14 ITEM 1B. UNRESOLVED STAFF COMMENTS ITEM 2. Properties ITEM 3. Legal Proceedings ITEM 4. Submission of Matters to a Vote of Security Holders Table of Contents PART II Market Information Our common stock is quoted on the NASDAQ Global Select Market (“NASDAQ”) under the symbol “PEGA.” The following table sets forth the range of high and low sales prices of our common stock on NASDAQ for each quarter in the years ended December 31, 2009 and 2008. Holders As of February 9, 2010, we had approximately 49 stockholders of record and approximately 33,800 beneficial owners of our common stock. Dividends In July 2006, we began paying a quarterly cash dividend of $0.03 per share of common stock. Quarterly cash dividends are expected to continue at $0.03 per share to stockholders of record as of the first trading day of each quarter, subject to change or elimination at any time by our Board of Directors. Equity Compensation Plan Information The following table sets forth information as of December 31, 2009 regarding our Amended and Restated 1994 Long-Term Incentive Plan (the “1994 Plan”), the 1996 Non-Employee Director Stock Option Plan (the “Director Plan”), the 2004 Long-Term Incentive Plan (the “2004 Plan”) and the 2006 Employee Stock Purchase Plan (the “2006 ESPP”). Our stockholders previously approved each of these plans and all amendments that were subject to stockholder approval. We have no equity compensation plans that have not been approved by stockholders. See Note 13 “Stock-Based Compensation” included in the notes to the accompanying consolidated financial statements for further information and description of our equity compensation plans. 15 ITEM 5. Market for Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities Common Stock Price 2009 2008 High Low High Low First Quarter $ 19.20 $ 11.74 $ 12.04 $ 8.73 Second Quarter $ 27.98 $ 16.21 $ 13.81 $ 9.63 Third Quarter $ 35.29 $ 22.23 $ 15.10 $ 11.87 Fourth Quarter $ 36.09 $ 25.75 $ 13.42 $ 9.58 (In thousands, except per share amounts) (a) (b) (c) Number of shares of common stock to be issued upon exercise of outstanding stock options and vesting of RSUs (1) Weighted-average exercise price of outstanding stock options (2) Number of shares of Common stock Remaining available For future issuance (excluding those in Column (a)) (3) Equity Compensation Plans approved by Stockholders 4,101 $ 9.95 2,040 (1) The number of shares of common stock issued upon exercise of vested stock options and vesting of restricted stock units (“RSUs”) will be less than 4,101,000 because of the “net settlement” feature of most of these options and RSUs. This feature enables the employee to satisfy the cost to exercise (in the case of options) and, if applicable, taxes due (in the case of options and RSUs) by surrendering shares to the Table of Contents In addition to the issuance of stock options, the 1994 Plan allowed for the issuance of stock appreciation rights, restricted stock and long-term performance awards. The Company does not intend to issue any additional options or make any other awards under the 1994 Plan or the Director Plan in the future. In addition to the issuance of stock options, the 2004 Plan allows for the issuance of stock purchase rights and other stock-based awards, including RSUs. Issuer Purchases of Equity Securities The following table sets forth information regarding our repurchases of our common stock during the fourth quarter of 2009. 16 Company based on the fair value of the shares at the exercise date (in the case of options) or vesting date (in the case of RSUs), instead of selling all of the shares on the open market to satisfy these obligations. The settlement of vested stock options and vested RSUs on a net share basis will result in fewer shares issued by the Company. During 2009, option and RSU holders net settled stock options and vested RSUs representing the right to purchase a total of 2,451,000 shares, of which only 1,188,000 were issued to the option and RSU holders and the balance of the shares were surrendered to the Company to pay for the exercise price and the applicable taxes. (2) The weighted-average exercise price does not take into account the shares issuable upon vesting of outstanding RSUs, which have no exercise price. (3) Includes approximately 443,000 shares remaining available for issuance as of December 31, 2009 under the 2006 ESPP. Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Share Repurchase Program (1) Approximate Dollar Value of Shares That May Yet Be Purchased Under Publicly Announced Share Repurchased Programs (1) (in thousands) 10/1/09 – 10/31/09 19,533 $ 32.22 19,533 $ 2,340 11/1/09 – 11/30/09 41,239 30.06 41,239 16,100 12/1/09 – 12/31/09 9,961 32.24 9,961 15,779 Total 70,733 $ 30.97 (1) On December 1, 2008, we publicly announced that our Board of Directors approved a $15.0 million share repurchase program effective December 1, 2008 and expiring on December 31, 2009 (the “Fourth Program”). On November 24, 2009, we publicly announced that our Board of Directors approved an additional $15.0 million for share repurchases under the Fourth Program and extended this Program’s expiration date to December 31, 2010. Under the Fourth Program, purchases will 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. The Company has 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, and of Rule 10b-18 under the Securities Exchange Act of 1934, as amended, (the “10b5-1 Plan”). All share repurchases under the Fourth Program during closed trading window periods were made pursuant to the 10b5-1 Plan. Table of Contents Stock Performance Graph and Cumulative Total Stockholder Return The following performance graph represents a comparison of the cumulative total stockholder return (assuming the reinvestment of dividends) for a $100 investment on December 31, 2004 in each of our common stock, the Total Return Index for the NASDAQ Composite (“NASDAQ Composite”), a broad market index, and the Standard & Poors (“S&P”) North Software-Software Index™ (“S&P NSSI”), a published industry index that was formerly the S&P Goldman Sachs Technology Software Index. We paid dividends of $0.12 per share during 2009, 2008, and 2007 and $0.06 per share during 2006. The graph lines merely connect measurement dates and do not reflect fluctuations between those dates. 17 Table of Contents The selected financial data presented below has been derived from our consolidated financial statements. This data may not be indicative of our future financial condition or results of operations and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, the consolidated financial statements and accompanying notes. 18 ITEM 6. Selected Financial Data Year Ended December 31, 2009 2008 2007 2006 2005 (in thousands, except per share amounts) Consolidated Statements of Operations Data: Total revenue $ 264,013 $ 211,647 $ 161,949 $ 126,023 $ 100,209 Income (loss) from operations 41,819 14,479 1,951 (7,114 ) 1,218 Income before provision for income taxes 47,415 15,672 9,942 1,187 5,319 Net income 32,212 10,977 6,595 1,842 5,192 Earnings per share: Basic $ 0.89 $ 0.30 $ 0.18 $ 0.05 $ 0.15 Diluted $ 0.85 $ 0.29 $ 0.18 $ 0.05 $ 0.14 Cash dividends declared per common share $ 0.12 $ 0.12 $ 0.12 $ 0.09 $ — Weighted-average number of common shares outstanding: Basic 36,208 36,146 35,875 35,229 35,774 Diluted 38,113 37,605 37,433 37,134 36,462 Year Ended December 31, 2009 2008 2007 2006 2005 (in thousands) Consolidated Balance Sheet Data: Total cash, cash equivalents, and marketable securities $ 202,653 $ 167,229 $ 149,981 $ 127,758 $ 114,735 Working capital 188,552 159,080 159,547 147,229 133,440 Long-term license installments, net of unearned interest income 2,976 5,413 8,267 17,458 31,371 Total assets 279,585 245,850 243,307 214,008 209,654 Capital lease obligation, including current portion — — — 63 166 Stockholders’ equity 205,219 173,114 172,944 166,158 167,682 Table of Contents Our products and services We develop and license rules-based BPM software and provide professional services, maintenance, and training related to our software. We focus our sales efforts on target accounts, which are companies or divisions within companies, and are typically large organizations that are among the leaders in their industry. Our strategy is to sell initial licenses to these target accounts that are focused on a specific purpose or area of operations, rather than selling large enterprise licenses. This strategy allows our customers to quickly realize business value from our software and limits their initial investment. Once a customer has realized this initial value, we work with the customer to identify opportunities for follow-on sales. Our license revenue is primarily derived from sales of our PRPC software and related solution frameworks. PRPC is a comprehensive platform for building and managing BPM applications that unifies business rules and business processes. Our solution frameworks are built on the capabilities of PRPC and are purpose- or industry -specific collections of best practice functionality to allow organizations to quickly implement new customer-facing practices and processes, bring new offerings to market, and provide customized or specialized processing to meet the needs of different customers, departments, geographies or regulatory requirements. These products often require less implementation assistance than prior generations of our software products. In many cases this has resulted in a shorter sales process and implementation period. PRPC and related solution frameworks can be used by a broad range of customers within financial services, insurance and healthcare markets, as well as other markets, such as life sciences, communications, travel and entertainment, and government. We also offer SmartPaaS, which is our platform-as-a service offering that allows customers to create PRPC applications using an internet-based infrastructure. This offering enables Pegasystems’ customers to immediately build their applications in a secure environment while minimizing their infrastructure and hardware costs. Our customers typically request professional services and training to assist them in implementing our products. Almost all of our customers also purchase maintenance on our products, which includes rights to upgrades and new releases, incident resolution and technical assistance. Professional services are provided directly by us and through our network of partners. By utilizing these partners, we have increased the supply of skilled service consultants that can assist our customers. Business overview We achieved license revenue growth of 51% in 2009 compared to 2008, including a 54% increase in perpetual license revenue and a 43% increase in term license revenue, despite the challenging economic conditions. We generated approximately $49.6 million in cash from operations in 2009, a 29% increase compared to 2008, and ended the year with $202.7 million in cash, cash equivalents, and marketable securities. We generated the majority of our 2009 license revenue from follow-on sales to existing customers. We believe these results reflect our ability to quickly and successfully deliver our versatile Build for Change technology to Fortune 500 customers across industries and international borders, allowing these customers to reduce operating costs and increase revenues within a rapid time-frame from implementation. These operational efficiencies experienced by our customers are part of the strong value proposition our technology provides to our customers. We believe our growth and success in 2009 were due to: 19 ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations • Increased market acceptance of our industry leading technology; • Expansion of our solutions frameworks offerings; • Disciplined and focused strategy of selling to targeted customers; • Expansion of our targeted customer list; ® Table of Contents We believe that the ongoing challenges for our business include continuing to drive revenue growth despite the continued challenging economic conditions and increased competition, continuing to expand our expertise in new and existing industries, and maintaining our leadership position in the BPM market. To support our growth and successfully address these challenges through 2010 we plan to: RESULTS OF OPERATIONS 2009 Compared to 2008 The increase in our total revenue during 2009 compared to 2008 was attributable to an increase in the demand for our software products due to growth in the BPM sector and our position as leader in that sector. We believe the demand for our software solutions in the difficult economic environment is primarily due to the strong value proposition and various licensing terms we offer our customers. The increase in gross profit was primarily due to the increase in license revenue and to a lesser extent due to the increase in maintenance revenue, partially offset by a decrease in our professional services gross profit. The increase in income before provision for income taxes during 2009 compared to 2008 was primarily due to our license and maintenance revenue growing at a faster rate than our operating expenses. These increases in revenue offset the higher expenses associated with our continued investment in research and development, expanding our sales and marketing personnel, and our professional services infrastructure. During 2008, due to credit market turmoil and adverse changes in the economy, we changed the mix of our investment portfolio to increase our holdings of tax-exempt pre-refunded municipal bonds, which resulted in $1.9 million of lower interest income in 2009 compared to 2008. Our income before provision for income taxes in 2009 was positively impacted by $2.1 million of foreign currency transaction gains. A change in the number or size of high value license arrangements, or a change in the mix between perpetual and term licenses, can cause our revenues to fluctuate materially from quarter to quarter. The revenue growth rate achieved in any historical period is not necessarily indicative of the results expected for future periods. 20 • Development and growth of our proficiency across new industries; and • Product improvements as a result of the expansion of our research and development efforts. • Continue to develop and increase our solutions frameworks offerings and expertise across targeted industries; • Hire significantly more sales and marketing professionals to expand our targeted customer list and increase partner utilization; • Protect and extend our technology leadership position; • Develop and expand our international operations; • Grow our professional services organization and partner alliances; and • Continue to invest in our research and development efforts in India and the U.S. (Dollars in thousands) Year Ended December 31, Increase 2009 2008 Total revenue $ 264,013 $ 211,647 $ 52,366 25 % Gross profit 173,076 129,890 43,186 33 % Total operating expenses 131,257 115,411 15,846 14 % Income before provision for income taxes 47,415 15,672 31,743 203 % Table of Contents Revenue The mix between perpetual and term license arrangements fluctuates based on customer circumstances. The increase in perpetual license revenue during 2009 compared to 2008 was driven by increases in the number of perpetual licenses. We generated the majority of our license revenue in 2009 from follow-on sales to existing customers. Many of the perpetual license arrangements include extended payment terms and/or additional rights of use that delay the recognition of revenue to future periods. The aggregate value of payments due under these perpetual and certain subscription licenses was $57.1 million as of December 31, 2009 compared to $30.3 million as of December 31, 2008. See the table of future cash receipts by year from these perpetual licenses and certain subscription licenses on page 30. We recognize revenue for our term license arrangements over the term of the agreement as payments become due or earlier if prepaid. The increase in term license revenue during 2009 compared to 2008 was primarily due to significant prepayments of certain term licenses. In addition, the increase in term license revenue in 2009 compared to 2008 was due to the increase in the aggregate value of payments for non-cancellable term licenses signed during 2009, 2008, and 2007 for which a portion of the revenue was recognized in 2009. The remainder of the revenue under these agreements will be recognized in future periods. The aggregate value of future payments due under these term licenses decreased to $76.3 million as of December 31, 2009 compared to $88.5 million as of December 31, 2008 primarily due to the higher proportion of new perpetual licenses arrangements in 2009 and due to significant prepayments in 2009. The aggregate value of future payments due under non-cancellable term licenses as of December 31, 2009 includes $29.3 million of term license payments that we expect to recognize as revenue in 2010. However, our actual term license revenue in 2010 could be higher than $29.3 million as we complete new term license agreements in 2010 or if we receive prepayments from existing term license agreements. See the table of future cash receipts by year from these term licenses on page 30. Subscription revenue primarily relates to our arrangements that include a right to unspecified future products and is recognized ratably over the term of the arrangement. The increase in subscription revenue during 2009 compared 2008 was primarily due to a new customer arrangement. The increase in maintenance revenue in 2009 compared to 2008 was primarily due to the continued increase in the installed base of our software and to a lesser extent due to fees paid by a customer to reinstate maintenance. 21 (Dollars in thousands) Year Ended December 31, Increase 2009 2008 License revenue Perpetual licenses $ 71,678 62 % $ 46,667 61 % $ 25,011 54 % Term licenses 36,638 32 % 25,611 33 % 11,027 43 % Subscription 7,618 6 % 4,294 6 % 3,324 77 % Total license revenue $ 115,934 100 % $ 76,572 100 % $ 39,362 51 % (Dollars in thousands) Year Ended December 31, Increase 2009 2008 Maintenance revenue Maintenance $ 50,099 $ 40,115 $ 9,984 25 % (Dollars in thousands) Year Ended December 31, Increase (Decrease) 2009 2008 Professional services revenue Consulting services $ 93,910 96 % $ 89,842 95 % $ 4,068 5 % Training 4,070 4 % 5,118 5 % (1,048 ) (20 )% Total Professional services $ 97,980 100 % $ 94,960 100 % $ 3,020 3 % Table of Contents Professional services are primarily consulting services related to new license implementations. While we continue to experience demand for these services as the number of our new license arrangements increases, our professional services revenue was negatively impacted by pricing pressures associated with a weaker global economy and the decline in the value of the European currencies relative to the U.S. dollar during 2009 compared to 2008. Our training revenues continue to be negatively impacted by a weak global economy. Professional services gross profit during 2009 compared to 2008 was adversely impacted by lower realization rates globally due to the challenging economic conditions. In addition, the direct costs associated with the professional services bundled with a license arrangement recognized on a subscription basis were recorded in the third quarter of 2009, but the related revenue will be recognized over the subscription period. The bundled professional services for this arrangement were completed during the third quarter of 2009. In addition, during the second half of 2009, a significant number of our professional services consultants completed our enhanced training curriculum to achieve the master level of PRPC certification, which resulted in lower billable hours and an increased use of contractors. We intend to continue our investment in the professional services organization in 2010 to support our license implementations. Operating expenses Selling and marketing expenses include compensation, benefit, and other headcount-related expenses associated with our selling and marketing personnel as well as advertising, promotions, trade shows, seminars, and other programs. The increase in selling and marketing expenses was primarily due to a $6.0 million increase in compensation and benefit expenses associated with higher headcount, as well as $4.4 million higher sales commissions in 2009 compared to 2008, mainly due to an increase in the value of our new license arrangements in 2009 compared to 2008. Selling and marketing expenses also increased due to a $0.5 million increase in contractor expenses and a $0.2 million increase in marketing campaign expenses, partially offset by a $0.5 million decrease in employment agency fees. 22 (Dollars in thousands) Year Ended December 31, Increase (Decrease) 2009 2008 Gross Profit Software license $ 115,813 $ 76,477 $ 39,336 51 % Maintenance 43,896 34,725 9,171 26 % Professional services 13,367 18,688 (5,321 ) (28 )% Total gross profit $ 173,076 $ 129,890 $ 43,186 33 % Maintenance gross margin 88 % 87 % Professional services gross margin 14 % 20 % (Dollars in thousands) Year Ended December 31, Increase 2009 2008 Selling and marketing Selling and marketing $ 74,378 $ 63,799 $ 10,579 17 % As a percent of total revenue 28 % 30 % Selling and marketing headcount 253 190 63 33 % (Dollars in thousands) Year Ended December 31, Increase 2009 2008 Research and development Research and development $ 38,862 $ 31,472 $ 7,390 23 % As a percent of total revenue 15 % 15 % Research and development headcount 222 162 60 37 % Table of Contents Research and development expenses include compensation, benefits, contracted services, and other headcount-related expenses associated with research and development. During the first three quarters of 2008, our research and development center in India was not operational and therefore associated start-up expenses were classified as general and administrative expenses. Subsequent to becoming operational in October 2008, all expenses associated with our development center are classified as research and development. The change in classification of these expenses resulted in a $2.1 million increase in research and development expenses during 2009 compared to 2008. The increase in research and development expenses during 2009 compared to 2008 was also due to a $4.1 million increase in compensation and benefit expenses associated with higher headcount, a $0.6 million increase in depreciation expense, and a $0.4 million increase in contractor expenses. General and administrative expenses include compensation, benefit, and other headcount-related expenses associated with the finance, legal, corporate governance, and other administrative headcount, as well as accounting, legal, and other administrative fees. During 2009 compared to 2008, the change in classification of the expenses related to the research and development center in India resulted in a $2.1 million decrease in general and administrative. In addition, general and administrative expenses decreased by $1.0 million due to a reduction in our reserves for non-income related taxes. These decreases in general and administrative expenses were partially offset by a $1.6 million increase in compensation and benefit expenses and a $1.5 million increase in contractor expenses. Stock-based compensation We recognize stock-based compensation expense associated with equity awards in our consolidated statements of income based on the fair value of these awards at the date of grant. The following table summarizes stock-based compensation expense included in our consolidated statements of income in 2009 and 2008: The increase in stock-based compensation expense in 2009 compared to 2008 was primarily due to our periodic stock option grant in December 2008 and new hire stock option grants, partially offset by a decrease in our stock-based compensation as a result of our refining our forfeiture estimate in the second quarter of 2009. As of December 31, 2009, we had approximately $6.7 million of unrecognized stock-based compensation expense related to the unvested portion of all our stock options and RSUs that is expected to be recognized over a 23 (Dollars in thousands) Year Ended December 31, Increase (Decrease) 2009 2008 General and administrative General and administrative $ 18,017 $ 20,140 $ (2,123 ) (11 )% As a percent of total revenue 7 % 10 % General and administrative headcount 144 129 15 12 % (Dollars in thousands) Year Ended December 31, Increase 2009 2008 Stock-based compensation expense: Cost of services $ 1,096 $ 995 $ 101 10 % Operating expenses 3,577 2,537 1,040 41 % Total stock-based compensation before tax 4,673 3,532 $ 1,141 32 % Income tax benefit (1,688 ) (1,090 ) Net stock-based compensation expense $ 2,985 $ 2,442 Table of Contents weighted-average period of approximately 2.4 years. See Note 13 “Stock-Based Compensation” in the notes to the accompanying consolidated financial statements for further information on our stock-based awards. The decrease in interest income in 2009 compared to 2008 was primarily due to our investment in lower yielding tax-exempt municipal bonds. During 2008, due to credit market turmoil and adverse changes in the economy, we changed the mix of our investment portfolio to increase our holdings of pre-refunded municipal bonds. These bonds are collateralized by the issuer purchasing U.S. Treasury securities to fund all the cash flows of the refunded municipal bonds that will mature when the issuer’s bond matures. The increase in foreign currency transaction gains resulted primarily from the increase in the value of foreign currency denominated net assets held in the U.S., consisting primarily of cash, receivables, license installments and accounts payable. As a result of the significant increase in the value of the British pound sterling and Euro relative to the U.S. dollar during 2009, we recorded a $2.1 million foreign currency exchange transaction gain as compared to a $4.5 million foreign exchange transaction loss in 2008. See Item 7A. “Quantitative and Qualitative Disclosure about Market Risk” for further discussion of our foreign currency exchange risk. Provision for income taxes The provision for income taxes represents current and future amounts owed for federal, state, and foreign taxes. During 2009 and 2008, we recorded a $15.2 million and $4.7 million provision, respectively, which resulted in an effective tax rate of 32% and 30%, respectively. Our effective income tax rate for 2009 was below the statutory federal income tax rate due to a $0.8 million benefit related to the current period domestic production activities, a $0.9 million benefit from tax-exempt income, and a $0.8 million reduction in the Company’s reserve for uncertain tax positions related to the settlement of the Company’s income tax audit with United Kingdom government and tax positions of prior years for which the statute of limitations has expired, all of which reduced the Company’s effective tax rate. These benefits were partially offset by $0.4 million of permanent differences, primarily related to nondeductible meals and entertainment expenses. Our effective income tax rate for 2008 was below the statutory federal income tax rate due to a $0.5 million benefit related to the current period domestic production activities, approximately $0.8 million of estimated federal income tax credits, and a $0.6 million benefit from tax-exempt income. These benefits were partially offset by an increase in the Company’s reserve for uncertain tax positions of $1.3 million, the majority of which is related to the state tax credits, and permanent differences of $0.4 million primarily related to nondeductible meals and entertainment expenses. As of December 31, 2009, the amount of unrecognized tax benefits totaled approximately $4.4 million, all of which if recognized, would decrease our effective tax rate. We expect that the changes in the unrecognized benefits within the next twelve months will be approximately $0.9 million related to tax positions for which the ultimate settlement is highly certain but for which there is uncertainty about the timing of such recognition. 24 (Dollars in thousands) Year Ended December 31, Increase (Decrease) 2009 2008 Interest income, Other income and Income taxes Interest income, net $ 3,144 $ 5,029 $ (1,885 ) (37 )% Foreign currency transaction gain (loss) 2,083 (4,537 ) 6,620 146 % Installment receivable interest income 347 597 (250 ) (42 )% Other income, net 22 104 (82 ) (79 )% Interest income and other $ 5,596 $ 1,193 $ 4,403 369 % Table of Contents 2008 Compared to 2007 The increase in our total revenue during 2008 compared to 2007 was attributable to an increase in the demand for our software products and related services due to growth in the BPM sector and our position as leader in this market space. We believe the demand for our software solutions in the current economic crisis is primarily due to the strong value proposition and flexible licensing terms we offer our customers. The increase in gross profit for 2008 compared to 2007 was due to the increase in both license and maintenance revenue despite a decrease in the professional services gross profit. The increase in income before provision for income taxes during 2008 compared to 2007 was primarily due to our license and maintenance revenue growth. These increases in revenue offset the higher expenses associated with our continued investment in expanding our sales and marketing personnel, professional services infrastructure, and research and development. During 2008, due to credit market turmoil and adverse changes in the economy, we changed the mix of our investment portfolio to increase our holdings of pre-refunded municipal bonds, which resulted in $1.7 million of lower interest income. Our income before provision for income taxes was also negatively impacted by $4.5 million of foreign currency transaction losses included in other income (expense), net. Revenue n/m = not meaningful The mix between perpetual and term license arrangements fluctuates based on customer circumstances. We generated the majority of our license revenue in 2008 from follow-on sales to existing customers. We recognize revenue for our term license arrangements over the term of the agreement as payments become due or earlier if prepaid. The term license revenue growth was driven by a 26% increase in the average value of term licenses and a 54% increase in the number of term licenses for which we recognized revenue in 2008 compared to 2007. The increase in term license revenue in 2008 compared to 2007 was due to the increase in the aggregate value of payments for non-cancellable term licenses signed during 2008, 2007, and 2006 for which a portion of these agreements was recognized as revenue in 2008 and the remainder will be recognized as revenue in future periods. The aggregate value of payments due under these term licenses increased to $88.5 million as of December 31, 2008 compared to $71.4 million as of December 31, 2007 and compared to $14.2 million as of December 31, 2006. The aggregate value of future payments due under non-cancellable term licenses as of December 31, 2008 includes $31.0 million of term license payments that we expect to recognize as revenue in 2009. However, our actual term license revenue in 2009 could be higher than $31.0 million as we complete new term license agreements in 2009. 25 (Dollars in thousands) Year Ended December 31, Increase 2008 2007 Total revenue $ 211,647 $ 161,949 $ 49,698 31 % Gross profit 129,890 96,747 33,143 34 % Total operating expenses 115,411 94,796 20,615 22 % Income before provision for income taxes 15,672 9,942 5,730 58 % (Dollars in thousands) Year Ended December 31, Increase 2008 2007 License revenue Perpetual licenses $ 46,667 61 % $ 37,914 74 % $ 8,753 23 % Term licenses 25,611 33 % 13,170 26 % 12,441 94 % Subscription 4,294 6 % — — 4,294 n/m Total license revenue $ 76,572 100 % $ 51,084 100 % $ 25,488 50 % Table of Contents The increase in perpetual license revenue in 2008 was primarily driven by an increase in the average value of perpetual licenses. Subscription revenue primarily relates to our arrangements that include a right to unspecified future products and is recognized ratably over the term of the arrangement. The increase in maintenance revenue in 2008 compared to 2007 was due to the continued increase in the installed base of our software and a larger number of new license arrangements in the second half of 2007 for which a full year of maintenance revenue was recognized in 2008 as compared to a partial year in 2007. The increase in maintenance revenue was also due to inflation adjustments recognized on a larger installed base of software licenses. Professional services are primarily consulting services related to new license implementations. Our U.S. customers accounted for 57% of the professional services revenue in 2008 as compared to 66% in 2007. Our European customers accounted for 36% of the professional services revenue in 2008 as compared to 24% in 2007. The revenue growth from our European customers in 2008 was due to our investment in expanding our infrastructure and sales and marketing in Europe. The increase in professional services revenue was partially offset by a decrease of approximately $1.9 million as a result of a 27% decline in the British pound sterling and an 11% decline in the European Euro relative to the U.S. dollar during the last half of 2008. As a result of the demand for these services, we have increased employee headcount in the professional services organization by 23% to 287 employees as of December 31, 2008 from 233 employees as of December 31, 2007. In addition to our own employees, we use contractors to provide these services. The increase in software license gross profit was due to the increase in our license revenue, which had no significant incremental associated direct costs. In the third and fourth quarters of 2008, we experienced a decline in demand for our professional services in the U.S. due to the current economic crisis. However, we continued to hire professional services employees and 26 (Dollars in thousands) Year Ended December 31, Increase 2008 2007 Maintenance revenue Maintenance $ 40,115 $ 31,196 $ 8,919 29 % (Dollars in thousands) Year Ended December 31, Increase 2008 2007 Professional services revenue Consulting services $ 89,842 95 % $ 75,410 95 % $ 14,432 19 % Training 5,118 5 % 4,259 5 % 859 20 % Total Professional services $ 94,960 100 % $ 79,669 100 % $ 15,291 19 % (Dollars in thousands) Year Ended December 31, Increase (Decrease) 2008 2007 Gross Profit Software license $ 76,477 $ 51,084 $ 25,393 50 % Maintenance 34,725 26,405 8,320 32 % Professional services 18,688 19,258 (570 ) (3 )% Total gross profit $ 129,890 $ 96,747 $ 33,143 34 % Maintenance gross margin 87 % 85 % Professional services gross margin 20 % 24 % Table of Contents improve our capacity in anticipation of increased demand in the first half of 2009 associated with the increased new license arrangements in the second half of 2008. The increased professional services expenses combined with the lower demand resulted in lower utilization and lower gross profit. We believe our investment in professional services will generate growth in license arrangements. Operating expenses The increase in selling and marketing expenses was primarily due to a $5.7 million increase in compensation and benefit expenses associated with higher headcount, as well as $2.4 million higher sales commissions in 2008 compared to 2007, mainly due to an increase in our new license arrangements in 2008 compared to 2007. Selling and marketing expenses also increased due to a $1.6 million increase in travel expenses associated with higher headcount and higher costs of travel, $0.8 million of higher recruiting and marketing agency fees associated with hiring additional employees. The increase in research and development expenses during 2008 was primarily due to a $4.0 million increase in compensation and benefit expenses associated with higher headcount and $0.6 million of higher offshore contractor expenses. The increase in contractor expenses related to ongoing development and testing, support for the latest release of PRPC, and an increase in contractor rates in 2008 compared to 2007. In 2008, we established a research and development center in India, for which we received favorable Special Economic Zone (“SEZ”) tax status approval from the Indian government. The center became operational in October 2008. Subsequent to this date, all expenses associated with the facility are classified as research and development expenses. Prior to becoming operational, the associated start-up expenses were classified as general and administrative expenses. In connection with building our operations in India, we incurred $0.2 million of higher travel costs, $0.2 million of higher recruiting agency fees associated with hiring additional employees and $0.1 million of higher equipment expenses. The increase in general and administrative costs during 2008 was primarily due to $3.0 million of higher compensation and benefit costs related to increased headcount and $2.2 million of start-up expenses for establishing our research and development center in India. In addition, we incurred $0.5 million of higher legal fees in 2008 primarily associated with the expansion of our European operations and patent work and $0.6 27 (Dollars in thousands) Year Ended December 31, Increase 2008 2007 Selling and marketing Selling and marketing $ 63,799 $ 51,743 $ 12,056 23 % As a percent of total revenue 30 % 32 % Selling and marketing headcount 190 153 37 24 % (Dollars in thousands) Year Ended December 31, Increase 2008 2007 Research and development Research and development $ 31,472 $ 26,198 $ 5,274 20 % As a percent of total revenue 15 % 16 % Research and development headcount 162 119 43 36 % (Dollars in thousands) Year Ended December 31, Increase 2008 2007 General and administrative General and administrative $ 20,140 $ 16,855 $ 3,285 19 % As a percent of total revenue 10 % 10 % General and administrative headcount 129 109 20 18 % Table of Contents million of higher tax planning and other tax-related expenses. We also incurred approximately $0.6 million of higher rent expense associated with the additional leased space in Cambridge, Massachusetts, India, and Europe. These increases were partially offset by $1.0 million of lower professional fees. Stock-based compensation We recognize stock-based compensation expense associated with equity awards in our consolidated statements of income based on the fair value of these awards at the date of grant. The following table summarizes stock-based compensation expense included in our consolidated statements of income in 2008 and 2007: The increase in stock-based compensation expense in 2008 compared to 2007 was due to stock-based awards granted in December 2007 and March 2008. As of December 31, 2008, we had approximately $2.1 million of unrecognized stock-based compensation expense related to the unvested portion of all our stock options that is expected to be recognized over a weighted-average period of approximately 2.0 years. As of December 31, 2008, we had approximately $1.9 million of unrecognized stock-based compensation expense related to the unvested portion of all our RSUs that is expected to be recognized over a weighted-average period of 2.1 years. See Note 13 “Stock-Based Compensation” in the notes to the accompanying consolidated financial statements for further information on our stock-based awards. n/m = not meaningful The decrease in interest income in 2008 compared to 2007 was primarily due to our investment in lower yielding tax-exempt municipal bonds and the decrease in interest income from installment receivables. We expect a continued reduction in interest income associated with the installment receivables as a result of the declining balance of term licenses on which revenue has been recognized in advance of payments. During 2008, due to credit market turmoil and adverse changes in the economy, we changed the mix of our investment portfolio to increase our holdings of pre-refunded municipal bonds. These bonds are collateralized by the issuer purchasing U.S. Treasury securities to fund all the cash flows of the refunded municipal bonds that will mature when the issuer’s bond matures. Other income (expense), net, consists primarily of foreign currency exchange gains and losses and realized gains and losses on the sale of our investments. The decrease in other income (expense), net, resulted primarily 28 Year Ended December 31, Increase (Dollars in thousands) 2008 2007 Stock-based compensation expense: Cost of services $ 995 $ 490 $ 505 103 % Selling and marketing 807 436 371 85 % Research and development 539 130 409 315 % General and administrative 1,191 562 629 112 % Total stock-based compensation before tax 3,532 1,618 $ 1,914 118 % Income tax benefit (1,090 ) (430 ) Net stock-based compensation expense $ 2,442 $ 1,188 (Dollars in thousands) Year Ended December 31, (Decrease) 2008 2007 Interest income, Other income and Income taxes Installment receivable interest income $ 597 $ 1,244 $ (647 ) (52 )% Other interest income, net 5,029 6,718 (1,689 ) (25 )% Other income (expense), net (4,433 ) 29 (4,462 ) n/m Interest income and other $ 1,193 $ 7,991 $ (6,798 ) (85 )% Table of Contents from the significant decrease in the value of foreign currency denominated net assets held in the U.S., consisting primarily of cash, license installments, receivables, and accounts payable. As a result of the significant decrease in the value of the British pound sterling and Euro relative to the U.S. dollar during 2008, we recorded a $4.5 million foreign currency exchange transaction loss as compared to a $0.3 million foreign exchange transaction gain in 2007. See Item 7A. “Quantitative and Qualitative Disclosure about Market Risk” for further discussion of our foreign currency exchange risk. Provision for income taxes The provision for income taxes represents current and future amounts owed for federal, state, and foreign taxes. During 2008 and 2007, we recorded a $4.7 million and $3.3 million provision, respectively, which resulted in an effective tax rate of 30% and 34%, respectively. The decrease in the effective tax rate during 2008 compared to 2007 was primarily due to the increased investment in tax-exempt municipal bonds and the benefit from the SEZ India tax holiday. These decreases in the effective tax rate were partially offset by an increase in our reserve for uncertain tax positions. During 2008, we recorded a charge related to positions taken on prior tax returns, which resulted in an increase of $0.9 million to our unrecognized tax benefits, the majority of which was related to state income tax credits. As of December 31, 2008, the amount of unrecognized tax benefits totaled approximately $6.2 million, of which $5.2 million, if recognized would impact our effective tax rate. We expect that the changes in the unrecognized benefits within the next twelve months would be approximately $1.3 million related to tax positions for which the ultimate settlement is highly certain but for which there is uncertainty about the timing of such recognition. Our effective income tax rate for 2008 was below the statutory federal income tax rate due to approximately $0.5 million of benefits related to the current period domestic production activities, approximately $0.8 million of estimated federal income tax credits, and approximately $0.6 million of benefit from tax-exempt income. These benefits were partially offset by an increase in the Company’s reserve for uncertain tax positions of $1.3 million, the majority of which is related to the state tax credits, and permanent differences of $0.4 million primarily related to nondeductible meals and entertainment expenses. Our effective income tax rate for 2007 was below the statutory federal income tax rate due to approximately $0.3 million of benefits related to the current period domestic production activities, approximately $0.5 million of estimated federal income tax credits, and approximately $0.2 million of state income tax credits. These benefits were partially offset by $0.3 million of permanent differences primarily related to nondeductible meals and entertainment expenses and approximately $0.2 million of prior year provision to tax return adjustments. LIQUIDITY AND CAPITAL RESOURCES 29 (in thousands) Year Ended December 31, 2009 2008 2007 Cash provided by (used in): Operating activities $ 49,581 $ 38,399 $ 25,347 Investing activities (18,163 ) (13,764 ) (24,847 ) Financing activities (5,049 ) (13,354 ) (251 ) Effect of exchange rate on cash 1,401 (1,904 ) 453 Net increase in cash and cash equivalents $ 27,770 $ 9,377 $ 702 Total cash, cash equivalents, and marketable securities $ 202,653 $ 167,229 $ 149,981 Table of Contents We have funded our operations primarily from cash provided by operations and we expect to continue funding our operations in this manner in 2010. The increase in cash, cash equivalents, and marketable securities in 2009 as compared to 2008 was primarily due to $49.6 million of cash provided by operations offset by $20.9 million in repurchases of our common stock and $4.3 million in dividend payments to our shareholders. The increase in cash, cash equivalents, and marketable securities in 2008 as compared to 2007 was primarily due to $38.4 million of cash provided by operations offset by $19.4 million in repurchases of our common stock. Working capital was $188.6 million as of December 31, 2009 compared to $159.1 million as of December 31, 2008. We believe that our current cash, cash equivalents, marketable securities, and cash from operations will be sufficient to fund our operations and our share repurchase program for at least the next 12 months. We also evaluate acquisition opportunities from time to time, which if pursued, could require use of our funds. Our financial services and insurance customers as a group represent a significant amount of our revenues and receivables, which we considered and determined did not have a material impact on our allowances for doubtful accounts and sales credit memos as of December 31, 2009. 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 $11.2 million increase in cash provided by operating activities in 2009 compared to 2008 was primarily due to the increase in our net income partially offset by the increase in the excess tax benefits from stock option exercises and vested RSUs (collectively the “equity awards”). Upon employee exercise of/vesting of the equity awards, the Company receives a tax deduction for the difference between the market value and exercise price of the equity awards, which reduces our current income taxes payable. The difference between this tax deduction and the cumulative stock-based compensation expense recorded in the financial statements is the excess tax benefit. The increase in the excess tax benefit in 2009 compared to 2008 is due to the significant increase in the Company’s stock price during 2009. The excess tax benefits are reported as a decrease in cash in operating activities and as an increase in cash in financing activities. The primary components of cash provided by operations during 2009 were $32.2 million of net income, a $16.3 million increase in accounts payable and accrued expenses due to the timing of payments, and a $5.1 million decrease in license installments for term license arrangements with extended payment terms, partially offset by $15.4 million of excess tax benefits from stock option exercises. Future Cash Receipts from License Arrangements The following table summarizes the cash receipts due in connection with our existing license agreements as of December 31, 2009. 30 As of December 31, (in thousands) Installment payments for licenses recorded on the balance sheet (1) Installment payments for term licenses not recorded on the balance sheet (2) Other license payments not recorded on the balance sheet (3) 2010 $ 2,829 $ 29,316 $ 39,569 2011 2,232 23,535 9,859 2012 1,292 16,105 7,718 2013 — 5,764 —2014 — 1,528 —Thereafter — 10 — Total 6,353 $ 76,258 $ 57,146 Unearned installment interest income (548 ) Total license installments receivable, net $ 5,805 Table of Contents Cash used in investing activities Net cash used in investing activities during 2009, 2008, and 2007 were primarily for purchases of marketable securities of $79.4 million, $194.5 million and $109.3 million, respectively, partially offset by the proceeds received from the sales, maturities and called debt securities of $67.3 million, $185.6 million and $87.2 million, respectively. In March 2008, we paid approximately $0.8 million in cash to acquire certain assets of privately held Focus Technology Group, Inc. and a related entity (collectively, “Focus”), that provides anti-fraud and anti-money laundering software to the banking industry. In September 2009, the parties to the original Focus asset purchase agreement entered into an amendment of that agreement such that $1.8 million of the original potential contingent consideration was forfeited and $0.3 million of the contingent consideration was earned and paid in January 2010. Cash used in financing activities Net cash used in financing activities during 2009, 2008, and 2007 were primarily for repurchases of our common stock and the payment of our quarterly dividend. On November 24, 2009, our Board of Directors approved an extension of the $15.0 million stock repurchase program originally announced in December 2008, to include an additional $15.0 million in repurchases and to extend the end date to December 31, 2010. Since 2004, our Board of Directors has approved annual stock repurchase programs that have authorized the repurchase up to $75.0 million of our common stock. Purchases under these programs may be made from time to time on the open market or in privately negotiated transactions as market conditions warrant, subject to regulatory and other considerations. Common stock repurchases The following table is a summary of our repurchase activity under all of our stock repurchase programs during 2009, 2008, and 2007: 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 31 (1) These license installment payments have already been recognized as license revenue and are included in short- and long-term license installments in the accompanying consolidated balance sheet as of December 31, 2009. (2) These amounts will be recognized as revenue in the future over the term of the agreement as payments become due or earlier if prepaid. (3) These amounts will be recognized as revenue in future periods and relate to perpetual and subscription licenses with extended payment terms and/or additional rights of use. (Dollars in thousands) 2009 2008 2007 Shares Amount Shares Amount Shares Amount Prior year authorizations at January 1, $ 12,862 $ 1,210 $ 6,872 Authorizations 15,000 30,000 10,000 Repurchases paid 673,066 (11,947 ) 1,503,551 (17,969 ) 799,347 (9,135 ) Repurchases unsettled 3,898 (136 ) 32,376 (379 ) 48,015 (569 ) Expirations — — (5,958 ) Authorized dollars remaining as of December 31, $ 15,779 $ 12,862 $ 1,210 Table of Contents option exercise price and the minimum statutory tax withholding obligations. During 2009 and 2008, option and RSU holders net settled stock options and vested RSUs representing the right to purchase a total of 2,451,000 shares and 425,000 shares, respectively, of which only 1,188,000 shares and 152,000 shares, respectively, were issued to the option and RSU holders and the balance of the shares were surrendered to us to pay for the exercise price and the applicable taxes. During 2009 and 2008, instead of receiving cash from the equity holders, we withheld shares with a value of $8.6 million and $0.9 million, respectively, for withholding taxes and $22.3 million and $2.1 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 2009, 2008, and 2007. Dividends On May 30, 2006, our Board of Directors approved an ongoing quarterly cash dividend of $0.03 per share, beginning with the second quarter ended June 30, 2006. Accordingly, the Company declared a cash dividend of $0.12 per share for each of the years ended December 31, 2009, 2008 and 2007 and paid cash dividends of $4.3 million, $4.4 million, and $4.3 million in 2009, 2008, and 2007, respectively. It is our current intention to pay a quarterly cash dividend of $0.03 per share to shareholders of record as of the first trading day of each quarter, however, the Board of Directors may terminate or modify this dividend program at any time without notice. Contractual obligations As of December 31, 2009, we had material purchase obligations for customer support and consulting services and payments under operating leases. Our principal administrative, sales, marketing, support, and research and development operations are located in approximately 105,000 square foot leased facility in Cambridge, Massachusetts. The lease for this facility expires in 2013, subject to our option to extend for two additional five-year periods. We also lease space for our other offices in the U.S., Australia, Canada, India, the United Kingdom and in other European countries. These leases expire at various dates through 2014. Rent expense under operating leases is recognized on a straight-line basis to account for scheduled rent increases. The excess of expense over current payments is recorded as deferred rent and included in accrued expenses and other long-term liabilities. As of December 31, 2009, our known contractual obligations, including future minimum rental payments required under operating leases with non-cancelable terms in excess of one year were as follows: 32 Payment due by period Contractual obligations: (in thousands) Total 2010 2011 & 2012 2013 & 2014 2015 and after Other Purchase obligations (1) $ 1,367 $ 1,362 $ 5 $ — $ — $ —Liability for uncertain tax positions (2) 4,442 881 — — — 3,561 Operating lease obligations (3) 17,930 4,929 10,527 2,474 — — Total $ 23,739 $ 7,172 $ 10,532 $ 2,474 $ — $ 3,561 (1) Represents the fixed or minimum amounts due under purchase obligations for customer support and consulting services. (2) Total contractual obligations include our liability for uncertain tax positions of approximately $4.4 million. We are unable to reasonably estimate the timing in individual years beyond 12 months due to uncertainties in the timing of the effective settlement of tax positions. The Company expects that the changes in the unrecognized benefits within the next twelve months will be approximately $0.9 million related to tax positions for which the ultimate settlement is highly certain but for which there is uncertainty about the timing of such recognition. Table of Contents Fair Value Inputs Fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or liability. The use of fair value to measure investments, with related unrealized gains or losses on investments, is a significant component to our consolidated results of operations. We value our investments by using quoted market prices and broker or dealer quotations which are based on third party pricing sources with reasonable levels of price transparency. The types of instruments valued based on quoted market prices in active markets include some of the government debt securities, some of the municipal debt securities, money market securities and most of the corporate debt securities. We do not adjust the quoted price for such instruments. The types of instruments valued based on other observable inputs include most of the municipal debt securities and some of the corporate debt securities. The price for each security at the measurement date is sourced from an independent pricing vendor. Periodically, management may assess the reasonableness of these sourced prices by comparing them to the prices provided by our portfolio managers to derive the fair value of these financial instruments. Management assesses the inputs of the pricing in order to categorize the financial instruments into the appropriate hierarchy levels. See Note 5 “Fair Value Measurements” in the notes to the accompanying consolidated financial statements for further discussion. CRITICAL ACCOUNTING POLICIES, SIGNIFICANT JUDGMENTS AND ESTIMATES Management’s discussion and analysis of the financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. 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 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. We consider the following accounting policies to be both those most important to the portrayal of our financial condition and those that require the most subjective judgment. If actual results differ significantly from management’s estimates and projections, there could be a material effect on our financial statements. Revenue recognition Our revenue is derived from software licenses, maintenance fees related to our software licenses, and professional services. Our license arrangements, whether involving a perpetual license or a term license, generally contain multiple elements. In addition to the license, these elements generally include professional consulting services, training, and software maintenance services. Software license revenues Perpetual software license fees are recognized as revenue when the software is delivered, any acceptance required by contract that is not perfunctory is obtained, no significant obligations or contingencies exist related to the software other than maintenance support, and all other revenue recognition criteria are met. Term software license fees are generally payable on a monthly basis under license agreements that typically have a three to five-year term and may be renewed for additional terms at the customer’s option. As a result of our focus on frequent sales to our targeted customers, our strategy to sell initial term licensing agreements to those customers with the goal to generate follow-on sales, and as a result of extended payment terms, we recognize term license revenue over the term of the agreement as payments become due or earlier if prepaid, provided all other criteria for revenue recognition have been met. 33 (3) Includes deferred rent of approximately $0.4 million included in accrued expenses and approximately $1.8 million in other long-term liabilities in the accompanying consolidated balance sheet as of December 31, 2009. Table of Contents Historically, the majority of our term license arrangements were larger agreements with extended payment terms that did not typically result in follow-on license agreements. We have a history of successfully collecting payments under the original payment terms, therefore for these arrangements, we have recognized the present value of the future term license payments upon customer acceptance, provided that no significant obligations or contingencies exist related to the software, other than maintenance support, and provided all other criteria for revenue recognition have been met. A portion of the license fees payable under these agreements (equal to the difference between the total license payments and the discounted present value of those payments) was initially deferred and recognized as installment receivable interest income (and is not part of total revenue) over the license term. For purposes of the present value calculations, the discount rates used were estimates of customers’ borrowing rates at the time of recognition, typically below prime rate. As of December 31, 2009, the discount rates associated with the remaining installment receivables ranged from 3.25% to 6.50%. As of December 31, 2009, the remaining balance of these installment receivables totaled approximately $5.8 million as summarized in the table on page 30. For licensing arrangements that include a right to unspecified future products, fees are accounted for as subscriptions and the revenue is recognized ratably over the term of the arrangement. Maintenance revenues Maintenance revenue is deferred and recognized ratably over the term of the support period. Perpetual software maintenance revenue is recognized over the term of the related maintenance agreement, which is generally one year and renewed on an annual basis thereafter. For term licenses, we recognize the entire arrangement fee ratably over the license term when the renewal rate or period is not substantive compared to the term license. In general, maintenance and support obligations are based on separately stated renewal rates in the arrangement that are deemed substantive and therefore represent vendor specific objective evidence (“VSOE”) of fair value. Professional services revenues Our services revenue is comprised of fees for consulting services, including software implementation, training, and reimbursable expenses. Consulting services may be provided on a “stand-alone” basis or bundled with a license and software maintenance services. Revenue from “stand-alone” training services and consulting services under time and materials contracts is recognized as services are performed. We have VSOE of fair value for our training services and consulting services under time and materials contracts in all geographic areas, except in Australia and a European country. Services may be provided on a fixed-price basis. We do not have VSOE of fair value for fixed-price services. When fixed-price services are part of a multiple element arrangement, and the services are not essential to the functionality of the software, and when services, including maintenance, are the only undelivered element, we recognize the revenue from the total arrangement ratably over the longer of the software maintenance period or the service period. In the past, in a limited number of our arrangements, the fixed-price services were essential to the arrangement because we made significant alterations to the functionality of the software or built complex interfaces necessary for the software to be functional in the customer’s environment. We have not been able to make reasonably dependable estimates for the purpose of determining our progress to completion, as we have limited experience with these types of unique and complex arrangements. Accordingly, when the fixed-price services are essential to the arrangement, all revenue and costs are deferred until the completion of the fixed-price services under the completed contract method. Revenue from fixed-price services that are not bundled with a software license is generally recognized ratably during the service period, which is typically less than four months. We warrant to our customers that our software products will conform to documented specifications. We have not experienced significant claims related to software warranties beyond the scope of maintenance support, which we are already obligated to provide, and consequently we have not established reserves for warranty obligations. 34 Table of Contents Our agreements with customers generally require us to indemnify the customer against claims that our software infringes third party patent, copyright, trademark or other proprietary rights. Such indemnification obligations are generally limited in a variety of industry-standard respects, including our right to replace an infringing product. As of December 31, 2009, we had not experienced any material losses related to these indemnification obligations and no claims with respect thereto were outstanding. We do not expect significant claims related to these indemnification obligations, and consequently, we have not established any related reserves. Deferred revenue Deferred software license revenue typically results from customer specific acceptance provisions and other arrangements for which all of the criteria to recognize revenue have not been met. Deferred maintenance revenue represents software license updates and product support contracts that are typically billed on an annual basis in advance and are recognized ratably over the support periods. Deferred professional services revenue represents advanced billings for consulting and training services that are recognized as the services are performed. Allowance for doubtful accounts and allowance for sales credit memos We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Our estimates are based on the composition of the accounts receivable aging, historical bad debts, changes in payment patterns, customer creditworthiness and current economic trends. If we used different assumptions, or if the financial condition of customers were to deteriorate that resulted in their inability to make required payments, additional provisions for doubtful accounts would be required and would increase bad debt expense. We record allowances for estimates of potential sales credit memos. We base these estimates on historical analyses of sales credit memos and assumptions about future events and experience with customer disputes. If we used different assumptions in calculating the allowance, adjustments would be reflected as changes to revenue. Stock-based compensation We recognize stock-based compensation expense associated with equity awards in our consolidated statements of income based on the fair value of these awards at the date of grant. Stock-based compensation is recognized over the requisite service period, which is generally the vesting period of the equity award, and adjusted each period for anticipated forfeitures. We recognize stock-based compensation using the ratable method, which treats each vesting tranche as if it were an individual grant. During the fourth quarter of 2007, our Board of Directors approved changes to our equity compensation program, including the granting of RSUs in addition to stock options, for periodic equity compensation grants. RSUs deliver to the recipient a right to receive a specified number of shares of our common stock upon vesting, net of tax withholding. Unlike stock options, there is no cost to the employee at share issuance. We value our RSUs at the fair value of our common stock on the grant date, which is the closing price of our common stock on the grant date, less the present value of expected dividends as the employee is not entitled to dividends during the requisite service period. We periodically grant stock options and RSUs for a fixed number of shares to employees and non-employee Directors. The exercise price for stock options is greater than or equal to the fair market value of the shares at the date of the grant. We estimate the fair value of stock options using the Black-Scholes option valuation model, which requires us to make estimates of key assumptions including the expected term of the option, the expected volatility of our stock price over the option’s expected term, the risk-free interest rate over the option’s expected term, and our expected annual dividend yield. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The expected volatility is based on the 35 Table of Contents historical volatility of our stock price. The expected annual dividend yield is based on the expected annual dividend of $0.12 per share divided by the average stock price. The risk-free interest rate is based on the yield of zero-coupon U.S. Treasury securities for a period that is commensurate with the expected option term at the time of grant. If factors change and we employ different assumptions in future periods, the compensation expense that we record may differ significantly from what we have recorded in the current period. The choice of a valuation model, and the underlying assumptions used in applying that model, involves significant judgment. Our judgment reflects our assessment of the most accurate method of valuing the stock options we issue based on our historical experience, knowledge of current conditions and beliefs of what could occur in the future given available information. Our judgment could change over time as additional information becomes available to us, or the facts underlying our assumptions change over time, and any change in our judgments could have a material effect on our financial statements. See Note 13 “Stock-Based Compensation” in the notes to the accompanying consolidated financial statements for further information. Accounting for Income Taxes We recognize deferred tax assets and liabilities using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. We record a valuation allowance to reduce our deferred taxes to an amount we believe is more likely than not to be realized. We consider future taxable income and prudent and feasible tax planning strategies in assessing the need for a valuation allowance. As a global company, we use significant judgment to calculate and provide for income taxes in each of the tax jurisdictions in which we operate. In the ordinary course of our business, there are transactions and calculations undertaken whose ultimate tax outcome cannot be certain. Some of these uncertainties arise as a consequence of transfer pricing for transactions with our subsidiaries and potential challenges to nexus and credit estimates. We estimate our exposure to unfavorable outcomes related to these uncertainties and estimate the probability for such outcomes. See Note 14 “Income Taxes” in the notes to the accompanying consolidated financial statements for further information on the Company’s liability for uncertain tax positions. Although we believe our estimates are reasonable, no assurance can be given that the final tax outcome will not be different from what is reflected in our historical income tax provisions, returns, and accruals. Such differences, or changes in estimates relating to potential differences, could have a material impact on our income tax provision and operating results in the period in which such a determination is made. New Accounting Pronouncements See Note 3 “Accounting Standards Not Yet Effective” in the notes to the accompanying consolidated financial statements for further discussion. 36 Table of Contents 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 and interest rates. To date we have not entered into derivative or hedging transactions to manage risk in connection with such fluctuations. Foreign currency exposure We derived approximately 34%, 38%, and 35% of our total revenue from sales to customers based outside of the U.S. in 2009, 2008, and 2007, respectively. Our international license and professional services sales have increasingly become denominated in foreign currencies. However, the operating expenses of our foreign operations are primarily denominated in foreign currencies, which partially offset our foreign currency exposure from sales. A decrease in the value of foreign currencies, particularly the British pound sterling and the Euro relative to the U.S. dollar, could adversely impact our revenues and operating results. Most of our transactions with customers are invoiced from our offices in the U.S. For those transactions that are denominated in currencies other than the U.S. dollar, we have receivables and license installments that are valued in foreign currencies. Our U.S. operating company holds cash in foreign currencies in order to support our foreign operations. Our functional currency is primarily the U.S. dollar, therefore, when there are changes in the foreign currency exchange rates versus the U.S. dollar, we recognize a foreign currency transaction gain or (loss) in our consolidated statements of income. In addition, our foreign subsidiaries have intercompany accounts that are eliminated in consolidation, but that expose us to foreign currency exchange rate fluctuation. Foreign currency exchange rate fluctuations on our short-term intercompany accounts are recorded as foreign currency transaction gains or (losses) in our consolidated statements of income. As of December 31, 2009, we had net monetary assets valued in foreign currencies subject to foreign currency transaction gains or (losses), consisting primarily of cash, receivables, and license installments, partially offset by accounts payable and intercompany payables, with a carrying value of approximately $76.5 million. A ten percent change in foreign currency exchange rates would have changed the carrying value of these net assets by approximately $7.6 million as of that date with a corresponding foreign currency gain (loss) recognized in our consolidated statement of income. During 2009, we recorded a $2.1 million foreign currency transaction gain due to the increase in the value of foreign currencies, primarily the Euro and British pound sterling, relative to the U.S. dollar. Interest rate exposure We invest primarily in tax-exempt municipal bonds, government sponsored enterprise bonds and corporate bonds that are fixed rate marketable debt securities. A 200 basis point increase in market interest rates would have reduced the fair value of our marketable debt securities by approximately $1.7 million as of December 31, 2009. Changes in market rates and the related impact on fair value of the investments do not generally affect net earnings as our investments are fixed rate securities and are classified as available-for-sale and as such, unrealized gains and losses, net of tax effect, are recorded in accumulated other comprehensive income in our accompanying consolidated balance sheets. However, when the investments are sold, the unrealized gains and losses are recorded as realized gains and losses and included in net income in the accompanying consolidated statements of income. We analyze our investments for impairments on an ongoing basis. As of the date of this filing, we are not aware of any downgrades, losses, or other significant deterioration in the fair value of our marketable securities. 37 ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk Table of Contents INDEX TO CONSOLIDATED FINANCIAL STATEMENTS 38 ITEM 8. Financial Statements and Supplementary Data Page Report of Independent Registered Public Accounting Firm 39 Consolidated Balance Sheets as of December 31, 2009 and 2008 40 Consolidated Statements of Income for the years ended December 31, 2009, 2008, and 2007 41 Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the years ended December 31, 2009, 2008, and 2007 42 Consolidated Statements of Cash Flows for the years ended December 31, 2009, 2008, and 2007 43 Notes to Consolidated Financial Statements 44 Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Pegasystems Inc. Cambridge, Massachusetts We have audited the accompanying consolidated balance sheets of Pegasystems Inc. and subsidiaries (the “Company”) as of December 31, 2009 and 2008, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Pegasystems Inc. and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 22, 2010 expressed an unqualified opinion on the Company’s internal control over financial reporting. /s/ DELOITTE & TOUCHE LLP Boston, Massachusetts February 22, 2010 39 Table of Contents PEGASYSTEMS INC. CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts) See notes to consolidated financial statements. 40 As of December 31, 2009 2008 ASSETS Current assets: Cash and cash equivalents $ 63,857 $ 36,087 Marketable securities 138,796 131,142 Total cash, cash equivalents, and marketable securities 202,653 167,229 Trade accounts receivable, net of allowance of $649 and $1,490 39,396 42,801 Short-term license installments 2,829 5,445 Deferred income taxes 2,523 4,351 Income taxes receivable 5,046 514 Other current assets 3,794 3,637 Total current assets 256,241 223,977 Long-term license installments, net of unearned interest income 2,976 5,413 Property and equipment, net 8,931 5,723 Long-term deferred income taxes and other assets 8,710 8,117 Intangible assets, net 336 479 Goodwill 2,391 2,141 Total assets $ 279,585 $ 245,850 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable $ 4,791 $ 4,726 Accrued expenses 6,748 9,925 Accrued compensation and related expenses 23,280 18,015 Deferred revenue 32,870 32,231 Total current liabilities 67,689 64,897 Income taxes payable 4,828 5,665 Other long-term liabilities 1,849 2,174 Total liabilities 74,366 72,736 Commitments and contingencies (Note 11) Stockholders’ equity: Preferred stock, $0.01 par value, 1,000 shares authorized; no shares issued and outstanding — — Common stock, $0.01 par value, 70,000 shares authorized; 36,818 shares and 35,810 shares issued and outstanding 368 358 Additional paid-in capital 121,389 117,926 Retained earnings 81,776 53,935 Accumulated other comprehensive income: Net unrealized gain on available for-sale marketable securities 539 1,062 Foreign currency translation adjustments 1,147 (167 ) Total stockholders’ equity 205,219 173,114 Total liabilities and stockholders’ equity $ 279,585 $ 245,850 Table of Contents PEGASYSTEMS INC. CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share amounts) See notes to consolidated financial statements. 41 Year ended December 31, 2009 2008 2007 Revenue: Software license $ 115,934 $ 76,572 $ 51,084 Maintenance 50,099 40,115 31,196 Professional services 97,980 94,960 79,669 Total revenue 264,013 211,647 161,949 Cost of revenue: Cost of software license 121 95 — Cost of maintenance 6,203 5,390 4,791 Cost of professional services 84,613 76,272 60,411 Total cost of revenue 90,937 81,757 65,202 Gross profit 173,076 129,890 96,747 Selling and marketing 74,378 63,799 51,743 Research and development 38,862 31,472 26,198 General and administrative 18,017 20,140 16,855 Total operating expenses 131,257 115,411 94,796 Income from operations 41,819 14,479 1,951 Interest income, net 3,144 5,029 6,718 Foreign currency transaction gain (loss) 2,083 (4,537 ) 264 Installment receivable interest income 347 597 1,244 Other income (expense), net 22 104 (235 ) Income before provision for income taxes 47,415 15,672 9,942 Provision for income taxes 15,203 4,695 3,347 Net income $ 32,212 $ 10,977 $ 6,595 Earnings per share Basic $ 0.89 $ 0.30 $ 0.18 Diluted $ 0.85 $ 0.29 $ 0.18 Weighted-average number of common shares outstanding Basic 36,208 36,146 35,875 Diluted 38,113 37,605 37,433 Cash dividends declared per share $ 0.12 $ 0.12 $ 0.12 Table of Contents PEGASYSTEMS INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (in thousands, except per share amounts) See notes to consolidated financial statements. 42 Common Stock Additional Paid-In Capital Retained Earnings Accumulated Other Comprehensive Income Total Stock- holders’ Equity Number of Shares Amount Balance at January 1, 2007 35,309 $ 353 $ 118,121 $ 46,549 $ 1,135 $ 166,158 Cumulative effect adjustment from adoption of accounting for income taxes — — — (1,490 ) — (1,490 ) Repurchase of common stock (847 ) (8 ) (9,696 ) — — (9,704 ) Exercise of stock options 1,679 17 10,719 — — 10,736 Issuance of stock under Employee Stock Purchase Plan 18 — 179 — — 179 Issuance of stock awards 26 — 275 — — 275 Exercise of common stock warrants 7 — — — — — Stock-based compensation expense — — 1,343 — — 1,343 Tax benefit from exercise of stock options net of deferred tax asset write-off of $211 — — 2,128 — — 2,128 Cash dividends declared ($0.12 per share) — — — (4,333 ) — (4,333 ) Realization of stock option tax benefit from net operating losses — — 332 — — 332 Comprehensive income: Foreign currency translation adjustments — — — — 375 375 Net unrealized gain on investments available-for-sale, net of tax $229 — — — — 350 350 Net income — — — 6,595 — 6,595 Total comprehensive income 7,320 Balance at December 31, 2007 36,192 362 123,401 47,321 1,860 172,944 Repurchase of common stock (1,536 ) (15 ) (18,333 ) — — (18,348 ) Issuance of common stock for share-based compensation plans 1,108 11 5,806 — — 5,817 Issuance of stock under Employee Stock Purchase Plan 24 — 265 — — 265 Stock-based compensation expense 22 — 3,532 — — 3,532 Tax benefit from exercise or vesting of equity awards, net of deferred tax asset write-off of $216 — — 3,255 — — 3,255 Cash dividends declared ($0.12 per share) — — — (4,363 ) — (4,363 ) Comprehensive income: Foreign currency translation adjustments — — — — (2,020 ) (2,020 ) Net unrealized gain on investments available-for-sale, net of tax of $2 — — — — 1,055 1,055 Net income — — — 10,977 — 10,977 Total comprehensive income 10,012 Balance at December 31, 2008 35,810 358 117,926 53,935 895 173,114 Repurchase of common stock (677 ) (7 ) (12,076 ) — — (12,083 ) Issuance of common stock for share-based compensation plans 1,645 17 (4,140 ) — — (4,123 ) Issuance of stock under Employee Stock Purchase Plan 15 — 335 — — 335 Exercise of common stock warrants 7 — — — — — Issuance of stock awards 18 454 454 Stock-based compensation expense — — 4,219 — — 4,219 Tax benefit from exercise or vesting of equity awards, net of deferred tax asset write-off of $740 — — 14,671 — — 14,671 Cash dividends declared ($0.12 per share) — — — (4,371 ) — (4,371 ) Comprehensive income: Foreign currency translation adjustments — — — — 1,314 1,314 Net unrealized loss on investments available-for-sale, net of tax of $45 — — — — (523 ) (523 ) Net income — — — 32,212 — 32,212 Total comprehensive income 33,003 Balance at December 31, 2009 36,818 $ 368 $ 121,389 $ 81,776 $ 1,686 $ 205,219 Table of Contents PEGASYSTEMS INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) See notes to consolidated financial statements. 43 Year ended December 31, 2009 2008 2007 Operating activities: Net income $ 32,212 $ 10,977 $ 6,595 Adjustment to reconcile net income to cash provided by operating activities: Excess tax benefits from exercise or vesting of equity awards (15,411 ) (3,471 ) (2,339 ) Deferred income taxes 1,413 (3,806 ) (163 ) Depreciation and amortization 2,801 2,153 1,912 Amortization of investments 3,910 2,108 280 Stock-based compensation expense 4,673 3,532 1,618 (Gain) loss on sale of investments (1 ) (84 ) 242 Loss on disposal of equipment 114 98 4 Change in operating assets and liabilities: Trade accounts receivable 3,405 3,121 (13,934 ) License installments 5,053 16,592 11,798 Income taxes receivable and other current assets (4,544 ) 448 1,058 Accounts payable and accrued expenses 16,311 7,396 5,206 Deferred revenue 639 (947 ) 16,116 Other long-term assets and liabilities (994 ) 282 (3,046 ) Cash provided by operating activities 49,581 38,399 25,347 Investing activities: Purchase of marketable securities (79,447 ) (194,474 ) (109,323 ) Matured and called marketable securities 67,327 91,706 78,016 Sale of marketable securities — 93,852 9,158 Payments for acquisition — (798 ) — Investment in property and equipment (6,043 ) (4,050 ) (2,698 ) Cash used in investing activities (18,163 ) (13,764 ) (24,847 ) Financing activities: Payments under capital lease obligation — — (63 ) Issuance of common stock for share-based compensation plans 4,473 6,720 10,736 Proceeds from sale of stock under Employee Stock Purchase Plan 335 265 179 Excess tax benefits from exercise or vesting of equity awards 15,411 3,471 2,339 Dividend payments to shareholders (4,346 ) (4,368 ) (4,307 ) Common stock repurchases for tax withholdings for net settlement of equity awards (8,596 ) (904 ) — Common stock repurchases under share repurchase programs (12,326 ) (18,538 ) (9,135 ) Cash used in financing activities (5,049 ) (13,354 ) (251 ) Effect of exchange rate on cash and cash equivalents 1,401 (1,904 ) 453 Net increase in cash and cash equivalents 27,770 9,377 702 Cash and cash equivalents, beginning of year 36,087 26,710 26,008 Cash and cash equivalents, end of year $ 63,857 $ 36,087 $ 26,710 Supplemental disclosures: Interest paid $ — $ 5 $ 6 Income taxes paid $ 7,024 $ 4,956 $ 3,127 Non-cash investing and financing activity: Dividends payable $ 1,105 $ 1,080 $ 1,085 Repurchases of common stock unsettled $ 136 $ 379 $ 569 Contingent consideration payable $ 250 $ — $ — Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION (a) Business The Company develops, markets, licenses, and supports software to automate complex, changing business processes. The Company provides implementation, consulting, training, and technical support services to facilitate the use of its software. (b) Management estimates and reporting The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S.”) requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. Actual results could differ from those estimates. Significant accounts with reported amounts based on estimates and judgments include revenue, trade and installment accounts receivable, allowance for doubtful accounts, allowance for sales credit memos, deferred income taxes, deferred revenue, and share-based compensation. (c) Principles of consolidation The consolidated financial statements include the accounts of Pegasystems Inc. and its wholly owned subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation. (d) Presentation The Company has evaluated subsequent events through February 22, 2010, the date the audited consolidated financial statements were issued. No subsequent events have taken place that meet the definition of a subsequent event that requires further disclosure in this filing. 2. SIGNIFICANT ACCOUNTING POLICIES The Company’s revenue is derived from software licenses, maintenance fees related to the Company’s software licenses, and professional services. The Company’s license arrangements, whether involving a perpetual license or a term license, generally contain multiple elements. In addition to the license, these elements generally include professional consulting services, training, and software maintenance services. Software license revenues Perpetual software license fees are recognized as revenue when the software is delivered, any acceptance required by contract that is not perfunctory is obtained, no significant obligations or contingencies exist related to the software, other than maintenance support, and all other revenue recognition criteria are met. Term software license fees are generally payable on a monthly basis under license agreements that typically have a three to five-year term and may be renewed for additional terms at the customer’s option. As a result of the Company’s focus on frequent sales to its targeted customers, the Company’s strategy is to sell initial term licensing agreements to those customers with the goal to generate follow-on sales, and as a result of extended payment terms, the Company recognizes term license revenue over the term of the agreement as payments become due or earlier if prepaid, provided all other criteria for revenue recognition have been met. 44 (a) Revenue recognition Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) Historically, the majority of the Company’s term license arrangements were larger agreements with extended payment terms that did not typically result in follow-on license agreements. The Company has a history of successfully collecting payments under the original payment terms, therefore for these arrangements, the Company has recognized the present value of the future term license payments upon customer acceptance, provided that no significant obligations or contingencies exist related to the software, other than maintenance support, and provided all other criteria for revenue recognition have been met. A portion of the license fees payable under these agreements (equal to the difference between the total license payments and the discounted present value of those payments) was initially deferred and recognized as installment receivable interest income (and is not part of total revenue) over the license term. For purposes of the present value calculations, the discount rates used were estimates of customers’ borrowing rates at the time of recognition, typically below prime rate. As of December 31, 2009, the discount rates associated with the remaining installment receivables ranged from 3.25% to 6.50%. For licensing arrangements that include a right to unspecified future products, fees are accounted for as subscriptions and the revenue is recognized ratably over the term of the arrangement. Maintenance revenues Maintenance revenue is deferred and recognized ratably over the term of the support period. Perpetual software maintenance revenue is recognized over the term of the related maintenance agreement, which is generally one year and renewed on an annual basis thereafter. For term licenses, we recognize the entire arrangement fee ratably over the license term when the renewal rate or period is not substantive compared to the term license. In general, maintenance and support obligations are based on separately stated renewal rates in the arrangement that are deemed substantive and therefore represent vendor specific objective evidence (“VSOE”) of fair value. Professional services revenues The Company’s services revenue is comprised of fees for training, consulting services including software implementation, and reimbursable expenses. Consulting services may be provided on a “stand-alone” basis or bundled with a license and software maintenance services. Revenue from “stand-alone” training services and consulting services under time and materials contracts is recognized as services are performed. The Company has VSOE of fair value for our training services and consulting services under time and materials contracts, in all geographic areas, except in Australia and a European country. Services may be provided on a fixed-price basis. The Company does not have VSOE of fair value for fixed-price services. When fixed-price services are part of a multiple element arrangement, and the services are not essential to the functionality of the software, and when services including maintenance, are the only undelivered element, the Company recognizes the revenue from the total arrangement ratably over the longer of the software maintenance period or the service period. In the past, in a limited number of the Company’s arrangements, the fixed-price services were essential to the arrangement because the Company made significant alterations to the functionality of the software or built complex interfaces necessary for the software to be functional in the customer’s environment. The Company has not been able to make reasonably dependable estimates for the purpose of determining the Company’s progress to completion, as the Company has limited experience with these types of unique and complex arrangements. Accordingly, when the fixed-price services are essential to the arrangement, all revenue and costs are deferred until the completion of the fixed-price services under the completed contract method. Revenue from fixed-price services that are not bundled with a software license is generally recognized ratably during the service period, which is typically less than four months. 45 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) The Company warrants to its customers that its software products will conform to documented specifications. The Company has not experienced significant claims related to software warranties beyond the scope of maintenance support, which it is already obligated to provide, and consequently it has not established reserves for warranty obligations. The Company’s agreements with customers generally require it to indemnify the customer against claims that the Company’s software infringes third party patent, copyright, trademark or other proprietary rights. Such indemnification obligations are generally limited in a variety of industry-standard respects, including the Company’s right to replace an infringing product. As of December 31, 2009, the Company had not experienced any material losses related to these indemnification obligations and no claims with respect thereto were outstanding. The Company does not expect significant claims related to these indemnification obligations, and consequently, the Company has not established any related reserves. Deferred revenue Deferred software license revenue typically results from customer specific acceptance provisions and other arrangements for which all of the criteria to recognize revenue have not been met. Deferred maintenance revenue represents software license updates and product support contracts that are typically billed on a per annum basis in advance and are recognized ratably over the support periods. Deferred professional services revenue represents advanced billings for consulting and training services that are recognized as the services are performed. Allowance for doubtful accounts and allowance for sales credit memos The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of the Company’s customers to make required payments. The Company’s estimates are based on the composition of the accounts receivable aging, historical bad debts, changes in payment patterns, customer creditworthiness and current economic trends. If the financial condition of the Company’s customers were to deteriorate resulting in their inability to make required payments, additional provisions for doubtful accounts would be required and would increase bad debt expense. The Company records allowances for estimates of potential sales credit memos. The Company bases these estimates on historical analyses of sales credit memos and assumptions about future events and experience with customer disputes. If the Company used different assumptions in calculating the allowance, adjustments would be reflected as changes to revenue. (b) Property and equipment Property and equipment are recorded at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets, which are three years for equipment, including software, and five years for furniture and fixtures. Leasehold improvements are amortized over the lesser of the life of the lease or the useful life of the asset. Repairs and maintenance costs are expensed as incurred. The Company capitalizes and amortizes certain direct costs associated with computer software developed or purchased for internal use. The Company amortizes capitalized software costs generally over three years commencing on the date the software is placed into service. During 2009, the Company capitalized $0.5 million of computer software costs related to the Company’s implementation of an enterprise resource planning system for internal use. These costs are recorded as fixed assets in progress until placed in service. During 2008 and 2007, the Company did not capitalize any costs for computer software developed for internal use. 46 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (c) Long-lived assets The Company evaluates its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Impairment is generally assessed by comparison of undiscounted cash flows expected to be generated by an asset to its carrying value, with the exception that goodwill impairment is assessed by use of a fair value model at a reporting unit level. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. The Company performed its annual impairment test in the fourth quarters of 2009 and 2008 and determined that goodwill was not impaired. (d) Research and development and software costs Research and development costs, other than certain software related costs, are expensed as incurred. Capitalization of computer software costs for computer software developed for resale begins upon the establishment of technical feasibility, generally demonstrated by a working model or an operative version of the computer software product. Such costs have not been material to date as technological feasibility is established within a short timeframe from the software’s general availability and, as a result, no internal costs were capitalized during 2009, 2008, and 2007. (e) Stock-Based Compensation The Company recognizes stock-based compensation expense associated with equity awards in its consolidated statements of income based on the fair value of these awards at the date of grant. Stock-based compensation is recognized over the requisite service period, which is generally the vesting period of the equity award, and adjusted each period for anticipated forfeitures. The Company recognizes stock-based compensation using the ratable method, which treats each vesting tranche as if it were an individual grant. See Note 13 “Stock-based Compensation” for discussion of the Company’s key assumptions included in determining the fair value of its equity awards at grant date. (f) Fair value of financial instruments The principal financial instruments held by the Company consist of cash equivalents, marketable securities, accounts receivable, and accounts payable. The carrying values of cash equivalents, marketable securities, accounts receivable, and accounts payable approximate their fair value. See Note 4 “Marketable Securities” and Note 5 “Fair Value Measurements” for further discussion of financial instruments that are carried at fair value on a recurring basis. (g) Foreign currency translation The translation of assets and liabilities for the majority of the Company’s foreign subsidiaries is made at period-end exchange rates, while revenue and expense accounts are translated at the average exchange rates during the period transactions occurred. The resulting translation adjustments are reflected in accumulated other comprehensive income. Realized and unrealized exchange gains or losses from transactions and adjustments are reflected in foreign currency transaction gain (loss), in the accompanying consolidated statements of income. (h) Income taxes The Company records deferred tax assets and liabilities using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. The Company records a valuation 47 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) allowance to reduce our deferred taxes to an amount we believe is more likely than not to be realized. The Company considers future taxable income and prudent and feasible tax planning strategies in assessing the need for a valuation allowance. As a global company, the Company uses significant judgment to calculate and provide for income taxes in each of the tax jurisdictions in which we operate. In the ordinary course of our business, there are transactions and calculations undertaken whose ultimate tax outcome cannot be certain. Some of these uncertainties arise as a consequence of transactions and arrangements made among related parties, transfer pricing for transactions with our subsidiaries, and potential challenges to nexus and credit estimates. The Company does not recognize a tax benefit unless it is more-likely-than-not that the tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit that is recorded for these positions is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. See Note 14 “Income Taxes” for further information. 3. ACCOUNTING STANDARDS NOT YET EFFECTIVE In September 2009, ASU 2009-13, Revenue Recognition (Topic 605) — Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”) was issued and will change the accounting for multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. Specifically, this guidance amends the criteria in Subtopic 605-25, Revenue Recognition-Multiple-Element Arrangements, for separating consideration in multiple-deliverable arrangements. This guidance establishes a selling price hierarchy for determining the selling price of a deliverable, which is based on: (a) vendor-specific objective evidence; (b) third-party evidence; or (c) estimates. This guidance also eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. In addition, this guidance significantly expands required disclosures related to a vendor’s multiple-deliverable revenue arrangements. ASU 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 with early adoption permitted. The impact of ASU 2009-13 on the Company’s consolidated financial statements will depend on the nature and terms of the Company’s revenue arrangements entered into or materially modified after the adoption date. However, based on the Company’s current customer arrangements, the Company does not believe the adoption of this ASU will have a material impact on the Company’s consolidated financial statements. In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820) – Improving Disclosures about Fair Value Measurements (“ASU 2010-06”), which amends Topic 820 to add new requirements for disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements related to Level 3 measurements. ASU 2010-06 also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. The ASU is effective for the first reporting period beginning after December 15, 2009, except for the requirements to provide the Level 3 activity of purchases, sales, issuances, and settlements on a gross basis, which will be effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early adoption is permitted. 48 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) 4. MARKETABLE SECURITIES The Company considers debt securities with maturities of three months or less when purchased, to be cash equivalents. Purchases and sales of securities are recorded on a settlement-date basis. 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 income. The Company determines the appropriate classification of its investments in debt securities at the time of purchase and re-evaluates such determination at each balance sheet date. The Company’s investments in government sponsored enterprise bonds include debt securities that may not be backed by the full faith and credit of the U.S. Government. During 2008, due to credit market turmoil and adverse changes in the economy, the Company changed the mix of its investment portfolio to increase its holdings of pre-refunded municipal bonds. These bonds are collateralized by the issuer purchasing U.S. Treasury securities to fund all the cash flows of the refunded municipal bonds that will mature when the issuer’s bond matures. As of December 31, 2009, remaining maturities of marketable debt securities ranged from January 2010 to July 2011. Proceeds from available-for-sale securities that were sold, matured or called during 2009 were $67.3 million with gross realized gains of $0.1 million and no gross realized losses. Proceeds from available-for-sale securities that were sold, matured or called during 2008 were $185.6 million with gross realized gains of $0.3 million and gross realized losses of $0.2 million. Proceeds from available-for-sale securities that matured or were called during 2007 were $87.2 million with gross realized losses of $0.2 million and no gross realized gains. Specific identification of the individual securities was used to determine the basis on which the gain or loss was calculated. 49 (in thousands) December 31, 2009 Amortized Cost Unrealized Gains Unrealized Losses Fair Value Marketable securities: Municipal bonds $ 112,127 601 (5 ) $ 112,723 Government sponsored enterprise bonds 19,650 17 (107 ) 19,560 Corporate bonds 6,517 — (4 ) 6,513 Marketable securities $ 138,294 618 (116 ) $ 138,796 (in thousands) December 31, 2008 Amortized Cost Unrealized Gains Unrealized Losses Fair Value Marketable securities: Municipal bonds $ 119,843 1,056 (3 ) $ 120,896 Government sponsored enterprise bonds 5,999 19 — 6,018 Corporate bonds 4,230 18 (20 ) 4,228 Marketable securities $ 130,072 1,093 (23 ) $ 131,142 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) The following table shows the gross unrealized losses and fair value of the Company’s investments, with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2009. All of these investments have been in an unrealized loss position for less than 12 months. The Company analyzes its investments for impairments on an ongoing basis. Factors considered in determining whether a loss is temporary include the length of time and extent to which the securities have been in an unrealized loss position and the Company’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated market recovery. The Company has the ability and intent to hold the investments with unrealized losses until anticipated recovery of fair value, which may be maturity. Therefore, the Company does not consider these investments to be other-than-temporarily impaired as of December 31, 2009. 5. FAIR VALUE MEASUREMENTS 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. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value, was established as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs other than the quoted prices in active markets that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which requires 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. On a recurring basis, the Company measures certain financial assets and liabilities at fair value, including the Company’s marketable securities. The Company’s investments are classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices, or broker dealer quotations and matrix pricing compiled by third party pricing vendors, respectively, which are based on third party pricing sources with reasonable levels of price transparency. 50 (in thousands) Less than 12 months Description of Securities Fair Value Unrealized Losses Government sponsored enterprise bonds $ 11,961 $ (107 ) Municipal bonds 10,472 (5 ) Corporate bonds 2,953 (4 ) Totals $ 25,386 $ (116 ) Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) The fair value hierarchy of the Company’s cash equivalents and marketable securities at fair value is as follows: Assets Measured at Fair Value on a Nonrecurring Basis Nonfinancial assets, such as property and equipment, and intangible assets are recognized at fair value when they are deemed to be other-than-temporarily impaired. During 2009, the Company did not recognize any impairment on any assets that are measured at fair value on a nonrecurring basis. 6. TRADE ACCOUNTS RECEIVABLE, NET OF ALLOWANCES Trade accounts receivable balances, which consist of billed and unbilled amounts, were $39.4 million and $42.8 million as of December 31, 2009 and 2008, respectively. Trade accounts receivable includes $6.0 million and $6.4 million as of December 31, 2009 and 2008, respectively, for services earned under time and material arrangements that had not been invoiced at the end of the respective period. The Company’s allowance for doubtful accounts was $0.1 million at December 31, 2009 and $0.4 million at December 31, 2008. 51 Fair Value Measurements at Reporting Date Using (in thousands) December 31, 2009 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Cash equivalents $ 9,880 $ 9,880 $ — Marketable securities: Municipal bonds $ 112,723 $ 27,152 $ 85,571 Government sponsored enterprise bonds 19,560 — 19,560 Corporate bonds 6,513 6,513 — Total marketable securities: $ 138,796 $ 33,665 $ 105,131 Fair Value Measurements at Reporting Date Using (in thousands) December 31, 2008 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Cash equivalents $ 10,512 $ 10,512 $ — Marketable securities: Municipal bonds $ 120,896 $ 36,776 $ 84,120 Government sponsored enterprise bonds 6,018 3,007 3,011 Corporate bonds 4,228 4,228 — Total marketable securities: $ 131,142 $ 44,011 $ 87,131 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) The Company also records allowances for estimates of potential sales credit memos when the related revenue is recorded and reviews those allowances periodically. The following reflects the activity of the allowance for sales credit memos for each of three years ended December 31: 7. PROPERTY AND EQUIPMENT The majority of the fixed assets in progress are software development costs related the Company’s implementation of an enterprise resource planning system for internal-use. Depreciation expense was approximately $2.5 million, $1.7 million, and $1.5 million for the years ended December 31, 2009, 2008, and 2007. Amortization expense was approximately $0.3 million, $0.5 million, and $0.5 million for the years ended December 31, 2009, 2008, and 2007. 8. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill represents the residual purchase price paid in a business combination after all identified assets have been recorded. Goodwill is not amortized, but is tested annually for impairment by comparing estimated fair value to its carrying value. The Company performed the annual impairment test in the fourth quarters of 2009 and 2008 and determined that goodwill was not impaired. On March 21, 2008, the Company acquired certain assets of privately held Focus Technology Group, Inc. and a related entity (collectively, “Focus”). Focus provides software products to the banking industry designed to detect and prevent financial fraud and money laundering. The Company believes that the acquisition extends the Company’s software capabilities and frameworks with respect to its anti-fraud and anti-money laundering offerings to the Company’s customers. The initial consideration for the acquisition was approximately $0.8 million in cash, including transaction costs. In addition to the initial purchase consideration, up to approximately $2.1 million of contingent consideration could have become due to the former owners of Focus, based on the achievement of certain performance milestones and sales targets during a period of 30 months from the 52 (in thousands) 2009 2008 2007 Balance at beginning of year $ 1,125 $ 986 $ 1,238 Provision for credit memos 2,600 1,777 1,160 Credit memos issued (3,185 ) (1,638 ) (1,412 ) $ 540 $ 1,125 $ 986 (in thousands) December 31, 2009 December 31, 2008 Computer equipment $ 6,654 $ 6,392 Leasehold improvements 5,714 3,620 Furniture and fixtures 2,227 2,948 Computer software purchased 1,342 1,495 Computer software developed for internal use 721 721 Fixed assets in progress 694 — 17,352 15,176 Less: accumulated depreciation and amortization (8,421 ) (9,453 ) Property and equipment, net of accumulated depreciation and amortization $ 8,931 $ 5,723 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) acquisition date. As a result of the purchase price allocation, the Company recorded intangible assets of $0.8 million, consisting of $0.5 million of technology designs, $0.1 million of non-compete agreements and $0.2 million of goodwill which is deductible for tax purposes. In September 2009, the parties to the original Focus asset purchase agreement entered into an amendment of that agreement such that $1.8 million of the original potential contingent consideration was forfeited and $0.3 million of the contingent consideration was earned and paid in January 2010. The Company recorded the additional $0.3 million consideration as an increase to goodwill in 2009. The results of the operations of Focus were included in the results of operations of the Company from the date of acquisition and were nominal. The following table presents the change in the carrying amount of goodwill: Intangible assets are recorded at cost and principally represent technology acquired in business combinations or from third parties. Amortization is recognized on a straight-line basis over the assets’ estimated useful lives. The technology designs and non-compete agreements are being amortized over their estimated useful lives of four and five years, respectively. Amortized intangible assets consist of the following: Amortization expense for acquired technology design and non-compete agreements was $0.1 million, $0.1 million, and $0 for the years ended December 31, 2009, 2008, and 2007, respectively. Future estimated amortization expense is $0.1 million, $0.1 million, $47,000 and $4,000 for the years ended December 31, 2010, 2011, 2012, and 2013, respectively. 9. RESTRICTED CASH The Company has approximately $0.8 million of restricted cash related to amounts deposited to secure a letter of credit for its Cambridge, Massachusetts office operating lease and is included in long-term other assets in the accompanying consolidated balance sheet. 53 (in thousands) 2009 2008 Balance as of January 1, $ 2,141 $ 1,933 Goodwill acquired during the year — 208 Adjustments to goodwill balances 250 — Balance as of December 31, $ 2,391 $ 2,141 (in thousands) Cost Accumulated Amortization Net Book Value As of December 31, 2009 Technology designs $ 490 $ (218 ) $ 272 Non-compete agreements 100 (36 ) 64 Intellectual property 1,400 $ (1,400 ) — Total $ 1,990 $ (1,654 ) $ 336 As of December 31, 2008 Technology designs $ 490 $ (95 ) $ 395 Non-compete agreements 100 (16 ) 84 Intellectual property 1,400 (1,400 ) — Total $ 1,990 $ (1,511 ) $ 479 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) 10. DEFERRED REVENUE 11. COMMITMENTS AND CONTINGENCIES The Company’s principal administrative, sales, marketing, support, and research and development operations are located in an approximate 105,000 square foot leased facility in Cambridge, Massachusetts. The lease for this facility expires in 2013, subject to the Company’s option to extend for two additional five-year periods. The Company also leases space for its other offices in the U.S., Australia, Canada, India, the United Kingdom and in other European countries. These leases expire at various dates through 2014. As of December 31, 2009, the Company’s future minimum rental payments required under operating leases with non-cancelable terms in excess of one year were as follows: Rent expense under operating leases is recognized on a straight-line basis to account for scheduled rent increases and a landlord tenant allowance. The excess of expense over current payments is recorded as deferred rent and included in accrued expenses and other long-term liabilities. As of December 31, 2009, deferred rent of approximately $0.4 million was included in accrued expenses and approximately $1.8 million was included in other long-term liabilities in the accompanying consolidated balance sheet. Total rent expense under operating leases was approximately $5.3 million for each of the years ended December 31, 2009 and 2008, respectively, and was $4.7 million for the year ended December 31, 2007. As of December 31, 2009, the Company did not have any unconditional purchase obligations. The Company is a party in various contractual disputes, litigation and potential claims arising in the ordinary course of business. The Company does not believe that the resolution of these matters will have a material adverse effect on its financial position or results of operations. Accordingly, no material accruals have been made to the Company’s consolidated balance sheets related to such contract disputes, litigation or potential claims. 54 (in thousands) December 31, 2009 December 31, 2008 Software license $ 4,413 $ 12,740 Maintenance 22,039 15,688 Professional services and other 6,418 3,803 $ 32,870 $ 32,231 (in thousands) For the calendar year Operating Leases 2010 $ 4,929 2011 5,176 2012 5,351 2013 2,177 2014 297 $ 17,930 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) 12. STOCKHOLDERS’ EQUITY (a) Preferred stock The Company has authorized 1,000,000 shares of preferred stock, which may be issued from time to time in one or more series. The Board of Directors has the authority to issue the shares of preferred stock in one or more series, to establish the number of shares to be included in each series, and to fix the designation, powers, preferences and rights of the shares of each series and the qualifications, limitations or restrictions thereof, without any further vote or action by the stockholders. The issuance of preferred stock could decrease the amount of earnings and assets available for distribution to holders of common stock, and may have the effect of delaying, deferring or defeating a change in control of the Company. The Company had not issued any shares of preferred stock through December 31, 2009. (b) Common stock The Company has 70,000,000 authorized shares of common stock, $0.01 par value per share, of which 36,818,355 shares were issued and outstanding at December 31, 2009. Since 2004, the Company’s Board of Directors has approved stock repurchase programs that have authorized the Company to repurchase in the aggregate up to $75.0 million of its common stock. Purchases under these programs may be made as market conditions warrant, subject to regulatory and other considerations, from time to time on the open market or in privately negotiated transactions. The following table is a summary of the Company’s repurchase activity under all of the Company’s repurchase programs for the years ended December 31: (c) Dividends On May 30, 2006, the Company’s Board of Directors approved an ongoing quarterly cash dividend of $0.03 per share, beginning with the second quarter ended June 30, 2006. Accordingly, the Company declared $0.12 per share, for the years ended December 31, 2009, 2008 and 2007, and paid cash dividends of $4.3 million, $4.4 million, and $4.3 million for the years ended December 31, 2009, 2008, and 2007, respectively. (d) Warrants summary In November 2007, the Company issued 5,815 shares of its common stock in connection with the exercise of previously issued warrants to International Business Machines Corporation (“IBM”). In accordance with the net exercise provisions of this warrant, the Company withheld 20,923 shares of the Company’s common stock to cover the exercise price, which shares were valued at approximately $0.3 million, based on the average closing price of the Company’s common stock over the five consecutive trading days ending on the day prior to the exercise date. 55 (Dollars in thousands) 2009 2008 2007 Shares Amount Shares Amount Shares Amount Prior year authorizations at January 1, $ 12,862 $ 1,210 $ 6,872 Authorizations 15,000 30,000 10,000 Repurchases paid 673,066 (11,947 ) 1,503,551 (17,969 ) 799,347 (9,135 ) Repurchases unsettled 3,898 (136 ) 32,376 (379 ) 48,015 (569 ) Expirations — — (5,958 ) Authorized dollars remaining as of December 31, $ 15,779 $ 12,862 $ 1,210 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) In November 2007 and August 2009, the Company issued 1,306 shares and 7,264 shares of its common stock, respectively, in connection with the exercise of warrants originally issued as part of the consideration for its acquisition of 1mind in 2002. These warrants were exercised by former stockholders of 1mind. In accordance with the net exercise provisions of these warrants, the Company withheld 102 shares and 214 shares of the Company’s common stock to cover the exercise price of the warrant, which shares were valued at approximately $1,200 and $6,400, respectively, based on the average closing price of the Company’s common stock over the ten consecutive trading days ending on the third trading day prior to the exercise date. The issuance of these shares was made in reliance on an exemption from registration provided by Regulation D under the Securities Act of 1933. As of December 31, 2009, there were outstanding warrants to purchase 3,567 shares of the Company’s common stock with an exercise price of $0.85 per share. These warrants expire in 2012. 13. STOCK-BASED COMPENSATION The majority of the Company’s stock-based compensation arrangements vest over either a four or five year vesting schedule and our stock options have a ten-year term. The Company recognizes stock-based compensation using the ratable method, which treats each vesting tranche as if it were an individual grant. During the fourth quarter of 2007, the Company’s Board of Directors approved changes to its equity compensation program, including the granting of restricted stock units (“RSUs”) in addition to stock options, for periodic equity compensation grants. RSUs deliver to the recipient a right to receive a specified number of shares of the Company’s common stock upon vesting. Unlike stock options, there is no cost to the employee at share issuance. The Company values its RSUs at the fair value of our common stock on the grant date, which is the closing price of our common stock on the grant date, less the present value of expected dividends, as the employee is not entitled to dividends during the requisite service period. Upon vesting of the RSUs, the Company withholds shares of common stock in an amount sufficient to cover its minimum statutory tax withholding obligations and issues shares of its common stock for the remaining amount. During the fourth quarter of 2007, the Company’s Board of Directors also approved the election by employees to receive 50% of their target incentive compensation under the Company’s Corporate Incentive Compensation Plan (the “CICP”) in the form of RSUs instead of cash, beginning with the CICP for 2008. If elected by an employee, the equity amount is equal in value on the date of grant to 50% of his or her target incentive opportunity, based on the employee’s base salary. The number of RSUs granted is determined by dividing 50% of the employee’s target incentive opportunity by the fair value of a RSU on the grant date. If elected, the equity grant occurs during the open trading period following the release of the prior year’s financial results and vests 100% on the CICP payout date of the following year for all participants. Vesting is conditioned upon threshold funding of the CICP and on continued employment; if threshold funding does not occur, the equity grant will be cancelled. The Company recognizes the associated stock-based compensation expense over the requisite service period beginning on the grant date and ending on the vest date. Beginning in December 2007, the Company began issuing options that allow for the settlement of vested stock options on a net share basis (“net settled stock options”), instead of settlement with a cash payment (“cash settled stock options”). With net settled stock options, the employee does not surrender any cash or shares upon exercise. Rather, the Company withholds the number of shares to cover the option exercise price and the minimum statutory tax withholding obligations from the shares that would otherwise be issued upon exercise. The employee receives the number of shares equal to the number of options being exercised less the number of shares necessary to satisfy the cost to exercise the options and, if applicable, taxes due on exercise based on the 56 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) fair value of the shares at the exercise date. The settlement of vested stock options on a net share basis results in fewer shares issued by the Company. In 2009 and 2008, the Company began offering certain employees the opportunity to convert certain outstanding cash settled stock options to net settled stock options. During 2009 and 2008, option and RSU holders net settled stock options and vested RSUs representing the right to purchase a total of 2,451,000 shares and 425,000 shares, respectively, of which only 1,188,000 and 152,000 shares, respectively, were issued to the option and RSU holders and the balance of the shares were surrendered to the Company to pay for the exercise price and the applicable taxes. Beginning in the third quarter of 2009, the Company’s Board of Directors approved the granting of RSUs, in addition to stock options, to new employees. Share-Based Compensation Plans: (a) 1994 Long-term Incentive Plan In 1994, the Company adopted a 1994 Long-Term Incentive Plan (as amended in 2003, the “1994 Plan”) to provide employees, Directors and consultants with opportunities to purchase stock through incentive stock options and non-qualified stock options. In addition to options, participants under the 1994 Plan were eligible to receive stock appreciation rights, restricted stock and long-term performance awards. The Compensation Committee of the Board of Directors (“Compensation Committee”) administers the 1994 Plan. Generally, the exercise price of options granted under the plan was equal to the fair market value of the underlying common stock on the date of grant. Options granted under the 1994 Plan generally vest over four years and expire no later than ten years from the date of grant. As of December 31, 2009, options to purchase an aggregate of approximately 963,000 shares of common stock were outstanding under the 1994 Plan. The Company does not intend to issue any additional options or make any other awards under the 1994 Plan in the future. (b) 1996 Non-Employee Director Stock Option Plan In 1996, the Company adopted a 1996 Non-Employee Director Stock Option Plan (the “Director Plan”), which provided for the grant to non-employee Directors of the Company of options to purchase shares of its common stock. All shares authorized for issue under this plan have been awarded. Beginning in July 2006, in lieu of granting fully vested options, the Company grants shares of its common stock to is non-employee directors under the 2004 Long-term incentive plan, as described below. Originally, the Director Plan provided for the grant to non-employee Directors on the date he or she first became a Director of an option to purchase 30,000 shares of common stock at a price equal to the fair market value thereof on the date of grant, such options to vest in equal annual installments over five years. In 1999, the Director Plan was amended to provide for (i) the grant to non-employee Directors on the date he or she first became a Director of an option to purchase 30,000 shares of common stock at a price per share equal to the fair market value thereof on the date of grant, such options to vest in equal annual installments over three years and (ii) the grant to each non-employee Director at the time of the regular meeting of the Board of Directors following the annual meeting of stockholders (commencing in 2000), of a fully vested option to purchase 10,000 shares of common stock at a price per share equal to the fair market value thereof on the date of grant. The Compensation Committee administers the Director Plan. As of December 31, 2009, options to purchase an aggregate of approximately 160,000 shares of common stock were outstanding under the Director Plan. (c) 2004 Long-Term Incentive Plan In 2004, the Company adopted a 2004 Long-Term Incentive Plan (the “2004 Plan”) to provide employees, non-employee Directors and consultants with opportunities to purchase stock through incentive stock options and non-qualified stock options. In addition to options, eligible participants under the 2004 Plan may be granted stock 57 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) purchase rights and other stock-based awards. As of December 31, 2009, a total of 7,000,000 shares of common stock had been authorized under the 2004 Plan and approximately 2,978,000 shares were subject to outstanding options and stock-based awards. Beginning in June 2006, each member of the Company’s Board of Directors (except the Company’s Chairman and Chief Executive Officer) is entitled to receive on an annual basis a number of shares of common stock, which as of March 2009 was equal to $70,000, divided by the fair market value of its common stock on the grant date. The Compensation Committee administers the 2004 Plan. Generally, the exercise price of options granted under the plan is equal to the fair market value of the underlying common stock on the date of grant. (d) 2006 Employee Stock Purchase Plan In 2006, the Company adopted a 2006 Employee Stock Purchase Plan (the “2006 ESPP”) pursuant to which the Company’s employees are entitled to purchase up to an aggregate of 500,000 shares of common stock at a price equal to 85% of the fair market value of the Company’s common stock on either the commencement date or completion date for offerings under the plan, whichever is less, or such higher price as the Company’s Board of Directors may establish from time to time. Until the Company’s Board of Directors determines otherwise, the Board has set the purchase price at 95% of the fair market value on the completion date of the offering period. As a result, the 2006 Stock Purchase Plan is non-compensatory and is tax qualified. Therefore, as of December 31, 2009, no compensation expense related to shares issued under the plan had been recognized. As of December 31, 2009, approximately 57,000 shares had been issued thereunder. Shares reserved As of December 31, 2009, there were approximately 2,040,000 shares remaining for issuance for future equity grants under the Company’s stock plans, consisting of approximately 1,597,000 shares under the 2004 Plan and approximately 443,000 shares under the 2006 ESPP. There were no shares available for future equity grants under the 1994 Plan or the Director Plan. Equity grants, Assumptions and Activity The Company periodically grants stock options and RSUs for a fixed number of shares to employees and non-employee Directors. The exercise price for stock options is greater than or equal to the fair market value of the shares at the date of the grant. During 2009, the Company issued approximately 1,660,000 shares to its employees under the Company’s share-based compensation plans and approximately 18,000 shares to its non-employee Directors. The following table presents the stock-based compensation expense included in the Company’s consolidated statements of income for 2009, 2008, and 2007. 58 (in thousands, except per share amounts) Year ended December 31, 2009 Year ended December 31, 2008 Year ended December 31, 2007 Stock-based compensation expense: Cost of services $ 1,096 $ 995 $ 490 Operating expenses 3,577 2,537 1,128 Total stock-based compensation before tax 4,673 3,532 1,618 Income tax benefit (1,688 ) (1,090 ) (430 ) Net stock-based compensation expense $ 2,985 $ 2,442 $ 1,188 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) Stock Options The Company estimates the fair value of stock options using a Black-Scholes option valuation model. Key inputs used to estimate the fair value of stock options include the exercise price of the award, the expected term of the option, the expected volatility of the Company’s common stock over the option’s expected term, the risk-free interest rate over the option’s expected term, and the Company’s expected annual dividend yield. The amount of stock-based compensation recognized during a period is based on the value of the portion of the awards that are ultimately expected to vest. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Based on the review of historical forfeiture data for the Company’s employees, an annual forfeiture rate of 5-20% has been applied and is re-evaluated and adjusted as necessary. Ultimately, the Company recognizes the actual expense over the vesting period only for the shares that vest. The weighted-average grant-date fair value for stock options granted in 2009, 2008, and 2007 was $10.15, $4.75, and $5.44 per share, respectively. The weighted-average assumptions used in the Black-Scholes option valuation model are as follows: The Company elected to adopt the alternative transition method (“short cut method”) in calculating their historical APIC pool of windfall tax benefits in regards to its share-based compensation. 59 Year ended December 31, 2009 Year ended December 31, 2008 Year ended December 31, 2007 Expected volatility (1) 41 % 46 % 53 % Expected term in years (2) 6.1 5.9 5.6 Risk-free interest rate (3) 2.52 % 2.36 % 4.02 % Expected annual dividend yield (4) 0.81 % 1.07 % 1.19 % (1) The expected volatility for each grant is determined based on the average of historical weekly price changes of the Company’s common stock over a period of time which approximates the expected option term. (2) The expected option term for each grant is determined based on the historical exercise behavior of employees and post-vesting employment termination behavior. (3) The risk-free interest rate is based on the yield of zero-coupon U.S. Treasury securities for a period that is commensurate with the expected option term at the time of grant. (4) The expected annual dividend yield is based on the weighted-average of the dividend yield assumptions used for options granted during the applicable period. The expected annual dividend is based on the expected dividend of $0.12 per share, per year ($0.03 per share, per quarter times 4 quarters) divided by the average stock price. Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) The following table summarizes the combined stock option activity under the Company’s stock option plans for the years ended December 31, 2009: The aggregate intrinsic value of stock options exercised (i.e., the difference between the market price at exercise and the price paid by the employee at exercise) in 2009, 2008, and 2007 was $42.8 million, $7.6 million, and $7.5 million, respectively. The aggregate intrinsic value of stock options outstanding and exercisable as of December 31, 2009 is based on the difference between the closing price of the Company’s stock of $34.00 on December 31, 2009 and the exercise price of the applicable stock options. As of December 31, 2009, the Company had unrecognized compensation expense related to the unvested portion of stock options of approximately $2.9 million that is expected to be recognized as expense over a weighted-average period of approximately 2.3 years. RSUs The weighted-average grant-date fair value for RSUs granted in 2009, 2008, and 2007 was $27.29, $11.23, and $11.71, respectively. The following table summarizes the combined RSU activity for periodic grants and the CICP under the 2004 Plan for the year ended December 31, 2009. 60 Cash settled options (in thousands) Net settled options (in thousands) Weighted-average exercise price Weighted- average remaining contractual term (in years) Aggregate intrinsic value (in thousands) Options outstanding as of January 1, 2009 1,202 5,045 $ 9.09 Granted — 320 25.93 Converted (cash settled to net settled) (94 ) 94 9.56 Exercised (457 ) (2,315 ) 9.74 Cancelled (29 ) (97 ) 12.61 Options outstanding as of December 31, 2009 622 3,047 $ 9.95 Weighted-average exercise price of options outstanding as of December 31, 2009 $ 8.85 $ 10.18 Vested and expected to vest as of December 31, 2009 570 2,736 $ 9.45 5.16 56,430 Weighted-average exercise price of options vested and expected to vest as of December 31, 2009 $ 8.78 $ 9.59 Exercisable as of December 31, 2009 492 2,107 $ 7.74 4.24 68,265 Weighted-average exercise price of options exercisable as of December 31, 2009 $ 8.63 $ 7.53 Shares (in thousands) Weighted- Average Grant-Date Fair Value Weighted- Average Remaining Contractual Term (in years) Aggregate Intrinsic Value (in thousands) Nonvested at January 1, 2009 412 $ 11.41 Granted 176 27.29 Vested (136 ) 10.96 Forfeited (20 ) 12.94 Nonvested at December 31, 2009 432 $ 17.94 1.92 $ 14,618 Vested and expected to vest at December 31, 2009 303 $ 18.26 1.73 $ 10,293 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) The RSUs associated with periodic grants vest over five years with 20% vesting after one year and the remaining 80% vesting in equal quarterly installments over the remaining four years. The RSUs granted in connection with the 2009 CICP will vest 100% on March 10, 2010, the CICP payout date. The Company expenses its stock-based compensation under the ratable method, which treats each vesting tranche as if it were an individual grant. The fair value of RSUs vested in 2009 and 2008 was $3.0 million and $0.5 million, respectively. No RSUs vested in 2007. The aggregate intrinsic value of RSUs outstanding and expected to vest as of December 31, 2009 is based on the difference between the closing price of the Company’s stock of $34.00 on December 31, 2009 and zero. As of December 31, 2009, the Company had approximately $3.8 million of unrecognized compensation cost related to all unvested RSUs that is expected to be recognized as expense over a weighted-average period of 2.4 years. 14. INCOME TAXES The components of income before provision for income taxes are as follows for the years ended December 31: The components of the provision for income taxes are as follows for the years ended December 31: 61 (in thousands) 2009 2008 2007 Domestic $ 42,513 $ 13,221 $ 8,343 Foreign 4,902 2,451 1,599 Total $ 47,415 $ 15,672 $ 9,942 (in thousands) 2009 2008 2007 Current: Federal $ 10,784 $ 6,947 $ 2,281 State 1,442 647 350 Foreign 1,564 907 879 Total current 13,790 8,501 3,510 Deferred: Federal 899 (2,651 ) 582 State 671 (1,063 ) (699 ) Foreign (157 ) (92 ) (46 ) Total deferred 1,413 (3,806 ) (163 ) Total provision $ 15,203 $ 4,695 $ 3,347 Total provision (benefit) Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) The effective income tax rate differed from the statutory federal income tax rate due to the following: The difference in the Company’s effective federal tax rate for 2009 as compared to the statutory rate was primarily the result of changes to the following tax provision items: domestic production activities, tax-exempt income, and a reduction in the Company’s reserve for uncertain tax positions, all of which reduced the Company’s effective tax rate. These decreases in the rate were offset by permanent differences for meals and entertainment and a change in the Company’s effective state tax rate. The Company has recorded a liability for uncertain tax matters, both domestic and foreign, which it believes could result in additional tax being due. Any additions or reductions to the liability for uncertain tax matters will be reflected in the Company’s effective tax rate in the period that additional facts become known. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of net deferred tax assets and liabilities are as follows: A valuation allowance has been provided for certain deferred tax assets when it is more likely than not that the Company will not realize the entire benefit of the assets. The $0.3 million increase in the valuation allowance 62 2009 2008 2007 Statutory federal income tax rate 35.0 % 35.0 % 35.0 % State income taxes, net of federal benefit and tax credits 1.8 (1.4 ) (2.4 ) Permanent differences 0.8 2.7 3.3 Extraterritorial income exclusion and domestic production activities (1.8 ) (3.4 ) (3.2 ) Federal research and experimentation credits (0.4 ) (4.9 ) (4.6 ) Tax effects of foreign activities (1.1 ) (1.6 ) (0.8 ) Tax-exempt income (1.8 ) (3.9 ) — Provision to return adjustments 0.1 0.3 1.5 Tax exposure reserve (1.7 ) 8.3 1.9 Valuation allowance 0.5 (1.3 ) 1.0 Other 0.7 0.2 2.0 Effective income tax rate 32.1 % 30.0 % 33.7 % (in thousands) 2009 2008 Software revenue $ 607 $ 1,990 Depreciation 521 487 Accruals and reserves 5,202 5,255 Unrealized loss on investments 35 (7 ) Intangibles 58 27 Tax credit carry forwards 3,872 3,700 Net deferred tax assets 10,295 11,452 Less valuation allowances (257 ) — Net deferred income taxes $ 10,038 $ 11,452 Reported as: Current deferred tax asset $ 2,523 $ 4,351 Long-term deferred income tax assets 7,515 7,101 Net deferred income taxes $ 10,038 $ 11,452 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) during 2009 was a valuation allowance recorded against state research credits generated during the current year. The $0.2 million decrease in the valuation allowance during 2008 was primarily due to the realization of benefits related to capital losses. As of December 31, 2009, the Company had available $3.9 million of state tax research and experimentation (“R&E”) and investment tax credits expiring in the years 2012 through 2024. Undistributed earnings of the Company’s foreign subsidiaries amounted to approximately $14.8 million as of December 31, 2009. The Company has not provided any additional federal or state income taxes or foreign withholding taxes on the undistributed earnings as such earnings have been indefinitely reinvested in the business. The Company adopted the provisions of accounting for uncertain tax positions on January 1, 2007. As a result, the Company recorded the cumulative effect of applying the provisions of accounting for uncertain tax positions and recorded a $1.5 million reduction to the January 1, 2007 retained earnings. A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows: Included in the total unrecognized tax benefits balance as of December 31, 2009 were $0.9 million of tax positions for which the ultimate settlement is highly certain but for which there is uncertainty about the timing of such deductibility. Due to the impact of deferred tax accounting, other than interest and penalties, a change in the income recognition period would not affect the annual effective tax rate but would accelerate the payment of cash to the tax authority to an earlier period. As of December 31, 2009, the total amount of unrecognized tax benefits totaled approximately $4.4 million, all of which if recognized, would decrease our effective tax rate in a future period. The Company expects that the changes in the unrecognized benefits within the next twelve months will be approximately $0.9 million related to tax positions for which the ultimate settlement is highly certain but for which there is uncertainty about the timing of such recognition. The Company reported in its reconciliation of gross uncertain tax benefits a $1.9 million reduction in unrecognized tax benefits for the year ended December 31, 2009. The Company recorded a $1.3 million reduction related to tax positions for which the ultimate settlement is highly certain but for which there is uncertainty about the timing of such recognition. This reduction does not affect the annual effective tax rate. The Company also recorded a $0.3 million reduction related to tax positions for which settlement was reached after its income tax audit with United Kingdom government and $0.2 million related to tax positions of prior years for which the statute of limitations has expired. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. For the year ended December 31, 2009, the Company recognized a reduction of interest expense of approximately 63 (in thousands) 2009 2008 Balance as of January 1, $ 6,201 $ 9,825 Additions based on tax positions related to the current year 128 450 Additions for tax positions of prior years 50 860 Reductions for tax positions of prior years (1,937 ) (4,934 ) Balance as of December 31, $ 4,442 $ 6,201 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) $0.5 million. For the years ended December 31, 2008 and 2007, the Company recognized interest expense of approximately $0.1 million and $0.2 million, respectively. As of December 31, 2009 and 2008, the Company had accrued approximately $1.3 million and $1.8 million, respectively, for interest and penalties. The Company files income tax returns in the U.S. and in foreign jurisdictions. Generally, the Company is no longer subject to U.S. federal, state, or local, or foreign income tax examinations by tax authorities for the years before 2006. With few exceptions, the statute of limitations remains open in all other jurisdictions for the tax years 2006 to the present. 15. EARNINGS PER SHARE Basic earnings per share is computed using the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted-average number of common shares outstanding during the period, plus the dilutive effect of outstanding options, warrants and RSUs, using the treasury stock method and the average market price of our common stock during the applicable period. Certain shares related to some of our outstanding stock options, warrants, 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. 16. GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS The Company currently operates in one operating segment — rules based Business Process Management (“BPM”) software. The Company derives substantially all of its operating revenue from the sale and support of one group of similar products and services. 64 (in thousands, except per share amounts) Year Ended December 31, 2009 2008 2007 Basic Net income $ 32,212 $ 10,977 $ 6,595 Weighted-average common shares outstanding 36,208 36,146 35,875 Earnings per share, basic $ 0.89 $ 0.30 $ 0.18 Diluted Net income $ 32,212 $ 10,977 $ 6,595 Weighted-average common shares outstanding 36,208 36,146 35,875 Weighted-average effect of dilutive securities: Stock options 1,297 1,382 1,546 RSUs 601 67 —Warrants 7 10 12 Effect of assumed exercise of stock options, warrants and RSUs 1,905 1,459 1,558 Weighted-average common shares outstanding, assuming dilution 38,113 37,605 37,433 Earnings per share, diluted $ 0.85 0.29 0.18 Outstanding options, warrants and RSUs excluded as impact would be anti-dilutive 362 1,523 1,121 Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) The Company’s international revenue is from sales to customers based outside of the U.S. The Company derived its operating revenue from the following geographic areas for the years ended December 31: The majority of the Company’s assets are located within the U.S. Long-lived assets (1) related to the Company’s U.S. and international operations as of December 31 were as follows: No single customer accounted for more than 10% of the Company’s revenue in 2009, 2008, and 2007. The following table summarizes the Company’s concentration of credit risk associated with customers accounting for more than 10% of the Company’s outstanding trade receivables and long and short-term license installments as of December 31: The Company’s financial services and insurance customers as a group represent a significant amount of the Company’s revenues and receivables, which the Company considered and determined it did not have a material impact on its allowances for doubtful accounts and sales credit memos as of December 31, 2009. Marketable securities are another financial instrument that potentially subject the Company to a concentration of credit risk. See Note 4 “Marketable Securities” and Note 5 “Fair Value Measurements” for further discussion. 65 (Dollars in thousands) 2009 2008 2007 U.S. $ 174,976 66 % $ 131,250 62 % $ 104,952 65 % United Kingdom 46,416 18 % 40,063 19 % 34,278 21 % Europe, other 27,127 10 % 27,345 13 % 8,755 5 % Other 15,494 6 % 12,989 6 % 13,964 9 % $ 264,013 100 % $ 211,647 100 % $ 161,949 100 % (Dollars in thousands) 2009 2008 U.S. $ 6,609 74 % $ 4,451 78 % India 2,072 23 % 919 16 % International, other 250 3 % 353 6 % $ 8,931 100 % $ 5,723 100 % (1) Long-lived assets exclude goodwill and intangible assets, which are not allocated to specific geographic locations as it is impracticable to do so. (Dollars in thousands) 2009 2008 Trade receivables $ 39,396 $ 42,801 Customer A — 11.7 % Long and short-term license installments $ 5,805 $ 10,858 Customer B 42.7 % 29.7 % Customer C 20.5 % 16.1 % Customer D 16.8 % 11.9 % Customer E 12.7 % 10.5 % Table of Contents PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) 17. EMPLOYEE BENEFIT PLANS The Company sponsors a 401(k) defined contribution retirement plan for qualifying employees pursuant to which the Company makes discretionary matching profit sharing contributions. Company contributions under the plan totaled approximately $1.6 million in 2009, $1.3 million in 2008, and $1.0 million in 2007. In addition, the Company has defined contribution plans for qualifying international employees and contributions expensed under those plans totaled approximately $1.0 million in 2009, approximately $0.6 million in 2008, and approximately $0.3 million in 2007. 18. SELECTED QUARTERLY INFORMATION (UNAUDITED) 66 (in thousands, except per share amounts) 2009 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Revenue $ 62,367 $ 63,878 $ 64,821 $ 72,947 Gross profit 41,836 42,286 40,761 48,193 Income from operations 12,335 11,830 7,465 10,189 Income before provision for income taxes 12,410 15,716 8,526 10,763 Net income 8,642 11,241 6,001 6,328 Earnings per share, basic $ 0.24 $ 0.31 $ 0.16 $ 0.17 Earnings per share, diluted $ 0.23 $ 0.30 $ 0.16 $ 0.16 (in thousands, except per share amounts) 2008 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Revenue $ 48,478 $ 51,119 $ 52,698 $ 59,352 Gross profit 28,926 30,346 32,142 38,476 Income from operations 2,166 2,584 3,441 6,288 Income before provision for income taxes 4,177 4,029 2,717 4,749 Net income 2,944 2,852 2,351 2,830 Earnings per share, basic $ 0.08 $ 0.08 $ 0.06 $ 0.08 Earnings per share, diluted $ 0.08 $ 0.08 $ 0.06 $ 0.08 Table of Contents None. (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 December 31, 2009. 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 December 31, 2009. (b) Management’s Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act. Under the supervision and with the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets, provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures are being made in accordance with authorizations of our management and Directors; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisitions, use or disposition of our assets that could have a material effect on our financial statements. Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2009. Based on this evaluation, our management concluded that we maintained effective internal control over financial reporting as of December 31, 2009, based on criteria in Internal Control — Integrated Framework issued by the COSO. Deloitte & Touche LLP, our independent registered public accounting firm which also audited our consolidated financial statements, has issued an attestation report on our internal control over financial reporting, which is included below. 67 ITEM 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure ITEM 9A. Controls and Procedures Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Pegasystems Inc. Cambridge, Massachusetts We have audited the internal control over financial reporting of Pegasystems Inc. and subsidiaries (the “Company”) as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2009 of the Company and our report dated February 22, 2010 expressed an unqualified opinion on those financial statements. 68 /s/ DELOITTE & TOUCHE LLP Boston, Massachusetts February 22, 2010 Table of Contents (c) 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 December 31, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. None. PART III Except as set forth below, the information required by this Item is contained in our proxy statement for our 2010 annual stockholders meeting (the “2010 proxy statement”) under the heading “Election of Directors,” and is incorporated herein by reference. Information relating to certain filings on Forms 3, 4, and 5 is contained in our 2010 proxy statement under the heading “Section 16(a) Beneficial Ownership Reporting Compliance,” and is incorporated herein by reference. Information required by this item pursuant to Items 401(h), 401(i), and 401(j) of Regulation S-K relating to an audit committee financial expert, the identification of the audit committee of our Board of Directors and procedures of security holders to recommend nominees to our Board of Directors is contained in the 2010 proxy statement under the heading “Corporate Governance” and is incorporated herein by reference. We have adopted a written code of conduct that applies to all of our employees, including our principal executive officer, principal financial officer, principal accounting officer, or persons performing similar functions. EXECUTIVE OFFICERS The names of our executive officers and certain information about them are set forth below as of February 1, 2010: Alan Trefler, age 53, a founder of Pegasystems, serves as Chief Executive Officer and Chairman and has been a Director since we organized in 1983. Prior to 1983, he managed an electronic funds transfer product for TMI Systems Corporation, a software and services company. Mr. Trefler holds a B.A. degree in Economics and Computer Science from Dartmouth College. Craig Dynes , age 54, joined Pegasystems in September 2006 as Chief Financial Officer and Senior Vice President. Mr. Dynes also served as the Company’s principal accounting officer from November 2007 until May 2008. From 2004 to 2006, Mr. Dynes served as Chief Financial Officer at Demandware, a venture-backed enterprise software firm. From 2003 to 2004, Mr. Dynes served as President and CEO of Narad Networks, a manufacturer of equipment for the cable television industry. From 1997 to 2002, Mr. Dynes served as Chief Financial Officer of SilverStream Software, Inc., an application development software company. Prior to SilverStream, Mr. Dynes held senior financial positions at Sybase Inc. and Powersoft Corp. Mr. Dynes is a graduate of the Richard Ivey School of Business Administration, the University of Western Ontario and is a Canadian Chartered Accountant. Efstathios Kouninis , age 48 , joined Pegasystems in April 2008 as Vice President of Finance. In May 2008, the Board of Directors appointed Mr. Kouninis as the Company’s Chief Accounting Officer. From February 2006 to April 2008, Mr. Kouninis served as Chief Financial Officer and Treasurer of Tasker Products Corporation, a publicly traded manufacturer of antimicrobial chemicals. From November 2004 to February 2006, Mr. Kouninis served on the Staff of the Division of Corporation Finance of the U. S. Securities and Exchange Commission. Mr. Kouninis holds a Post Baccalaureate in Accounting, a M.S. in taxation from Bentley College, and a B.S. from the University of Massachusetts. 69 ITEM 9B. Other Information ITEM 10. Directors, Executive Officers, and Corporate Governance Table of Contents Douglas Kra, age 47 , joined Pegasystems in November 2004 as Vice President of Global Services. From 2002 to 2004, Mr. Kra served as Vice President at eLoyalty Corp., a consulting company specializing in customer relationship management. From 2000 to 2001, Mr. Kra served as President of Zefer Corp., an internet consulting firm. Prior to Zefer, Mr. Kra spent ten years at Cambridge Technology Partners Inc. in a variety of senior roles. He holds a B.A. in Computer Science from Brandeis University and an M.B.A. in finance from the New York University Stern School of Business. Max Mayer, age 60 , joined Pegasystems in 2004 as Vice President of Corporate Development. In November 2008, Mr. Mayer was promoted to Senior Vice President of Corporate Development. From 1999 to 2004, Mr. Mayer served as President and CEO of The Mayer Group, a management consulting firm. From 1995 to 1996, Mr. Mayer was President of Norstan, a publicly traded communications company. Prior to 1995, Mr. Mayer spent 15 years with Digital Equipment Corporation. He holds a B.A. from the University of Pennsylvania, an M.B.A. from Boston University, and completed executive education at Insead in Fontainebleau, France. Michael Pyle , age 55 , joined Pegasystems in 1985 and has served as Senior Vice President of Product Development since August 2000. Including his positions with Pegasystems, Mr. Pyle’s professional background encompasses almost thirty years of software development and managerial experience throughout Europe and the U.S. Mr. Pyle completed his B.C.S. specializing in Computer Science and Systems Programming at the Civil Service College in London. Leon Trefler, age 49, joined Pegasystems in April 1998 as an Account Executive for Strategic Business Development. Since then he has held various senior sales management positions across the Company and in Channel Sales. In 2002, he launched the commercialization of PRPC. From April 2007 to January 2010, Mr. Trefler served as Vice President of Sales, North America and in January 2010, Mr. Trefler was promoted to Senior Vice President of Sales. Mr. Trefler holds a B.A. degree from Dartmouth College. Alan Trefler and Leon Trefler are brothers. There are no other family relationships among any of our executive officers or Directors. The information required by this item is contained in the 2010 proxy statement under the headings “Directors Compensation”, “Compensation Discussion and Analysis”, and “Executive Compensation” and is incorporated herein by reference. Information required by this item with respect to securities authorized for issuance under our equity compensation plans is included in Item 5. Market For Registrant’s Common Stock, Related Stockholder Matters, and Issuer Purchases of Equity Securities in Part II of this report. Information required by this item with respect to stock ownership of certain beneficial owners and management is contained in the 2010 proxy statement under the heading “Security Ownership of Certain Beneficial Owners and Management” and is incorporated herein by reference. The information required by this item is contained in the 2010 proxy statement under the heading “Certain Relationships and Related Transactions” and is incorporated herein by reference. The information required by this item is contained in the 2010 proxy statement under the heading “Independent Registered Public Accounting Firm Fees and Services” and is incorporated herein by reference. 70 ITEM 11. Executive Compensation ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ITEM 13. Certain Relationships and Related Transactions, and Director Independence ITEM 14. Principal Accountant Fees and Services Table of Contents PART IV (a) The following are filed as part of this Annual Report on Form 10-K: (1) Financial Statements The following consolidated financial statements are included in Item 8: (b) Exhibits The exhibits listed in the Exhibit Index immediately preceding such exhibits are filed as part of this Annual Report on Form 10-K. (c) Financial Statement Schedules All financial statement schedules are omitted because the required information is not present or not present in sufficient amounts to require submission of the schedule or because the information is reflected in the consolidated financial statements or notes thereto. 71 ITEM 15. Exhibits and Financial Statement Schedules Page Consolidated Balance Sheets as of December 31, 2009 and 2008 40 Consolidated Statements of Income for the years ended December 31, 2009, 2008, and 2007 41 Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the years ended December 31, 2009, 2008, and 2007 42 Consolidated Statements of Cash Flows for the years ended December 31, 2009, 2008, and 2007 43 Table of Contents Signatures Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. Date: February 22, 2010 Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below on February 22, 2010 by the following persons on behalf of the Registrant and in the capacities indicated. 72 PEGASYSTEMS INC. B Y : /s/ CRAIG DYNES Craig Dynes Senior Vice President, Chief Financial Officer (principal financial officer) (duly authorized officer) Signature Title /s/ ALAN TREFLER Alan Trefler Chief Executive Officer and Chairman (principal executive officer) /s/ CRAIG DYNES Craig Dynes Senior Vice President, Chief Financial Officer (principal financial officer) /s/ EFSTATHIOS KOUNINIS Efstathios Kouninis Vice President of Finance and Chief Accounting Officer (principal accounting officer) /s/ RICHARD JONES Richard Jones Vice Chairman and Director /s/ CRAIG CONWAY Craig Conway Director /s/ PETER GYENES Peter Gyenes Director /s/ STEVEN KAPLAN Steven Kaplan Director /s/ JAMES O’HALLORAN James O’Halloran Director /s/ WILLIAM WYMAN William Wyman Director Table of Contents EXHIBIT INDEX 73 Exhibit No. Description 3.3 Restated Articles of Organization, of the Registrant. (Filed as exhibit 99.2 to the Registrant’s June 2, 2005 Form 8-K and incorporated herein by reference.) 3.4 Amended and Restated Bylaws of Pegasystems Inc. (Filed as Exhibit 99.3 to the Registrant’s April 1, 2009 Form 8-K and incorporated herein by reference.) 4.1 Specimen Certificate Representing the Common Stock. (Filed as exhibit 4.1 to the Registrant’s Registration Statement on Form S-1 (Registration No. 333-03807) or an amendment thereto and incorporated herein by reference.) 10.1++ Amended and Restated 1994 Long-Term Incentive Plan. (Filed in the Registrant’s Proxy Statement for its 2003 annual stockholders meeting and incorporated herein by reference.) 10.2++ 1996 Non-Employee Director Stock Option Plan. (Filed in the Registrant’s Proxy Statement for its 2000 annual stockholders meeting and incorporated herein by reference.) 10.3 Lease Agreement dated February 26, 1993 between the Registrant and Riverside Office Park Joint Venture. (Filed as exhibit 10.13 to the Registrant’s Registration Statement on Form S-1 (Registration No. 333-03807) or an amendment thereto and incorporated herein by reference.) 10.4 Amendment Number 1 to Lease Agreement dated August 17, 1994 between the Registrant and Riverside Office Park Joint Venture. (Filed as exhibit 10.14 to the Registrant’s Registration Statement on Form S-1 (Registration No. 333-03807) or an amendment thereto and incorporated herein by reference.) 10.5 Amendment Number 8 to Lease Agreement dated July 31, 2002 between the Registrant and NOP Riverfront LLC. (Filed as exhibit 10.23 to the Registrant’s 2002 Form 10-K and incorporated herein by reference.) 10.6 Letter Amendment to Lease Agreement dated July 31, 2002 between the Registrant and NOP Riverfront LLC. (Filed as exhibit 10.24 to the Registrant’s 2002 Form 10-K and incorporated herein by reference.) 10.7++ 2004 Long-Term Incentive Plan, as amended on November 24, 2008. +10.8++ Form of Employee Stock Option Agreement, as amended on December 15, 2009. +10.9++ Form of Restricted Stock Unit Agreement, as amended on December 15, 2009. 10.10 Form of Non-Employee Director Stock Option Agreement. (Filed as exhibit 10.2 to the Registrant’s September 30, 2004 Form 10-Q and incorporated herein by reference.) 10.11++ Offer Letter between the Registrant and Douglas I. Kra dated October 19, 2004. (Filed as exhibit 10.20 to the Registrant’s 2004 Form 10-K and incorporated herein by reference.) 10.12 Form of Director Indemnification Agreement. (Filed as Exhibit 99.1 to the Registrant’s April 11, 2005 Form 8-K and incorporated herein by reference.) 10.13++ 2006 Employee Stock Purchase Plan, as amended on February 14, 2008. (Filed as exhibit 10.15 to the Registrant’s 2007 Form 10-K and incorporated herein by reference.) 10.14++ Compensation program for members of the Registrant’s Board of Directors, effective May 30, 2006. (Detailed in Registrant’s June 5, 2006 Form 8-K and incorporated herein by reference.) 10.15++ Offer Letter between the Registrant and Craig A. Dynes dated September 7, 2006. (Filed as Exhibit 99.1 to the Registrant’s September 7, 2006 Form 8-K and incorporated herein by reference.) Table of Contents 74 10.16 Amendment Number 10 to Lease Agreement dated July 24, 2006 between the Registrant and NOP Riverfront LLC. (Filed as exhibit 10.1 to the Registrant’s September 30, 2006 Form 10-Q and incorporated herein by reference.) 10.17++ Amendment to Stock Option Agreement between the Registrant and Richard H. Jones dated December 29, 2006. (Filed as Exhibit 99.1 to the Registrant’s January 4, 2007 Form 8-K and incorporated herein by reference.) 10.18++ 2008 Section 16 Officers Corporate Incentive Compensation Plan. (Filed as Exhibit 99.1 to the Registrant’s February 21, 2008 Form 8-K and incorporated herein by reference.) 10.19++ 2008 Section 16 Officers Base Salaries and Target Bonus Payments. (Filed as Exhibit 99.2 to the Registrant’s February 21, 2008 Form 8-K and incorporated herein by reference.) 10.20++ Offer Letter between the Registrant and Efstathios A. Kouninis dated April 25, 2008. (Filed as Exhibit 99.1 to the Registrant’s June 5, 2008 Form 8-K and incorporated herein by reference.) 10.21 Amendment Number 11 to Lease Agreement dated as of June 11, 2008 between the Registrant and NOP Riverfront LLC. (Filed as Exhibit 10.2 to the Registrant’s June 30, 2008 Form 10-Q and incorporated herein by reference.) 10.22++ Offer Letter between the Registrant and Max Mayer dated April 20, 2004. 10.23++ Director Indemnification Agreement dated as of March 8, 2009 by and between Pegasystems Inc. and Peter Gyenes. (Filed as Exhibit 99.1 to the Registrant’s March 11, 2009 Form 8-K and incorporated herein by reference.) 10.24++ 2009 Section 16 Officer/FLT Member Corporate Incentive Compensation Plan. (Filed as Exhibit 99.1 to the Registrant’s March 19, 2009 Form 8-K and incorporated herein by reference.) 10.25++ 2009 Executive Officers Base Salaries and Target Bonus Payments. (Filed as Exhibit 99.2 to the Registrant’s March 19, 2009 Form 8-K and incorporated herein by reference.) 10.26++ Director Indemnification Agreement dated as of March 26, 2009 by and between Pegasystems Inc. and Craig Conway. (Filed as Exhibit 99.1 to the Registrant’s April 1, 2009 Form 8-K and incorporated herein by reference.) 10.27++ 2010 Section 16 Officer/FLT Member Corporate Incentive Compensation Plan. (Filed as Exhibit 99.1 to the Registrant’s February 17, 2010 Form 8-K and incorporated herein by reference.) 10.28++ 2010 Section Executive Officers Base Salaries and Target Bonus Payments. (Filed as Exhibit 99.2 to the Registrant’s February 17, 2010 Form 8-K and incorporated herein by reference.) +21.1 Subsidiaries of the Registrant. +23.1 Consent of Independent Registered Public Accounting Firm—Deloitte & Touche LLP. +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. ++ Management contracts and compensatory plan or arrangements required to be filed pursuant to Item 15(c) of Form 10-K. + Filed herewith Exhibit 10.8 Pegasystems Inc. Effective (“Grant Date”), you (the “Optionee”) have been granted a Nonstatutory Stock Option (the “Option”) to buy shares of Pegasystems Inc. (the “Company”) common stock at an exercise price of US per share (the “Exercise Price”), pursuant to the Pegasystems Inc. 2004 Long-Term Incentive Plan (the “Plan”). The total exercise price of the shares granted is US . Shares subject to this Option will vest 20% on the first anniversary of the Grant Date and the balance of 80% will vest in 16 equal quarterly installments between the first and fifth anniversaries of the Grant Date. Expiration: Options expire in ten years from the Grant Date. The undersigned Optionee agrees to all of the terms of the Plan and all those set forth on Exhibits A and B attached hereto and incorporated herein by reference (the “Option Agreement”). IN WITNESS WHEREOF, the Company and the Optionee have executed this instrument as of the date set forth above. Pegasystems Inc. Notice of Grant of Stock Option and Option Agreement ID: 04-2787865 101 Main Street Cambridge, MA 02142 FIRST_NAME_ MIDDLE_NAME _ LAST_NAME _ Option Number: ADDRESS_LINE 1 Plan: CITY STATE COUNTRY ZIPCODE ID: Pegasystems Inc. By: Alan Trefler, Chairman and Chief Executive Officer FIRST_NAME_ MIDDLE_NAME LAST_NAME Exhibit A To Notice of Grant of Stock Option and Option Agreement for Non-U.S. Employees 1. Exercise Price . The Exercise Price is equal to Fair Market Value, as defined in Section 2(o) of the Plan, of a share of the Company’s Common Stock on the date of the Notice of Grant of Stock Option and Option Agreement for Non-U.S. Employees (of which this Exhibit A is a part) (the “Option Agreement”). 2. Option Exercise . Once vested, the Option shall remain exercisable in whole or in part at any time through and including the day immediately preceding the date set forth under the heading “Expiration” on the Option Agreement (the “Expiration Date”), after which the Option shall expire and no longer be exercisable. The Option shall be exercisable by notice to the Company or the Company’s designated stock option administrator, which shall: (a) state the election to exercise the Option, the number of shares of Common Stock with respect to which it is being exercised, and, if different than the Optionee, the person in whose name the stock certificate or certificates for such shares of Common Stock are to be registered, and the address and Social Security number of such person; (b) be signed by the person or persons entitled to exercise the Option, and if the Option is being exercised by a person or persons other than the Optionee, be accompanied by proof satisfactory to the Company’s legal counsel of the right of such person or persons to exercise the Option; and (c) if to the Company, be in writing and delivered in person or by certified mail to the Chief Financial Officer of the Company or, if to the Company’s designated stock option administrator, be in the manner and form specified by such stock option administrator. Payment of the full purchase price of any shares of Common Stock, with respect to which the Option is being exercised, shall accompany the notice of exercise of the Option and such payment may be made in cash or check payable to the Company. Alternatively, the Optionee may elect to pay the full purchase price of any shares of Common Stock, with respect to which the Option is being exercised, by having the Company withhold, or by tendering to the Company through a stock swap, such number of shares of Common Stock as are equal in value to the full purchase price. The certificate or certificates for shares of Common Stock as to which the Option is exercised shall be registered in the name of the person or persons exercising the Option. 3. Termination of Service . If the Optionee terminates Service other than by reason of the Optionee’s death, Disability or Retirement, the Optionee may exercise his or her Option for three months following such termination to the extent that the Option is vested on the date of termination (but in no event later than the expiration of the term of the Option). 4. Retirement of Optionee . If the Optionee terminates Service as a result of Retirement, the Optionee may exercise his or her Option for 24 months following such termination to the extent that the Option is vested on the date of termination (but in no event later than the expiration of the term of the Option). 5. Disability of Optionee . If the Optionee terminates Service as a result of the Optionee’s Disability, the Optionee may exercise his or her Option for 24 months following such termination to the extent that the Option is vested on the date of termination (but in no event later than the expiration of the term of the Option). 6. Death of Optionee . If the Optionee dies while a Service Provider, the Option may be exercised by the Optionee’s estate or by a person who acquires the right to exercise the Option by bequest or inheritance for 12 months following the Optionee’s termination of Service because of death. 7. Optionee’s Agreement . The Optionee agrees to all the terms stated in the Option Agreement (of which this Exhibit is a part), as well as to the terms of the Plan (which shall control in case of conflict with the Option Agreement), a copy of which is attached and of which the Optionee acknowledges receipt. 8. Withholding . Regardless of any action the Company and/or the Optionee’s employer (the “Employer”) take with respect to any or all income tax (including U.S. federal, state and local tax and/or non-U.S. tax), social insurance, payroll tax, payment on account or other tax-related withholding (“Tax-Related Items”), the Optionee acknowledges that the ultimate liability for all Tax-Related Items legally due by the Optionee is and remains the Optionee’s responsibility and that the Company and/or the Employer (i) make no representations or undertakings regarding the treatment of any Tax-Related Items in connection with any aspect of the Option, including the grant, vesting or exercise of the Options, the subsequent sale of any shares of Common Stock acquired at exercise and the receipt of any dividends; and (ii) do not commit to structure the terms of the grant or any aspect of the Option to reduce or eliminate the Optionee’s liability for Tax-Related Items. Prior to the relevant taxable event, the Optionee shall pay or make arrangements satisfactory to the Company and/or the Employer to satisfy all withholding and payment on account obligations of the Company and/or the Employer. In this regard, the Optionee authorizes the Company and/or the Employer to withhold all applicable Tax-Related Items legally payable by the Optionee from any wages or other cash compensation paid to the Optionee by the Company and/or the Employer. Alternatively, or in addition, if permissible under local law, the Optionee authorizes the Company and/or the Employer, at its discretion and pursuant to such procedures as it may specify from time to time, to satisfy the obligations with regard to all Tax-Related Items legally payable by the Optionee by one or a combination of the following: (i) withholding otherwise deliverable shares of Common Stock, provided that the Company only withholds the amount of shares of Common Stock necessary to satisfy the minimum withholding amount; (ii) arranging for the sale of shares of Common Stock otherwise deliverable to the Optionee (on the Optionee’s behalf and at the Optionee’s direction pursuant to this authorization); or (iii) withholding from the proceeds of the sale of shares of Common Stock acquired upon exercise of the Option. If the obligation for Tax-Related Items is satisfied by withholding a number of shares of Common Stock as described herein, the Optionee is deemed to have been issued the full number of shares of Common Stock subject to the Option, notwithstanding that a number of the shares of Common Stock are held back solely for the purpose of paying the Tax-Related Items due as a result of any aspect of the Option. The Optionee shall pay to the Company and/or the Employer any amount of Tax-Related Items that the Company and/or the Employer may be required to withhold as a result of the Optionee’s participation in the Plan that cannot be satisfied by the means previously described. The Company may refuse to deliver to the Optionee any shares of Common Stock pursuant to the Option if the Optionee fails to comply with the Optionee’s obligations in connection with the Tax-Related Items as described in this section. 9. Rights as Shareholders . The Optionee shall have no rights as a shareholder of the Company with respect to any of the shares of Common Stock covered by the Option until the issuance of a stock certificate or certificates upon the exercise of the Option, and then only with respect to the shares of Common Stock represented by such certificate or certificates. 10. Non-Transferability . The Option may not be transferred in any manner other than by will or by the laws of descent and distribution. The terms of the Option shall be binding upon the executors, administrators, heirs and successors of the Optionee. 11. Compliance with Securities, Tax and Other Law . The Option may not be exercised if the issuance of shares of Common Stock upon such exercise would constitute a violation of any applicable federal or state securities law or any other law or valid regulation. As a condition to the exercise of the Option, the Company may require the Optionee, or any person acquiring the right to exercise the Option, to make any representation or warranty that the Company deems to be necessary under any applicable securities, tax, or other law or regulation. 12. Adjustments upon Changes in Capitalization . In the event of any change in the shares subject to the Plan or to any Option granted under the Plan by reason of a merger, consolidation, reorganization, recapitalization, stock dividend, stock split, combination or exchange of shares of Common Stock, or other change in the structure of the Company, the number of shares of Common Stock subject to each outstanding Option and/or the Option price with respect to the shares of Common Stock shall be appropriately adjusted by the Company and such adjustment shall be final, binding and conclusive. 13. No Right to Employment . The granting of the Option does not confer upon the Optionee the right to continue in the Service of the Company, or affect in any way the right and power of the Company to terminate the Service of the Optionee at any time with or without assigning a reason therefor, to the same extent as the Company might have done if the Option had not been granted. 14. No Guarantee . The Company offers no guarantee or assurance that the Company’s stock has any value at the time of this grant or will have any value or liquidity at any future time. 15. Acknowledgment of Nature of Plan and Option . In accepting the Option, the Optionee acknowledges that: (a) the Plan is established voluntarily by the Company, it is discretionary in nature, and it may be modified, amended, suspended or terminated by the Company at any time, unless otherwise provided in the Plan and this Option Agreement; (b) the Option is voluntary and occasional and does not create any contractual or other right to receive future grants of Options, or benefits in lieu of Options, even if Options have been granted repeatedly in the past; (c) all decisions with respect to future Options, if any, will be at the sole discretion of the Company; (d) the Optionee’s participation in the Plan is voluntary; (e) the Option is an extraordinary item that does not constitute compensation for services of any kind rendered to the Company or any Related Company, and which is outside the scope of the employment contract, if any; (f) the Option is not part of normal or expected compensation or salary for any purposes, including, but not limited to, calculation of any severance, resignation, termination, redundancy, end of service payments, bonuses, long-service awards, pension or retirement or welfare benefits or similar payments and in no event should be considered as compensation for, or relating in any way to, past services for the Company or any Related Company; (g) in the event that the Optionee is not an Employee of the Company or any Related Company, the Option and the Optionee’s participation in the Plan will not be interpreted to form an employment or service contract or relationship with the Company or any Related Company; (h) the future value of the underlying shares of Common Stock is unknown and cannot be predicted with any certainty; (i) if you exercise your Option and obtain shares of Common Stock, the value of those shares of Common Stock acquired upon exercise may increase or decrease in value, even below the Option price; (j) in consideration of the Option, no claim or entitlement to compensation or damages shall arise from termination of the Option or from any diminution in value of the Option or shares of Common Stock acquired upon exercise of the Option resulting from termination of the Optionee’s service by the Company or any Related Company (for any reason whatsoever and whether or not in breach of local labor laws) and the Optionee irrevocably releases the Company and any Related Company from any such claim that may arise; if, notwithstanding the foregoing, any such claim is found by a court of competent jurisdiction to have arisen, then, by signing the Option Agreement, the Optionee shall be deemed irrevocably to have waived the Optionee’s entitlement to pursue such claim; (k) in the event of termination of the Optionee’s Service (whether or not in breach of local labor laws), the Optionee’s right to receive an Option and vest in the Option under the Plan, if any, will terminate effective as of the date that the Optionee is no longer actively employed and will not be extended by any notice period mandated under local law ( e.g. , active employment would not include a period of “garden leave” or similar period pursuant to local law); the Administrator shall have the exclusive discretion to determine when the Optionee is no longer actively employed for purposes of the Option; (l) the Company is not providing any tax, legal or financial advice, nor is the Company making any recommendations regarding the Optionee’s participation in the Plan or the Optionee’s acquisition or sale of the underlying shares of Common Stock; and (m) the Optionee is hereby advised to consult with the Optionee’s personal tax, legal and financial advisors regarding the Optionee’s participation in the Plan before taking any action related to the Plan. 16. Data Privacy Notice and Consent . The Optionee hereby explicitly and unambiguously consents to the collection, use and transfer, in electronic or other form, of the Optionee’s personal data as described in this Option Agreement and any other Option grant materials by and among, as applicable, the Employer, the Company and its Subsidiaries for the exclusive purpose of implementing, administering and managing the Optionee’s participation in the Plan. The Optionee understands that the Company and the Employer may hold certain personal information about the Optionee, including, but not limited to, the Optionee’s name, home address and telephone number, date of birth, social insurance number or other identification number, salary, nationality, job title, any shares of stock or directorships held in the Company, details of all Options or any other entitlement to shares of stock granted, exercised, canceled, vested, unvested or outstanding in the Optionee’s favor, for the exclusive purpose of implementing, administering and managing the Plan (“Data”). The Optionee understands that Data will be transferred to a third party stock plan service provider(s) as may be selected by the Company, which is assisting the Company with the implementation, administration and management of the Plan. The Optionee understands the recipients of the Data may be located in the Optionee’s country, in the United States or elsewhere, and that the data recipients’ country may have different data privacy laws and protections than the Optionee’s country. The Optionee understands that the Optionee may request a list with the names and addresses of any potential recipients of the Data by contacting the Optionee’s local human resources representative. The Optionee authorizes the Company and any other possible recipients which may assist the Company (presently or in the future) with implementing, administering and managing the Plan to receive, possess, use, retain and transfer the Data, in electronic or other form, for the sole purpose of implementing, administering and managing the Optionee’s participation in the Plan. The Optionee understands that Data will be held only as long as is necessary to implement, administer and manage the Optionee’s participation in the Plan. The Optionee understands that the Optionee may, at any time, view Data, request additional information about the storage and processing of Data, require any necessary amendments to Data or refuse or withdraw the consents herein, in any case without cost, by contacting in writing the Optionee’s local human resources representative. The Optionee understands, however, that refusing or withdrawing the Optionee’s consent may affect the Optionee’s ability to participate in the Plan. For more information on the consequences of the Optionee’s refusal to consent or withdrawal of consent, the Optionee understands that the Optionee may contact the Optionee’s local human resources representative. 17. Amendment and Termination of Option . The Company may not, without the consent of the Optionee, alter or impair any Option granted under the Plan. The Option shall be considered terminated in whole or in part, to the extent that, in accordance with the provisions of the Plan, it can no longer be exercised for shares of Common Stock originally subject to the Option. 18. Language . If the Optionee has received this Option Agreement or any other document related to the Plan translated into a language other than English and if the translated version is different from the English version, the English version will control. 19. Electronic Delivery . The Company may, in its sole discretion, decide to deliver any documents related to the Option or future grants made under the Plan by electronic means or request that the Optionee consent to participate in the Plan by electronic means. The Optionee hereby consents to receive such documents by electronic delivery and agrees to participate in the Plan through an on-line or electronic system established and maintained by the Company or a third party designated by the Company. 20. Governing Law . The Option Agreement shall be governed by and interpreted in accordance with the laws of The Commonwealth of Massachusetts, without regard to any applicable conflicts of law provisions thereof. For purposes of litigating any dispute that arises directly or indirectly from the relationship of the parties evidenced by this Option or this Option Agreement, the parties hereby submit to and consent to the exclusive jurisdiction of The Commonwealth of Massachusetts and agree that such litigation shall be conducted only in the courts of Middlesex County, Massachusetts, or the federal courts for the United States for the district of Massachusetts, and no other courts, where this grant of Options is made and/or to be performed. 21. Severability . In the event any one or more of the provisions of the Option Agreement shall for any reason be held to be invalid, illegal or unenforceable, the remaining provisions of the Option Agreement shall be unimpaired, and the invalid, illegal or unenforceable provision shall be replaced by a mutually acceptable provision, which being valid, legal and enforceable, comes closest to the intention of the parties underlying the invalid, illegal or unenforceable provision. 22. Definitions . All capitalized terms used herein and not otherwise defined shall have the meanings assigned to such terms in the Plan. 23. Exhibit B . Notwithstanding any provision herein, the Optionee’s participation in the Plan shall be subject to any special terms and conditions as set forth in Exhibit B for the Optionee’s country of residence, if any. The Exhibit B constitutes part of this Option Agreement. Exhibit B To Notice of Grant of Option and Option Agreement for Non-U.S. Employees This Exhibit B includes additional terms and conditions that govern the Options granted to the Optionee if the Optionee resides in the countries contained herein. Capitalized terms used but not defined herein shall have the meanings ascribed to them in the Notice of Grant of Option and Option Agreement for Non-U.S. Employees ( of which this Exhibit B is a part ) or the Plan. This Exhibit B also includes information regarding exchange controls and certain other issues of which the Optionee should be aware with respect to the Optionee’s participation in the Plan. The information is based on the securities, exchange control and other laws in effect in the respective countries as of December 2009. Such laws are often complex and change frequently. As a result, the Company strongly recommends that the Optionee not rely on the information noted herein as the only source of information relating to the consequences of the Optionee’s participation in the Plan because the information may be out of date at the time the Optionee acquires shares of Common Stock or sells shares of Common Stock the Optionee acquires under the Plan. In addition, the information is general in nature and may not apply to the Optionee’s particular situation, and the Company is not in a position to assure the Optionee of any particular result. Accordingly, the Optionee is strongly advised to seek appropriate professional advice as to how the relevant laws in the Optionee’s country apply to the Optionee’s specific situation. If the Optionee is a citizen or resident of another country, or is considered a resident of another country for local law purposes, the information contained in this Exhibit B may not be applicable to the Optionee. Australia Withholding This provision supplements Section 8 (Withholding): Prior to the relevant taxable event, the Optionee will provide the Company with their Australian Tax File Number (TFN) or Australian Business Number (ABN). Failure to do so will result in the requirement for the Company to withhold Australian tax at the rate of 46.5%. Reform to the taxation of employee share schemes With effect from 1 July 2009, Optionee share options shall be taxed upfront, unless there is a “real risk of forfeiture”. Where there is a “real risk of forfeiture,” options shall generally be taxed at the earliest of: • Vesting of the option • Cessation of employment • 7 years after grant Canada Option Exercise The paragraphs below replace Section 2 (Option Exercise) of Exhibit A to the Option Agreement: Once vested, the Option shall remain exercisable in whole or in part at any time through and including the day immediately preceding the date set forth under the heading “Expiration” on the Option Agreement (the “Expiration Date”), after which the Option shall expire and no longer be exercisable. The Option shall be exercisable by notice to the Company or the Company’s designated stock option administrator, which shall: Payment of the full purchase price of any shares of Common Stock, with respect to which the Option is being exercised, shall accompany the notice of exercise of the Option and such payment may be made in cash or check payable to the Company. Alternatively, the Optionee may elect to pay the full purchase price of any shares of Common Stock, with respect to which the Option is being exercised, by having the Company withhold such number of shares of Common Stock as are equal in value to the full purchase price. The certificate or certificates for shares of Common Stock as to which the Option is exercised shall be registered in the name of the Optionee. For further clarity, any shares issued of the Common Stock of the Company upon exercise of an Option shall be issued solely in the name of the Optionee and not in the name of any other person, including a person with whom the Optionee is dealing at non-arm’s length. Upon exercise of the Option, the Optionee shall receive shares of the Common Stock of the Company and under no circumstances shall the Administrator elect to have the employee receive cash (or any other security) in lieu of the Common Stock of the Company. To this effect, section 13(e) of the Plan (and any other similar section) do not apply in Canada. Furthermore, at all times the Optionee should hold less than 10% of the shares of the Common Stock of the Company or any Related Company. Withholding The paragraphs below replace Section 8 of Exhibit A to the Option Agreement: Generally, there are Canadian requirements to withhold source deductions on stock options benefits. Although stock options benefits are considered to be remuneration subject to source deductions, Canada recognizes that requiring additional withholding from cash payments, such as normal salary, as a result of a stock option benefit can create hardship for the employee. This hardship will be created when either the benefit is very large in proportion to the employee’s normal salary or the option is exercised later in the year. As a result, employers may make withholdings from employees’ cash remuneration to the extent possible, without imposing actual hardship. Where the non-cash benefit is the only form of income received from that employer, the employer will not be required to withhold tax on the amount of such benefits. Stock option benefits are also subject to social security taxes in Canada. These benefits are subject to Canada Pension Plan withholdings but not Employment Insurance withholdings. The province of Ontario will also levy payroll taxes to fund the Canadian health service. (a) state the election to exercise the Option and the number of shares of Common Stock with respect to which it is being exercised, (b) be signed by the Optionee; and (c) if to the Company, be in writing and delivered in person or by certified mail to the Chief Financial Officer of the Company or, if to the Company’s designated stock option administrator, be in the manner and form specified by such stock option administrator. The employment benefit and, if applicable, related 50% deduction will be reported on the Optionee T4 for the year in which the tradable options are exercised or sold. The Optionee must report these amounts on his or her individual income tax return for the same year. If the Optionee qualifies and elects to defer a part of the employment benefit arising on exercise to the date of sale, the employer (i.e. the Related Company) will report the deferred benefit on the T4 slip in the year of exercise, however the benefit will not be included in income for that year. The Optionee must complete and file Form T1212, “Statement of Deferred Security Option Benefits” with his or her federal tax return for each year in which arises a balance of deferred benefit outstanding. In the year the Optionee sells the shares, the Optionee must report the deferred benefit on his or her tax return. Acknowledgement of nature of plan The paragraphs below replace Section 15 of Exhibit A to the Option Agreement [new or amended paragraphs are shown in italics at g and j]: In accepting the Option, the Optionee acknowledges that: (a) the Plan is established voluntarily by the Company, it is discretionary in nature, and it may be modified, amended, suspended or terminated by the Company at any time, unless otherwise provided in the Plan and this Option Agreement; (b) the Option is voluntary and occasional and does not create any contractual or other right to receive future grants of Options, or benefits in lieu of Options, even if Options have been granted repeatedly in the past; (c) all decisions with respect to future Options, if any, will be at the sole discretion of the Company; (d) the Optionee’s participation in the Plan is voluntary; (e) the Option is an extraordinary item that does not constitute compensation for services of any kind rendered to the Company or any Related Company, and which is outside the scope of the employment contract, if any; (f) the Option is not part of normal or expected compensation or salary for any purposes, including, but not limited to, calculation of any severance, resignation, termination, redundancy, end of service payments, bonuses, long-service awards, pension or retirement or welfare benefits or similar payments and in no event should be considered as compensation for, or relating in any way to, past services for the Company or any Related Company; (g) the Company has decided to grant Options under the Plan to individuals who are employees of the Company or any Related Company; and under no circumstances, the Optionee should be considered a Consultant or a “non-employee Officer or non-employee Director” of the Company or any Related Company; (h) the future value of the underlying shares of Common Stock is unknown and cannot be predicted with any certainty; (i) if you exercise your Option and obtain shares of Common Stock, the value of those shares of Common Stock acquired upon exercise may increase or decrease in value, even below the Option price; (j) at all times the Optionee should hold less than 10% of the shares of the Common Stock of the Company or any Related Company;  Germany Exchange Control Information Cross-border payments in excess of €12,500 must be reported monthly to the German Federal Bank. If the Optionee uses a German bank to transfer a cross-border payment in excess of €12,500 in connection with the sale of shares of Common Stock acquired under the Plan, the bank will make the report for the Optionee. In addition, the Optionee must report any receivables or payables or debts in foreign currency exceeding €5,000,000 on a monthly basis. Hong Kong Obligation to report the share option gains to the tax authority The Optionee is obliged to declare the gains realized by the exercise, assignment or release of the share options to the Hong Kong Inland Revenue Department (“IRD”) in their Individual Tax Return for the year of assessment in which the share options are exercised, assigned or released. If the Optionee is eligible to lodge any offshore non-taxable claim on their share option gains, the Optionee is required to lodge such claim in their Individual Tax Return. Therefore, it is the Optionee’s responsibility to prove to the satisfaction of the IRD on their non-taxable claim lodged with documentary evidence in support. Reporting requirement Upon the commencement of Hong Kong employment/assignment of the Optionee, the Optionee’s employer (the “Employer”) is obliged to file the Commencement Notice (Form IR 56E) for reporting the term of employment and share options details to the IRD within 3 months from the date of commencement of employment. Annual Employer’s Return (Form IR 56B) is required to be filed to the IRD by end of April to report the remuneration paid/accrued to the Optionee, including the share option gains, for each year ended 31 March. Further to the filing of the said Forms, the IRD will normally create a tax file for the Optionee and issue the annual Individual Tax Return to the Optionee (usually in May) to ascertain their tax position. If there is no Individual Tax Return issued by the IRD to the Optionee for reporting the share option gain in the year of exercise, the Optionee is obliged to voluntarily inform the IRD on this tax chargeability arising from the exercise as well as other Hong Kong taxable employment income within four months after the end of the basis period during which the year of assessment is concerned (i.e. the informing deadline is 31 July given the fiscal year ends on 31 March). (k) in consideration of the Option, no claim or entitlement to compensation or damages shall arise from termination of the Option or from any diminution in value of the Option or shares of Common Stock acquired upon exercise of the Option resulting from termination of the Optionee’s service by the Company or any Related Company (for any reason whatsoever and whether or not in breach of local labor laws) and the Optionee irrevocable releases the Company and any Related Company from any such claim that may arise; if, notwithstanding the foregoing, any such claim is found by a court of competent jurisdiction to have arisen, then, by signing the Option Agreement, the Optionee shall be deemed irrevocably to have waived the Optionee’s entitlement to pursue such claim; (l) in the event of termination of the Optionee’s Service (whether or not in breach of local labor laws), the Optionee’s right to receive an Option and vest in the Option under the Plan, if any, will terminate effective as of the date that the Optionee is no longer actively employed and will not be extended by any notice period mandated under local law (e.g., active employment would not include a period of “garden leave” or similar period pursuant to local law); the Administrator shall have the exclusive discretion to determine when the Optionee is no longer actively employed for purposes of the Option; (m) the Company is not providing any tax, legal or financial advice, nor is the Company making any recommendations regarding the Optionee’s participation in the Plan or the Optionee’s acquisition or sale of the underlying shares of Common Stock; and (n) the Optionee is hereby advised to consult with the Optionee’s personal tax, legal and financial advisors regarding the Optionee’s participation in the Plan before taking any action related to the Plan. Leaving Hong Kong If the share option is only exercised, assigned or released after the Optionee permanently departs from Hong Kong, the Employer should report the share option gains by filing the Departure Notice (Form IR 56G) and provide a copy for the Optionee. The Optionee also needs to discharge their voluntary informing chargeability obligation as mentioned above not later than 4 months after the end of the year of assessment in which the share option gains are derived. Even if the Employer fails to submit the Departure Notice to report the taxable share option gain, the Optionee still needs to comply with their own reporting obligation. In order to assist with finalizing the salary-related tax liabilities prior to permanent departure, the Optionee is allowed, as a concession, to elect to have the tax liabilities finalized on the basis of a notional exercise of the share options. The notional gain is calculated on the basis as if the options had been exercised on a day within 7 days before the date of submission of the Optionee’s tax return for the final year of assessment in which the Optionee departs. As a further concession, the IRD is prepared to accept an election made within 3 months from the date of departure from Hong Kong if no election has been made before departure. In this case, the date of departure will be taken as the date of notional exercise for the purpose of calculating the gain. An election once made cannot be withdrawn before the actual exercise, assignment or release, except: If it transpires that the gain in respect of the actual exercise, assignment or release is less than the amount assessed in respect of the notional exercise, the IRD has indicated in its Departmental Interpretation and Practice Note that they will favorably consider any application for appropriate amendment and re-assessment. Withholding The paragraphs below supplement Section 8 (Withholding) of Exhibit A to the Option Agreement. The Employer is not required to withhold the Optionee’s share option gains unless the Optionee permanently departs from Hong Kong. The Employer is statutorily required to withhold money payment from the Optionee for a period of one month after the Departure Notification (Form IR 56G) was filed to the IRD, unless consent (by the issue of a Letter of Release to the employer with a copy to the Optionee after they have settled all their tax liabilities) is given by the IRD. Hence, if the Optionee derives share option gains and there is money paid to them by the Employer, the Employer has the withholding obligation. (i) within the objection period of the assessment in which the gain of the notional exercise is included; or (ii) total forfeiture of the options with no replacement or compensation before the actual exercise. India Exchange Control Information As per the foreign exchange laws (“regulations”) in India, there are no restrictions on the amount of remittances that the Optionee can make for acquiring Options provided that the following conditions are fulfilled: Ireland Restriction on Types of Shares Issued to Directors If the Optionee is a director or shadow director of an Irish Subsidiary, the Optionee’s Options will be paid in newly issued shares of Common Stock only. In no event will the Options be settled in treasury shares. Director Notification Requirement If the Optionee is a director, shadow director or secretary of an Irish Subsidiary, the Optionee must notify the Irish Subsidiary in writing within five business days of receiving or disposing of an interest in the Company ( e.g ., Options, shares of Common Stock, etc.), or within five business days of becoming aware of the event giving rise to the notification requirement, or within five business days of becoming a director or secretary if such an interest exists at the time. This notification requirement also applies with respect to the interests of a spouse or minor children (whose interests will be attributed to the director, shadow director or secretary). Netherlands By participating in the Plan the Optionee acknowledges that the Optionee’s Options can cease to vest on termination of employment under the terms of the Plan. It is a condition of participation in the Plan that the Optionee agrees to these terms. Poland Securities reporting If the Optionee holds more than €10,000 of foreign securities (including following the grant of Options) the Optionee must declare details of the shares and options (whether or not the options have vested) to the National Bank of Poland. The form of declaration must be submitted within 30 days of the end of the year. Singapore Leaving Singapore With effect from January 1, 2003, Optionees who are foreign citizens or are Singapore Permanent residents leaving Singapore permanently are taxed on a “deemed exercise” basis for any options or units or shares granted or issued during Singapore employment. This would also include any unvested or restricted options or units or shares granted whilst exercising employment in Singapore. 1. The Company issuing the shares effectively, directly or indirectly, holds in the Indian company, whose employees / directors are being offered shares, not less than 51% of its equity, and 2. The shares under the Plan are offered by the issuing company globally on a uniform basis (with the same terms and with the same rights) . As per the deemed exercise rule, all Options, units, or stock which have been granted during Singapore employment are deemed to have been exercised, irrespective whether the Options have vested or not. The taxable value is the difference between the fair market value (which would be the fair market value one month prior to the date of departure) and the exercise price. Director withholding Independent Directors who are Non Resident in Singapore and have received Options by virtue of their being on the Board of the Singapore Company will be subject to tax in Singapore and liable for tax withholding. Spain This provision supplements Section 15 (Acknowledgment of Nature of Plan and Option) of Exhibit A to the Option Agreement: In accepting the Options, the Optionee consents to participation in the Plan and acknowledges that the Optionee has received a copy of the Plan. The Optionee understands that the Company has unilaterally, gratuitously and discretionally decided to grant Options under the Plan to individuals who may be employees of the Company or its Subsidiaries throughout the world. The decision is a limited decision that is entered into upon the express assumption and condition that any grant will not bind the Company or any Related Company. Consequently, the Optionee understands that the Options are granted on the assumption and condition that the Options and any shares of Common Stock acquired upon exercise of the Options are not a part of any employment contract (either with the Company or any Related Company) and shall not be considered a mandatory benefit, salary for any purposes (including severance compensation) or any other right whatsoever. Further, the Optionee understands that the Optionee will not be entitled to continue vesting in any Options once the Optionee’s Service with the Company or any Related Company ceases. In addition, the Optionee understands that this grant would not be made to the Optionee but for the assumptions and conditions referred to above; thus, the Optionee acknowledges and freely accepts that should any or all of the assumptions be mistaken or should any of the conditions not be met for any reason, then any grant of or right to the Options shall be null and void. Exchange Control Information The Optionee must declare the acquisition of shares of Common Stock to the Dirección General de Política Comercial e Inversiones Exteriores (the DGPCIE) of the Ministerio de Economía for statistical purposes. As the shares are listed on a stock exchange the acquisition will be filled in a form D-5B. The form will be declared to the Registro de Inversiones of the Dirección General de Política Comercial e Inversiones Exteriores of the Ministerio de Industria, Turismo y Comercio. The Optionee must also declare ownership of any shares of Common Stock with the Directorate of Foreign Transactions each January whilst the shares of Common Stock are owned in the following cases: Foreign currency payments (i.e., dividends or sale proceeds) have to be declared when the amount exceed 6,010.12 Euros on form B3. • The shares of the company are listed on the stock exchange. • The shareholding in the company has to be at least 10% or more. • The investment is more than 1,502,530.26 Euros. The information provided to the financial institution is the following: A payment is made by bank transfer the following information should be provided to the financial institution when the amount exceeds 50,000 euros: Sweden No country specific terms and conditions apply. United Kingdom Withholding The paragraphs below replace Section 8 (Withholding) of Exhibit A to the Option Agreement: Regardless of any action the Company or the Optionee’s employer (the “Employer”) takes with respect to any or all income tax, primary and secondary Class 1 National Insurance contributions, payroll tax or other tax-related withholding attributable to or payable in connection with or pursuant to the grant, vesting, exercise, release or assignment of any Option (“Tax-Related Items”), the Optionee acknowledges that the ultimate liability for all Tax-Related Items legally due by the Optionee is and remains the Optionee’s responsibility. Furthermore, the Company and/or the Employer (i) make no representations or undertakings regarding the treatment of any Tax-Related Items in connection with any aspect of the Option, including the grant, vesting or exercise of the Options, the subsequent sale of any shares of Common Stock acquired at exercise and the receipt of any dividends; and (ii) do not commit to structure the terms of the grant or any aspect of the Option to reduce or eliminate the Optionee’s liability for Tax-Related Items. As a condition of any Options becoming exercisable and the issuance of shares of Common Stock upon exercise of the Options, the Company and/or the Employer shall be entitled to withhold and the Optionee agrees to pay, or make adequate arrangements satisfactory to the Company and/or the Employer to satisfy, all obligations of the Company and/or the Employer to account to HM Revenue & Customs (“HMRC”) for any Tax-Related Items by the Due Date, which is 90 days, or such other period as required under U.K. law, after the event giving rise to the Tax-Related Items (the “Chargeable Event”). In this regard, except as provided in the next sentence, such payment shall be made by means of the Company withholding and/or reacquiring a number of shares of Common Stock issued upon exercise of the Options having a Fair Market Value equal to the amount of Tax-Related Items that the Company determines it or the Employer is required to account to HMRC under applicable tax laws with respect to the Options (with such obligation determined based on any applicable minimum statutory withholding rates). In the event that the Company cannot (under applicable legal, regulatory, listing or other requirements, or otherwise) satisfy such obligation in such method, the Company may satisfy its entitlement to withhold under this Option Agreement by either or a combination of the following methods: (i) by requiring the Optionee to pay such amount in cash or check; and/or (ii) by deducting such amount out of any other compensation otherwise payable to the Optionee. For these purposes, the Fair Market Value of the shares of Common Stock to be withheld or repurchased, as applicable, shall be determined on the date that Tax-Related Items are to be determined. • The Optionee’s name, address, and fiscal identification number • Non resident’s name, address and fiscal identification number. • The amount of the payment, payment method, currency of origin and value in euros. • The reasons for the payment. • Resident name, address and fiscal identification number. • Non resident name, address and fiscal identification number. • The amount, currency of origin and value of payment in euros. • The reason for the payment. The Optionee shall pay to the Company or the Employer any amount of Tax-Related Items that the Company or the Employer may be required to account to HMRC with respect to the Chargeable Event that cannot be satisfied by the means previously described. If payment or withholding is not made by the Due Date, the Optionee agrees that the amount of any uncollected Tax-Related Items shall (assuming the Optionee is not a director or executive officer of the Company (within the meaning of Section 13(k) of the U.S. Securities and Exchange Act of 1934, as amended)), constitute a loan owed by the Optionee to the Employer, effective on the Due Date. The Optionee agrees that the loan will bear interest at the then-current HMRC Official Rate and it will be immediately due and repayable, and the Company and/or the Employer may recover it at any time thereafter by any of the means referred to above. If any of the foregoing methods of collection are not allowed under Applicable Laws or if the Optionee fails to comply with the Optionee’s obligations in connection with the Tax-Related Items as described in this section, the Company may refuse to deliver the shares of Common Stock acquired under the Plan. Joint Election As a condition to exercising the Options, the Optionee agrees to accept any liability for secondary Class 1 National Insurance contributions (the “Employer’s Liability”) which may be payable by the Company and/or the Employer in connection with the Options and any event giving rise to Tax-Related Items. To accomplish the foregoing, the Optionee agrees to execute a joint election with the Company (the “Election”), the form of such Election being formally approved by HMRC, and any other consent or elections required to accomplish the transfer of the Employer’s Liability to the Optionee. The Optionee further agrees to execute such other joint elections as may be required between the Optionee and any successor to the Company and/or the Employer. If the Optionee does not enter into the Election when the Optionee accepts the Option Agreement or when otherwise requested by the Company and/or Employer, or if the Election is revoked at any time by HMRC, the Optionee will not be entitled to exercise the Option unless the Optionee agree to pay an amount equal to the Employer’s Liability to the Company, the Employer and/or any Related Company. The Optionee further agrees that the Company and/or the Employer may collect the Employer’s Liability by any of the means set forth in the Withholding section of the Option Agreement. Exhibit 10.9 Pegasystems Inc. Effective (“Grant Date”), you (the “Recipient”) have been granted an award of restricted stock units pursuant to the Pegasystems Inc. 2004 Long-Term Incentive Plan (the “Plan”). The current total value of the award is . The awards will vest 20% on the first anniversary of the Grant Date and the balance of 80% will vest in 16 equal quarterly installments between the first and fifth anniversaries of the Grant Date. The undersigned Recipient agrees to all of the terms of the Plan and all those set forth on Exhibits A and B attached hereto and incorporated herein by reference (the “Award Agreement”). By your signature and the Company’s signature below, you and the Company agree that this award is granted under and governed by the terms and conditions of the Plan as amended and the Award Agreement, all of which are attached and made a part of this document. Pegasystems Inc. Notice of Grant of Award and Award Agreement ID: 04-2787865 101 Main Street Cambridge, MA 02142 FIRST_NAME_MIDDLE_NAME_ LAST_NAME_ Award Number: ADDRESS Plan: CITY , STATE COUNTRY ZIPCODE ID: Pegasystems Inc. By: Alan Trefler, Chairman and Chief Executive Officer FIRST_NAME MIDDLE_NAME LAST_NAME Exhibit A To Notice of Grant of Award and Award Agreement for Non-U.S. Employees 1. Conversion of Restricted Stock Units to Common Stock . Each restricted stock unit (“RSU”) granted in the Notice of Grant of Award and Award Agreement for Non-U.S. Employees (of which this Exhibit A is a part) (the “Award Agreement”) represents the right of the person receiving such grant (the “Recipient”) to receive one share of the common stock (“Common Stock”) of Pegasystems Inc. (the “Company”) subject to the vesting requirements listed in the Award Agreement and to the other terms and conditions of this Award Agreement. On each vesting date listed in the Award Agreement, the Company will issue such number of shares of Common Stock as are equal to the applicable number of RSUs vesting on such date, less such number of shares of Common Stock as are required to be withheld to satisfy Recipient’s tax withholding obligations. 2. Vesting . RSUs will vest on the dates listed in the Award Agreement if the Recipient remains in the active employment of the Company in good standing from the date of grant through the applicable vesting date. RSUs will cease to vest immediately upon the cessation of Recipient’s active employment with the Company, for any reason. 3. Recipient’s Agreement . The Recipient agrees to all the terms stated in the Award Agreement (of which this Exhibit is a part), as well as to the terms of the Plan (which shall control in case of conflict with the Award Agreement), a copy of which is attached and of which the Recipient acknowledges receipt. 4. Withholding . Regardless of any action the Company and/or the Recipient’s employer (the “Employer”) take with respect to any or all income tax (including U.S. federal, state and local tax and/or non-U.S. tax), social insurance, payroll tax, payment on account or other tax-related withholding (“Tax-Related Items”), the Recipient acknowledges that the ultimate liability for all Tax-Related Items legally due by the Recipient is and remains the Recipient’s responsibility and that the Company and/or the Employer (i) make no representations or undertakings regarding the treatment of any Tax-Related Items in connection with any aspect of the Award, including the grant of the RSUs, the vesting of the RSUs, the delivery of shares of Common Stock, the subsequent sale of any shares of Common Stock acquired at vesting and the receipt of any dividends or dividend equivalents; and (ii) do not commit to structure the terms of the grant or any aspect of the Award to reduce or eliminate the Recipient’s liability for Tax-Related Items. Prior to the relevant taxable event, the Recipient shall pay or make arrangements satisfactory to the Company and/or the Employer to satisfy all withholding and payment on account obligations of the Company and/or the Employer. In this regard, the Recipient authorizes the Company and/or the Employer to withhold all applicable Tax-Related Items legally payable by the Recipient from any wages or other cash compensation paid to the Recipient by the Company and/or the Employer. Alternatively, or in addition, if permissible under local law, the Recipient authorizes the Company and/or the Employer, at its discretion and pursuant to such procedures as it may specify from time to time, to satisfy the obligations with regard to all Tax-Related Items legally payable by the Recipient by one or a combination of the following: (i) withholding otherwise deliverable shares of Common Stock, provided that the Company only withholds the amount of shares of Common Stock necessary to satisfy the minimum withholding amount; (ii) arranging for the sale of shares of Common Stock otherwise deliverable to the Recipient (on the Recipient’s behalf and at the Recipient’s direction pursuant to this authorization); or (iii) withholding from the proceeds of the sale of shares of Common Stock acquired upon vesting of the Award. If the obligation for Tax-Related Items is satisfied by withholding a number of shares of Common Stock as described herein, the Recipient is deemed to have been issued the full number of shares of Common Stock subject to the Award, notwithstanding that a number of the shares of Common Stock are held back solely for the purpose of paying the Tax-Related Items due as a result of any aspect of the Award. The Recipient shall pay to the Company and/or the Employer any amount of Tax-Related Items that the Company and/or the Employer may be required to withhold as a result of the Recipient’s participation in the Plan that cannot be satisfied by the means previously described. The Company may refuse to deliver to the Recipient any shares of Common Stock pursuant to the Award if the Recipient fails to comply with the Recipient’s obligations in connection with the Tax-Related Items as described in this section. 5. Rights as Shareholders . The Recipient shall have no rights as a shareholder of the Company with respect to any of the RSUs until the issuance of shares of Common Stock at the time of vesting, and then only with respect to those shares of Common Stock issued. 6. Non-Transferability . The Award may not be transferred in any manner other than by will or by the laws of descent and distribution. The terms of the Award shall be binding upon the executors, administrators, heirs and successors of the Recipient. 7. Compliance with Securities, Tax and Other Law . No shares of Common Stock may be issued if the issuance of shares would constitute a violation of any applicable federal or state securities law or any other law or valid regulation. As a condition to issuance of Common Stock, the Company may require the Recipient, or any person acquiring the right to receive the Common Stock, to make any representation or warranty that the Company deems to be necessary under any applicable securities, tax, or other law or regulation. 8. Adjustments upon Changes in Capitalization . In the event of any change in the shares subject to the Plan or to any Award granted under the Plan by reason of a merger, consolidation, reorganization, recapitalization, stock dividend, stock split, combination or exchange of shares, or other change in the structure of the Company, the number of RSUs and the number of shares of Common Stock shall be appropriately adjusted by the Company and such adjustment shall be final, binding and conclusive. 9. No Right to Employment . The granting of the Award does not confer upon the Recipient the right to continue in the service of the Company, or affect in any way the right and power of the Company to terminate the service of the Recipient at any time with or without assigning a reason therefor, to the same extent as the Company might have done if the Award had not been granted. 10. No Guarantee . The Company offers no guarantee or assurance that the Company’s stock has any value at the time of this grant or will have any value or liquidity at any future time. 11. Acknowledgment of Nature of Plan and Award . In accepting the Award, the Recipient acknowledges that: (a) the Plan is established voluntarily by the Company, it is discretionary in nature, and it may be modified, amended, suspended or terminated by the Company at any time, unless otherwise provided in the Plan and this Award Agreement; (b) the Award is voluntary and occasional and does not create any contractual or other right to receive future awards of RSUs, or benefits in lieu of RSUs, even if RSUs have been awarded repeatedly in the past; (c) all decisions with respect to future awards, if any, will be at the sole discretion of the Company; (d) the Recipient’s participation in the Plan is voluntary; (e) the Award is an extraordinary item that does not constitute compensation for services of any kind rendered to the Company or any Related Company, and which is outside the scope of the service contract, if any; (f) the Award is not part of normal or expected compensation or salary for any purposes, including, but not limited to, calculation of any severance, resignation, termination, redundancy, end of service payments, bonuses, long-service awards, pension or retirement or welfare benefits or similar payments and in no event should be considered as compensation for, or relating in any way to, past services for the Company or any Related Company; (g) in the event that the Recipient is not an Employee of the Company or any Related Company, the Award and the Recipient’s participation in the Plan will not be interpreted to form an employment or service contract or relationship with the Company or any Related Company; (h) the future value of the underlying shares of Common Stock is unknown and cannot be predicted with any certainty; (i) in consideration of the Award, no claim or entitlement to compensation or damages shall arise from termination of the Award or from any diminution in value of the Award or shares of Common Stock acquired upon vesting of the Award resulting from termination of the Recipient’s service by the Company or any Related Company (for any reason whatsoever and whether or not in breach of local labor laws) and the Recipient irrevocably releases the Company and any Related Company from any such claim that may arise; if, notwithstanding the foregoing, any such claim is found by a court of competent jurisdiction to have arisen, then, by signing the Award Agreement, the Recipient shall be deemed irrevocably to have waived the Recipient’s entitlement to pursue such claim; (j) in the event of termination of the Recipient’s service (whether or not in breach of local labor laws), the Recipient’s right to receive an Award and vest in the Award under the Plan, if any, will terminate effective as of the date that the Recipient is no longer actively employed and will not be extended by any notice period mandated under local law ( e.g. , active employment would not include a period of “garden leave” or similar period pursuant to local law); the Administrator shall have the exclusive discretion to determine when the Recipient is no longer actively employed for purposes of the Award; (k) the Company is not providing any tax, legal or financial advice, nor is the Company making any recommendations regarding the Recipient’s participation in the Plan or the Recipient’s acquisition or sale of the underlying shares of Common Stock; and (l) the Recipient is hereby advised to consult with the Recipient’s personal tax, legal and financial advisors regarding the Recipient’s participation in the Plan before taking any action related to the Plan. 12. Data Privacy Notice and Consent . The Recipient hereby explicitly and unambiguously consents to the collection, use and transfer, in electronic or other form, of the Recipient’s personal data as described in this Award Agreement and any other RSU grant materials by and among, as applicable, the Employer, the Company and its Subsidiaries for the exclusive purpose of implementing, administering and managing the Recipient’s participation in the Plan. The Recipient understands that the Company and the Employer may hold certain personal information about the Recipient, including, but not limited to, the Recipient’s name, home address and telephone number, date of birth, social insurance number or other identification number, salary, nationality, job title, any shares of stock or directorships held in the Company, details of all RSUs or any other entitlement to shares of stock awarded, canceled, vested, unvested or outstanding in the Recipient’s favor, for the exclusive purpose of implementing, administering and managing the Plan (“Data”). The Recipient understands that Data will be transferred to a third party stock plan service provider(s) as may be selected by the Company, which is assisting the Company with the implementation, administration and management of the Plan. The Recipient understands the recipients of the Data may be located in the Recipient’s country, in the United States or elsewhere, and that the data recipients’ country may have different data privacy laws and protections than the Recipient’s country. The Recipient understands that the Recipient may request a list with the names and addresses of any potential recipients of the Data by contacting the Recipient’s local human resources representative. The Recipient authorizes the Company and any other possible recipients which may assist the Company (presently or in the future) with implementing, administering and managing the Plan to receive, possess, use, retain and transfer the Data, in electronic or other form, for the sole purpose of implementing, administering and managing the Recipient’s participation in the Plan. The Recipient understands that Data will be held only as long as is necessary to implement, administer and manage the Recipient’s participation in the Plan. The Recipient understands that the Recipient may, at any time, view Data, request additional information about the storage and processing of Data, require any necessary amendments to Data or refuse or withdraw the consents herein, in any case without cost, by contacting in writing the Recipient’s local human resources representative. The Recipient understands, however, that refusing or withdrawing the Recipient’s consent may affect the Recipient’s ability to participate in the Plan. For more information on the consequences of the Recipient’s refusal to consent or withdrawal of consent, the Recipient understands that the Recipient may contact the Recipient’s local human resources representative. 13. Amendment and Termination of Award . The Company may not, without the consent of the Recipient, alter or impair any Award granted under the Plan. The Award shall be considered terminated in whole or in part, to the extent that, in accordance with the provisions of the Plan, the Recipient no longer has the right to receive shares of Common Stock under the Plan. 14. Language . If the Recipient has received this Award Agreement or any other document related to the Plan translated into a language other than English and if the translated version is different from the English version, the English version will control. 15. Electronic Delivery . The Company may, in its sole discretion, decide to deliver any documents related to the Award or future awards made under the Plan by electronic means or request that the Recipient consent to participate in the Plan by electronic means. The Recipient hereby consents to receive such documents by electronic delivery and agrees to participate in the Plan through an on-line or electronic system established and maintained by the Company or a third party designated by the Company. 16. Governing Law and Venue . The Award Agreement shall be governed by and interpreted in accordance with the laws of The Commonwealth of Massachusetts, without regard to any applicable conflicts of law provisions thereof. For purposes of litigating any dispute that arises directly or indirectly from the relationship of the parties evidenced by this Award or this Award Agreement, the parties hereby submit to and consent to the exclusive jurisdiction of The Commonwealth of Massachusetts and agree that such litigation shall be conducted only in the courts of Middlesex County, Massachusetts, or the federal courts for the United States for the district of Massachusetts, and no other courts, where this Award of RSUs is made and/or to be performed. 17. Severability . In the event any one or more of the provisions of the Award Agreement shall for any reason be held to be invalid, illegal or unenforceable, the remaining provisions of the Award Agreement shall be unimpaired, and the invalid, illegal or unenforceable provision shall be replaced by a mutually acceptable provision, which being valid, legal and enforceable, comes closest to the intention of the parties underlying the invalid, illegal or unenforceable provision. 18. Definitions . All capitalized terms used herein and not otherwise defined shall have the meanings assigned to such terms in the Plan. 19. Exhibit B . Notwithstanding any provision herein, the Recipient’s participation in the Plan shall be subject to any special terms and conditions as set forth in Exhibit B for the Recipient’s country of residence, if any. The Exhibit B constitutes part of this Award Agreement. Exhibit B To Notice of Grant of Award and Award Agreement for Non-U.S. Employees This Exhibit B includes additional terms and conditions that govern the RSUs granted to the Recipient if the Recipient resides in the countries contained herein. Capitalized terms used but not defined herein shall have the meanings ascribed to them in the Notice of Grant of Award and Award Agreement for Non-U.S. Employees ( of which this Exhibit B is a part ) or the Plan. This Exhibit B also includes information regarding exchange controls and certain other issues of which the Recipient should be aware with respect to the Recipient’s participation in the Plan. The information is based on the securities, exchange control and other laws in effect in the respective countries as of December 2009. Such laws are often complex and change frequently. As a result, the Company strongly recommends that the Recipient not rely on the information noted herein as the only source of information relating to the consequences of the Recipient’s participation in the Plan because the information may be out of date at the time the Recipient acquires shares of Common Stock or sells shares of Common Stock the Recipient acquires under the Plan. In addition, the information is general in nature and may not apply to the Recipient’s particular situation, and the Company is not in a position to assure the Recipient of any particular result. Accordingly, the Recipient is strongly advised to seek appropriate professional advice as to how the relevant laws in the Recipient’s country apply to the Recipient’s specific situation. If the Recipient is a citizen or resident of another country, or is considered a resident of another country for local law purposes, the information contained in this Exhibit B may not be applicable to the Recipient. Australia Withholding This provision supplements Section 8 (Withholding): Prior to the relevant taxable event, the Recipient will provide the Company with their Australian Tax File Number (TFN) or Australian Business Number (ABN). Failure to do so will result in the requirement for the Company to withhold Australian tax at the rate of 46.5%. Reform to the taxation of Employee share schemes With effect from 1 July 2009, RSUs shall be taxed up front, unless there is a “real risk of forfeiture”. Where there is a “real risk of forfeiture,” RSUs shall generally be taxed at the earliest of: Canada Vesting of RSUs Income tax arises on the fair market value of the shares on vesting. No deferral election is possible for RSUs. • Vesting of the award (when it is no longer subject to forfeiture) • Cessation of employment • 7 years after grant For further clarity, any shares issued of the Common Stock of the Company under an RSU shall be issued solely in the name of the Recipient and not in the name of any other person, including a person with whom the Recipient is dealing at non-arm’s length. The Recipient shall receive shares of the Common Stock of the Company and under no circumstances shall the Administrator elect to have the Recipient receive cash (or any other security) in lieu of the Common Stock of the Company. To this effect, section 13(e) of the Plan (and any other similar section) do not apply in Canada. Furthermore, at all times the Recipient should hold less than 10% of the shares of the Common Stock of the Company or any Related Company. Withholding The paragraphs below replace Section 4 of Exhibit A to the Award Agreement: Generally, there are Canadian requirements to withhold source deductions on the vesting of RSUs. Although RSU benefits are considered to be remuneration subject to source deductions, Canada recognizes that requiring additional withholding from cash payments, such as normal salary, as a result of a stock benefit can create hardship for the employee. This hardship will be created when either the benefit is very large in proportion to the employee’s normal salary or the award vests later in the year. As a result, employers may make withholdings from employees’ cash remuneration to the extent possible, without imposing actual hardship. Where the non-cash benefit is the only form of income received from that employer, the employer will not be required to withhold tax on the amount of such benefits. RSU benefits are also subject to social security taxes in Canada. These benefits are subject to Canada Pension Plan withholdings but not Employment Insurance withholdings. The province of Ontario will also levy payroll taxes to fund the Canadian health service. The employment benefit will be reported on the Recipient T4 for the year in which the RSUs vest. The Recipient must report these amounts on his or her individual income tax return for the same year. Acknowledgement of nature of plan The paragraphs below replace Section 11 of Exhibit A to the Award Agreement [new or amended paragraphs are shown in italics at g and i]: In accepting the RSU Award, the Recipient acknowledges that: (a) the Plan is established voluntarily by the Company, it is discretionary in nature, and it may be modified, amended, suspended or terminated by the Company at any time, unless otherwise provided in the Plan and this Agreement; (b) the Award is voluntary and occasional and does not create any contractual or other right to receive future grants of RSU Awards, or benefits in lieu of RSUs, even if RSUs have been granted repeatedly in the past; (c) all decisions with respect to future RSUs, if any, will be at the sole discretion of the Company; (d) the Recipient’s participation in the Plan is voluntary;  Germany Exchange Control Information Cross-border payments in excess of €12,500 must be reported monthly to the German Federal Bank. If the Recipient uses a German bank to transfer a cross-border payment in excess of €12,500 in connection with the sale of shares of Common Stock acquired under the Plan, the bank will make the report for the Recipient. In addition, the Recipient must report any receivables or payables or debts in foreign currency exceeding €5,000,000 on a monthly basis. (e) the Award is an extraordinary item that does not constitute compensation for services of any kind rendered to the Company or any Related Company, and which is outside the scope of the employment contract, if any; (f) the Award is not part of normal or expected compensation or salary for any purposes, including, but not limited to, calculation of any severance, resignation, termination, redundancy, end of service payments, bonuses, long-service awards, pension or retirement or welfare benefits or similar payments and in no event should be considered as compensation for, or relating in any way to, past services for the Company or any Related Company; (g) the Company has decided to grant Awards under the Plan to individuals who are Employees of the Company or any Related Company; and under no circumstances, the Employee should be considered a Consultant or a “non-employee Officer or non-employee Director” of the Company or any Related Company; (h) the future value of the underlying shares of Common Stock is unknown and cannot be predicted with any certainty; (i) at all times the Recipient should hold less than 10% of the shares of the Common Stock of the Company or any Related Company; (j) in consideration of the Award, no claim or entitlement to compensation or damages shall arise from termination of the Award or from any diminution in value of the Award or shares of Common Stock acquired resulting from termination of the Recipient’s service by the Company or any Related Company (for any reason whatsoever and whether or not in breach of local labor laws) and the Recipient irrevocable releases the Company and any Related Company from any such claim that may arise; if, notwithstanding the foregoing, any such claim is found by a court of competent jurisdiction to have arisen, then, by signing the Award Agreement, the Recipient shall be deemed irrevocably to have waived the Recipient’s entitlement to pursue such claim; (k) in the event of termination of the Recipient’s Service (whether or not in breach of local labor laws), the Recipient’s right to receive an Award and vest in the Award under the Plan, if any, will terminate effective as of the date that the Recipient is no longer actively employed and will not be extended by any notice period mandated under local law (e.g., active employment would not include a period of “garden leave” or similar period pursuant to local law); the Administrator shall have the exclusive discretion to determine when the Recipient is no longer actively employed for purposes of the Award; (l) the Company is not providing any tax, legal or financial advice, nor is the Company making any recommendations regarding the Recipient’s participation in the Plan or the Recipient’s acquisition or sale of the underlying shares of Common Stock; and (m) the Recipient is hereby advised to consult with their personal tax, legal and financial advisors regarding the employee’s participation in the Plan before taking any action related to the Plan. Hong Kong Obligation to report the RSUs to the tax authority The Recipient is obliged to declare the gains realized in relation to RSUs to the Hong Kong Inland Revenue Department (“IRD”) in their Individual Tax Return for the relevant year of assessment. If the Recipient is eligible to lodge any offshore non-taxable claim on RSU gains, the Recipient is required to lodge such claim in their Individual Tax Return. Therefore, it is the Recipient’s responsibility to prove to the satisfaction of the IRD on their non-taxable claim lodged with documentary evidence in support. The IRD has issued the revised Departmental Interpretation and Practice Note (“DIPN”) No. 38 regarding the employee share-based benefits in March 2008 which has expressed the IRD’s view on the timing and taxability of the share award benefits. This sets a general guideline for taxpayers in ascertaining the tax treatment of their share award benefits. DIPN is not legally binding and not a rule of law and the revised DIPN No. 38 may not cover every type of share award benefit. Participants should take individual tax advice on their share award benefits. Reporting requirement Upon the commencement of Hong Kong employment/assignment of the Recipient, the employer (the “Employer”) is obliged to file the Commencement Notice (Form IR 56E) for reporting the term of employment and RSU details to the IRD within 3 months from the date of commencement of employment. Annual Employer’s Return (Form IR 56B) is required to be filed to the IRD by end of April to report the remuneration paid/accrued to the Recipient, including the RSU gains, for each year ended 31 March. Further to the filing of the said Forms, the IRD will normally create a tax file for the Recipient and issue the annual Individual Tax Return to the Recipient (usually in May) to ascertain their tax position. If there is no Individual Tax Return issued by the IRD to the Recipient for reporting the RSU gain in the year of award or of vesting, as appropriate, the Recipient is obliged to voluntarily inform the IRD on this tax chargeability arising from the exercise as well as other Hong Kong taxable employment income within four months after the end of the basis period during which the year of assessment is concerned (i.e. the informing deadline is 31 July given the fiscal year ends on 31 March). Leaving Hong Kong If the RSU benefit is taxable in Hong Kong even if it is received after the Recipient permanently departs from Hong Kong, the Employer should report the RSU gains by filing the Departure Notice (Form IR 56G) and provide a copy for the Recipient. The Recipient also needs to discharge their voluntary informing chargeability obligation as mentioned above not later than 4 months after the end of the year of assessment in which the RSU gains are derived. Even if the Employer fails to submit the Departure Notice to report the taxable RSU gain, the Recipient still needs to comply with his or her own reporting obligation. Withholding The paragraphs below supplement Section 4 (Withholding) of Exhibit A to the RSU Award Agreement. The Employer is not required to withhold the Recipient’s share gains unless the Recipient permanently departs from Hong Kong. The Employer is statutorily required to withhold money payment from the Recipient for a period of one month after the Departure Notification (Form IR 56G) was filed to the IRD, unless consent (by the issue of a Letter of Release to the employer with a copy to the Recipient after they have settled all their tax liabilities) is given by the IRD. If the Recipient derives share gains and there is money paid to them by the Employer, the Employer has the withholding obligation. To facilitate finalizing the salary-related tax liabilities prior to permanent departure, the Recipient is allowed, as a concession, to elect to have the tax liabilities finalized on the basis of a deemed vesting of the share awards. The Recipient may elect to be assessed on either (i) the deemed value on a day within 7 days before the submission of the Recipient’s tax return for the final year of assessment in which the Recipient departs or (ii) the deemed value on the date of departure if the election is made within 3 months from the date of permanent departure from Hong Kong. Once an election is accepted by the IRD and the assessment is made accordingly, the election cannot be withdrawn. A subsequent request to revise the assessment will not be entertained unless the assessment is objected to within the statutory time allowed for objection. If the actual share award gain is higher than the amount assessed under deemed vesting, the IRD has indicated in DIPN No. 38 that it will not seek to increase the assessment for the sole reason that the value upon vesting has increased. India No country specific terms and conditions apply. Ireland Restriction on Types of Shares Issued to Directors If the Recipient is a director or shadow director of an Irish Subsidiary, the Recipient’s RSUs will be paid in newly issued shares of Common Stock only. In no event will the RSUs be settled in treasury shares. Director Notification Requirement If the Recipient is a director, shadow director or secretary of an Irish Subsidiary, the Recipient must notify the Irish Subsidiary in writing within five business days of receiving or disposing of an interest in the Company ( e.g ., RSUs, shares of Common Stock, etc.), or within five business days of becoming aware of the event giving rise to the notification requirement, or within five business days of becoming a director or secretary if such an interest exists at the time. This notification requirement also applies with respect to the interests of a spouse or minor children (whose interests will be attributed to the director, shadow director or secretary). Netherlands By participating in the Plan the Recipient acknowledges that his or her Award can cease to vest on termination of employment under the terms of the Plan. It is a condition of participation in the Plan that the Recipient agrees to these terms. Poland Securities reporting If the Recipient holds more than €10,000 of foreign securities (including following the grant of Awards) the Recipient must declare details of the shares (whether or not the shares have vested) to the National Bank of Poland. The form of declaration must be submitted within 30 days of the end of the year. Singapore Leaving Singapore With effect from January 1, 2003, Recipients who are foreign citizens or are Singapore Permanent residents leaving Singapore permanently are taxed on a “deemed exercise” basis for any options or units or shares granted or issued during Singapore employment. This would also include any unvested or restricted options or units or shares granted whilst exercising employment in Singapore. As per the deemed exercise rule, all Awards, units, or stock which have been granted during Singapore employment are deemed to have been exercised, irrespective whether the Awards have vested or not. The taxable value is the fair market value (which would be the fair market value one month prior to the date of departure). Director withholding Independent Directors who are Non Resident in Singapore and have received Awards by virtue of their being on the Board of the Singapore Company will be subject to tax in Singapore and liable for tax withholding. Spain This provision supplements Section 11 (Acknowledgment of Nature of Plan and Award) of Exhibit A to the Award Agreement: In accepting the RSUs, the Recipient consents to participation in the Plan and acknowledges that the Recipient has received a copy of the Plan. The Recipient understands that the Company has unilaterally, gratuitously and discretionally decided to grant RSUs under the Plan to individuals who may be employees of the Company or its Subsidiaries throughout the world. The decision is a limited decision that is entered into upon the express assumption and condition that any grant will not bind the Company or any Related Company. Consequently, the Recipient understands that the RSUs are granted on the assumption and condition that the RSUs and any shares of Common Stock acquired upon vesting of the RSUs are not a part of any employment contract (either with the Company or any Related Company) and shall not be considered a mandatory benefit, salary for any purposes (including severance compensation) or any other right whatsoever. Further, the Recipient understands that the Recipient will not be entitled to continue vesting in any RSUs once the Recipient’s employment with the Company or any Related Company ceases. In addition, the Recipient understands that this grant would not be made to the Recipient but for the assumptions and conditions referred to above; thus, the Recipient acknowledges and freely accepts that should any or all of the assumptions be mistaken or should any of the conditions not be met for any reason, then any grant of or right to the RSUs shall be null and void. Exchange Control Information The Recipient must declare the acquisition of shares of Common Stock to the Dirección General de Política Comercial e Inversiones Exteriores (the DGPCIE) of the Ministerio de Economía for statistical purposes. As the shares are listed on a stock exchange the acquisition will be filled in a form D-5B. The form will be declared to the Registro de Inversiones of the Dirección General de Política Comercial e Inversiones Exteriores of the Ministerio de Industria, Turismo y Comercio. The Recipient must also declare ownership of any shares of Common Stock with the Directorate of Foreign Transactions each January whilst the shares of Common Stock are owned in the following cases: Foreign currency payments (i.e., dividends or sale proceeds) have to be declared when the amount exceeds 6,010.12 Euros on form B3. The information provided to the financial institution is the following: A payment is made by bank transfer the following information should be provided to the financial institution when the amount exceeds 50,000 Euros: Sweden No country specific terms and conditions apply. United Kingdom RSUs Payable Only in Shares of Common Stock Notwithstanding any discretion in the Plan or anything to the contrary in the Award Agreement, if the Recipient is resident and ordinarily resident in the United Kingdom, the grant of RSUs does not provide any right for the Recipient to receive a cash payment and the RSUs are payable in shares of Common Stock only. Withholding The paragraphs below replace Section 4 (Withholding) of Exhibit A to the Award Agreement: Regardless of any action the Company or the Recipient’s employer (the “Employer”) takes with respect to any or all income tax, primary and secondary Class 1 National Insurance contributions, payroll tax or other tax-related withholding attributable to or payable in connection with or pursuant to the grant, vesting, release or assignment of any RSUs subject to the Award (“Tax-Related Items”), the Recipient acknowledges that the ultimate liability for all Tax-Related Items legally due by the Recipient is and remains the Recipient’s responsibility. Furthermore, the Company and/or the Employer (i) make no representations or undertakings regarding the treatment of any Tax-Related Items in connection with any aspect of the RSUs, including the grant of the RSUs, the vesting of the RSUs, the delivery of shares of Common Stock, the subsequent sale of any shares of Common Stock acquired under the Plan and the receipt of any dividends or dividend equivalents; and (ii) do not commit to structure the terms of the grant or any aspect of the RSUs to reduce or eliminate the Recipient’s liability to Tax-Related Items. • The shares of the company are listed on the stock exchange. • The shareholding in the company has to be at least 10% or more. • The investment is more than 1,502,530.26 Euros. • The Recipient’s name, address, and fiscal identification number • Non resident’s name, address and fiscal identification number. • The amount of the payment, payment method, currency of origin and value in euros. • The reasons for the payment. • Resident name, address and fiscal identification number. • Non resident name, address and fiscal identification number. • The amount, currency of origin and value of payment in euros. • The reason for the payment. As a condition of any RSUs subject to the Award vesting and the issuance of shares of Common Stock in payment of the RSUs, the Company and/or the Employer shall be entitled to withhold, and the Recipient agrees to pay, or make adequate arrangements satisfactory to the Company and/or the Employer to satisfy, all obligations of the Company and/or the Employer to account to HM Revenue & Customs (“HMRC”) for any Tax-Related Items by the Due Date, which is 90 days, or such other period as required under U.K. law, after the event giving rise to the Tax-Related Items (the “Chargeable Event”). In this regard, except as provided in the next sentence, such payment shall be made by means of the Company withholding and/or reacquiring a number of shares of Common Stock issued in payment of (or otherwise issuable in payment of, as the case may be) the RSUs having a Fair Market Value equal to the amount of Tax-Related Items that the Company determines it or the Employer is required to account to HMRC under applicable tax laws with respect to the RSUs (with such withholding obligation determined based on any applicable minimum statutory withholding rates). In the event that the Company cannot (under applicable legal, regulatory, listing or other requirements, or otherwise) satisfy such obligation in such method, the Company and/or the Company may satisfy its entitlement to withhold under this Award Agreement by either or a combination of the following methods: (i) by requiring the Recipient to pay such amount in cash or check; and/or (ii) by deducting such amount out of any other compensation otherwise payable to the Recipient. For these purposes, the Fair Market Value of the shares of Common Stock to be withheld or repurchased, as applicable, shall be determined on the date that Tax-Related Items are to be determined. The Recipient shall pay to the Company or the Employer any amount of Tax-Related Items that the Company or the Employer may be required to account to HMRC with respect to the Chargeable Event that cannot be satisfied by the means previously described. If payment or withholding is not made by the Due Date, the Recipient agrees that the amount of any uncollected Tax-Related Items shall (assuming the Recipient is not a director or executive officer of the Company (within the meaning of Section 13(k) of the U.S. Securities and Exchange Act of 1934, as amended)), constitute a loan owed by the Recipient to the Employer, effective on the Due Date. The Recipient agrees that the loan will bear interest at the then-current HMRC Official Rate and it will be immediately due and repayable, and the Company and/or the Employer may recover it at any time thereafter by any of the means referred to above. If any of the foregoing methods of collection are not allowed under Applicable Laws or if the Recipient fails to comply with the Recipient’s obligations in connection with the Tax-Related Items as described in this section, the Company may refuse to deliver the shares of Common Stock acquired under the Plan. Joint Election As a condition of the Recipient’s participation in the Plan and the vesting of the RSUs, the Recipient agrees to accept any liability for secondary Class 1 National Insurance contributions (the “Employer’s Liability”) which may be payable by the Company and/or the Employer in connection with the RSUs and any event giving rise to Tax-Related Items. To accomplish the foregoing, the Recipient agrees to execute a joint election with the Company (the “Election”), the form of such Election being formally approved by HMRC, and any other consent or elections required to accomplish the transfer of the Employer’s Liability to the Recipient. The Recipient further agrees to execute such other joint elections as may be required between the Recipient and any successor to the Company and/or the Employer. If the Recipient does not enter into the Election when the Recipient accepts the Award Agreement or when otherwise requested by the Company and/or Employer, or if the Election is revoked at any time by HMRC, the RSUs will cease vesting and become null and void, and no shares of Common Stock will be acquired under the Plan, unless the Recipient agrees to pay an amount equal to the Employer’s Liability to the Company, the Employer and/or any Related Company. The Recipient further agrees that the Company and/or the Employer may collect the Employer’s Liability by any of the means set forth in the Withholding section of the Award Agreement. Exhibit 21.1 SUBSIDIARIES OF PEGASYSTEMS INC. Name of Subsidiary State or Jurisdiction of Entity Pegasystems Limited England Pegasystems Proprietary Limited Australia Pegasystems Worldwide Inc. Massachusetts Pegasystems Investment Inc. Massachusetts Pegasystems Company Canada Pegasystems Private Limited Singapore Pegasystems Worldwide India Private Limited India Pegasystems Mauritius Mauritius Pegasystems GmbH Germany Pegasystems B.V. Netherlands Pegasystems A.G. Switzerland Pegasystems Sp.Zoo Poland Pegasystems Spain, S.L. Spain Pegasystems France, an S.A.R.L. France Exhibit 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in Registration Statement Nos. 333-09305, 333-53746, 333-89707, 333-104788, 333-116660, and 333-135596 on Form S-8 of our reports dated February 22, 2010 relating to the financial statements of Pegasystems Inc. and the effectiveness of Pegasystems Inc.’s internal control over financial reporting, appearing in this Annual Report on Form 10-K of Pegasystems Inc. for the year ended December 31, 2009. /s/ DELOITTE & TOUCHE LLP Boston, Massachusetts February 22, 2010 Exhibit 31.1 I, Alan Trefler, certify that: Date: February 22, 2010 1. I have reviewed this Annual Report on Form 10-K of Pegasystems Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. /s/ ALAN TREFLER Chairman and Chief Executive Officer (principal executive officer) Exhibit 31.2 I, Craig Dynes, certify that: Date: February 22, 2010 1. I have reviewed this Annual Report on Form 10-K of Pegasystems Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. /s/ CRAIG DYNES Senior Vice President, Chief Financial Officer (principal financial officer) Exhibit 32 CERTIFICATION PURSUANT TO SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Pegasystems Inc. (the Company) on Form 10-K for the year ended December 31, 2009 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), Alan Trefler, Chairman and Chief Executive Officer of Pegasystems Inc., and Craig Dynes, Chief Financial Officer and Senior Vice President of Pegasystems Inc., each certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: Dated: February 22, 2010 Dated: February 22, 2010 (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ ALAN TREFLER Chairman and Chief Executive Officer (principal executive officer) /s/ CRAIG DYNES Senior Vice President, Chief Financial Officer (principal financial officer) 

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