Pegasystems
Annual Report 2015

Plain-text annual report

PEGASYSTEMS INC FORM 10-K (Annual Report) Filed 02/25/16 for the Period Ending 12/31/15 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 STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 FORM 10-K xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT of 1934For the fiscal year ended December 31, 2015 ¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT of 1934Commission 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) One Rogers StreetCambridge, MA 02142-1209(Address of principal executive offices) (zip code)(617) 374-9600(Registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which RegisteredCommon Stock, $0.01 par value per share NASDAQ Global Select MarketSecurities registered pursuant to Section 12(g) of the Act:None Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x 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 ¨ No xIndicate 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 12months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨Indicate by check mark 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’sknowledge, 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. Large accelerated filer x Accelerated filer ¨Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company ¨Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No xThe 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 commonstock on the last business day of the Registrant’s most recently completed second fiscal quarter (June 30, 2015) was approximately $826 million.There were 76,271,224 shares of the Registrant’s common stock, $0.01 par value per share, outstanding on February 11, 2016.DOCUMENTS INCORPORATED BY REFERENCEPortions of the Registrant’s definitive proxy statement related to its 2016 annual meeting of stockholders to be filed subsequently are incorporated by reference into Part IIIof this report. Table of ContentsTABLE OF CONTENTS Item Page PART I 1 Business 3 1A Risk Factors 11 1B Unresolved Staff Comments 18 2 Properties 18 3 Legal Proceedings 19 4 Mine Safety Disclosures 19 PART II 5 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 20 6 Selected Financial Data 23 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations 24 7A Quantitative and Qualitative Disclosure about Market Risk 40 8 Financial Statements and Supplementary Data 43 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 75 9A Controls and Procedures 75 9B Other Information 75 PART III 10 Directors, Executive Officers, and Corporate Governance 76 11 Executive Compensation 77 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 77 13 Certain Relationships and Related Transactions, and Director Independence 78 14 Principal Accounting Fees and Services 78 PART IV 15 Exhibits, Financial Statement Schedules 79 Signatures 80 2Table of ContentsPART IForward-looking statementsThis Annual Report on Form 10-K contains or incorporates forward-looking statements within the meaning of section 27A of the Securities Act of 1933 andsection 21E of the Securities Exchange Act of 1934. These forward-looking statements are based on current expectations, estimates, forecasts, and projectionsabout the industry and markets in which we operate and on management’s beliefs and assumptions. Other written or oral statements that constitute forward-lookingstatements may be made by us or on our behalf. Words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “could,” “estimate,” “may,” “target,” “strategy,”“is intended to,” “project,” “guidance,” or variations of such words and similar expressions are intended to identify such forward-looking statements. Thesestatements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict. We have identified certainrisk 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-lookingstatements we make. We do not intend to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. ITEM 1.BusinessPegasystems Inc. was incorporated in Massachusetts in 1983. Our stock is traded on the NASDAQ Global Select Market under the symbol PEGA. OurWebsite 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 AnnualReport on Form 10-K. Unless the context otherwise requires, references in this Annual Report on Form 10-K to “the Company,” “Pega,” “we,” “us,” or “our” referto Pegasystems Inc. and its subsidiaries.Our business: Applications Engineered for EvolutionWe believe business success requires that organizations become digital, and that a new generation of strategic applications can accelerate how organizationsbecome modern digital enterprises. We develop, market, license, and support strategic software applications for marketing, sales and onboarding, customer service,and operations, in addition to licensing our Pega 7 platform for clients that wish to build and extend their own applications. Our software is designed to assistclients in building, deploying, and evolving strategic enterprise applications, creating an environment in which business and IT can collaborate to manage back-office operations, front office sales, marketing, and/or customer service needs.Our strategic applications are built on Pega 7, our unified on-cloud and on-premises platform (“Pega 7” or “Pega 7 platform”). Pega 7 uses a comprehensiveset of visual models to build applications: process models, predictive analytics, user experience (“UX”) designs, decision logic, etc. This visual, model-basedapproach is designed to be faster in building, deploying, and evolving strategic applications than traditional programming, and to empower our clients to betterengage their customers, simplify processes, and turn the power of change into a competitive advantage.Our applications and platform intersect with and encompass several traditional software markets, including: Customer Relationship Management (“CRM”),Business Process Management (“BPM”), Business Rules Management Systems (“BRMS”), Dynamic Case Management (“DCM”), Decision Management,including Predictive and Adaptive analytics, and the Vertical Specific Software (“VSS”) market of industry solutions and packaged applications.We also provide consulting services and implementation support, training, and technical support services to help clients maximize the business value fromour software. Our clients include Global 3000 companies and government agencies that seek to manage complex enterprise systems and customer service issuesmore nimbly and cost-effectively. Our strategy is to sell a client a series of licenses, each focused on a specific purpose or area of operations. 3Table of ContentsOur partnersWe maintain alliances with global systems integrators and technology consulting firms that provide consulting services to our clients. Strategic partnershipswith technology consulting firms and systems integrators are important to our sales efforts because they influence buying decisions, help us to identify salesopportunities, 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 clients. Currently, our partners include well respected, major firms such as Accenture PLC,Atos SE, Capgemini SA, Cognizant Technology Solutions Corporation, EY, Infosys Limited, Tech Mahindra Limited, PricewaterhouseCoopers LLP, TataConsultancy Services Limited, Virtusa Corporation, and Wipro Limited.Our productsPega’s applications help streamline business operations, connect enterprises to their customers in real-time across channels, and adapt to meet changingrequirements. Our applications can be deployed in the cloud or on-premises, providing our clients with the flexibility to operate the software according to their ownpreferences.Pega 7Pega 7 is a unified platform that enables clients to build enterprise applications in a fraction of the time it would take using traditional programmingtechnologies. Pega 7 is engineered to support complex, global enterprises, allowing for application development and deployment on a patented, layered architecturethat supports reuse across lines of business, geographies, and customer segments. Our platform features a model-driven, visual, code-free approach to applicationdevelopment that enables business and IT to collaborate, using a visual “language” that models the requirements and design of the application through readilyunderstandable metaphors. This agile approach facilitates continuous improvement methodologies, such as Lean Six Sigma, to effectively manage individualprojects or help drive a complete enterprise transformation. All aspects of the application are captured in the model, including business strategy mapping, businessprocesses, data models, case definitions, rules, decisions, reporting, interfaces, intelligent work management capabilities, business activity monitoring, and the UXacross both web and mobile devices.Once defined this way, the finished application and documentation are generated and ready for use. Our approach bypasses the error-prone and time-consuming process of manually translating requirements into code. The software application is created automatically and directly from the model, helping to closethe costly gap between vision and execution. Changes to the code are made by changing the model, and application documentation is generated directly from themodel. The Pega 7 platform is standards-based and can leverage a client’s existing technology to create new business applications that cross technology silos andbridge front and back-office. Pega 7 was previously marketed as PegaRULES Process Commander and the Build for Change platform.Strategic ApplicationsPegasystems also offers purpose or industry-specific software applications built on the Pega 7 platform. These applications for Marketing, Sales andOnboarding, Customer Service, and Operations provide a best-practice starting point as well as industry-specific business processes. As they are built on the Pega 7platform, these applications deliver flexibility beyond traditional “commercial off the shelf” products. We believe our applications allow our clients to offerdifferentiated service and value to their customers. Pega 7 enables organizations to implement new processes quickly, refine customer experiences, bring newofferings to market, and provide customized or specialized processing to help meet the needs of different customers, departments, geographies, or regulatoryrequirements. 4Table of ContentsPega Customer Relationship Management ApplicationsPega’s Customer Relationship Management Applications are designed to evolve to meet changing business needs. Our applications offer process-driven,customer-centric CRM software that maximizes the lifetime value of customers and helps reduce the costs of serving customers. We provide marketing, sales andonboarding, and customer service applications to optimize sales processes and customer service interactions.Pega Marketing helps enterprises manage customer relationships across inbound and outbound channels. It incorporates predictive and adaptive analyticsand business rules in real time to evaluate the context of each customer interaction, and dynamically recommends the most relevant action, offer, content, andchannel.Pega Sales Automation automates and manages the sales process from prospecting to product fulfillment. Our software allows enterprises to capture bestpractices, and guides sales teams through the sales and customer onboarding processes.Pega Customer Service provides a contact center desktop, case management for customer service, mobile field service, self-service, and industry specificprocesses and data models. It allows enterprises to deliver consistent interactions across channels, adapt to changing business requirements, and improve employeeproductivity.Pega provides Operations Applications to support a variety of business needs including risk, fraud, and compliance management; exceptions andinvestigations; order fulfillment; claims processing; insurance underwriting; and product development.These applications incorporate and leverage many common technical capabilities. Our case management and business process technology facilitates thefulfillment of customer requests, while our Next-Best-Action analytics predict and adapt to customer behavior to improve both business outcomes and the customerexperience.Real-time decision management is incorporated into these applications to guide actions and optimize process outcomes based on business objectives.Capabilities for cross-sell/up-sell, retention, service recommendations, and collections that can be changed with model-driven tools, help businesses deployautomated decision-making quickly. The predictive and adaptive analytics incorporated into these applications support the creation and refinement of decisionmodels to improve outcomes.Social listening, text analytics, and natural language processing capabilities are also available in our Pega Customer Relationship Management Applications.These allow our clients to collect social content in tweets, blogs, and posts on Facebook or in other social communities, and enrich it by detecting language, topic,taxonomy, and sentiment. Using this capability, our clients are able to monitor, triage, and respond to social content across multiple channels, and turn it intoactionable social intelligence.Our Pega Co-Browse collaboration technology enables users to provide fast service by simultaneously “co-browsing” web pages with their customers. Thetechnology is designed to allow our clients to engage customers in real time, and can also be used to enable employees to collaborate on work across physicallocations.The Pega Mobility capabilities in our Pega 7 platform are designed to help clients efficiently build, manage, and deploy mobile applications as part of aunified Omni-channel experience. By using Pega Mobility, enterprises can deploy Pega applications as packaged, branded mobile applications and manage thecomplex elements of the mobile application lifecycle including security, integration, testing, and management of mobile applications and devices. Our mobileapplication development solutions help businesses to reduce the development time, deployment cost, and complexity associated with run-the-business mobileapplications. 5Table of ContentsPega Cloud ®Pega Cloud ® allows clients to develop, test and deploy, on an accelerated basis, our strategic applications and Pega 7 platform using a secure, flexibleInternet-based infrastructure. Pega Cloud provides production and development and testing (“Dev/Test”) services to accelerate the development and deployment ofPegasystems’s strategic applications and the Pega 7 platform. This allows our clients to minimize infrastructure cost while focusing on their core revenuegenerating competencies.Our services and supportWe offer services and support through our global customer success group, our global customer support group, and our PegaACADEMY training servicesgroup. We also utilize third party contractors to assist us in providing these services.Global Customer SuccessOur Global Customer Success group combines our sales and Pega consulting groups and provides guidance and implementation services to our clients andpartners on how to best apply our technology and develop strong implementation expertise.Global Customer SupportOur Global Customer Support group is responsible for technical support of our products. Support services include managing the online Support Community,proactive problem prevention through education and knowledge sharing, and problem tracking, prioritization, escalation, diagnosis, and resolution.PegaACADEMY – Training ServicesThe success of our sales strategy for multiple follow-on sales to target clients depends on our ability to train a large number of partners and clients toimplement our technology. We offer instructor-led and online training for our staff, clients, and partners. Instructor-led training is offered at our regional trainingfacilities in North America, the United Kingdom, India, Australia, and at third-party facilities in numerous other locations, including client sites. Online training is aconvenient and cost effective way to learn our software anytime, anywhere. We expect online training to continue to help expand the number of trained andcertified experts globally. We have also partnered with universities to offer Pega courseware as part of the student curriculum, taught by Pega instructors anduniversity professors to expand our ecosystem. Our courses are designed to meet the specific requirements of various project implementation roles to include bothbusiness and system architects, system administrators, and project leaders.Our marketsOur target clients are industry-leading Global 3000 organizations that require strategic applications to differentiate them in the markets they serve byincreasing business agility, driving growth, improving productivity, attracting and retaining customers, and reducing risk. We deliver applications tailored to ourclients’ specific industry needs. We also enable enterprise transformation initiatives by providing an application development platform that digitizes end-to-endprocesses and allows for multi-channel customer interactions, all enhanced by Next-Best-Action analytics.Our clients are Global 3000 organizations in the financial services, healthcare, insurance, communications and media, public sector, manufacturing, and lifesciences markets. 6Table of ContentsFinancial ServicesFinancial services organizations rely on software to market, onboard, cross-sell, retain, and service their customers as well as automate the operations thatsupport these customer interactions. Our customer service, sales and new account onboarding, Know Your Customer (“KYC”), marketing, collections, and disputemanagement applications allow clients to be responsive to changing business requirements.HealthcareHealthcare organizations seek software that integrates their front and back-offices and helps them deliver personalized care and customer service whilereducing cost, automating processes, and increasing operational efficiency. Our applications allow healthcare clients to address sales, service, operations, financial,administrative, and coverage requirements of healthcare consumerism and reform.InsuranceInsurance companies, whether competing globally or nationally for customers and channels, need software to automate the key activities of distributionmanagement, quoting, underwriting, claims, and policy servicing. Insurers are also becoming increasingly sensitive to ways to improve customer service and theoverall customer experience. Our applications for insurance carriers help increase business value by delivering customer-focused experiences and personalizedinteractions that help drive higher sales, lower expense ratios, and mitigate risk.Communications and MediaCommunications and media organizations need to address high levels of customer churn, growing pressure to increase revenue, and an ability to respondquickly to changing market conditions. Our applications enable organizations to reshape the way they market and sell to customers, streamline onboarding andfulfillment operations, and bring new services and products to market.Public SectorGovernment agencies need to modernize legacy systems and processes to meet the growing demands for improved constituent service, lower costs, reducedfraud and greater levels of transparency. Our applications deliver advanced capabilities to streamline operations and optimize service delivery through an agile,omni-channel approach.ManufacturingManufacturers worldwide are transforming their businesses to better engage customers and suppliers, as well as to directly manage the performance of theirproducts—from the earliest designs and throughout the product life-cycle. Our manufacturing applications address field service; help reduce supplier risk; managewarranties, recalls, repairs, and returns; and extend existing enterprise resource planning system capabilities.Life SciencesLife sciences organizations are looking for solutions to improve customer engagement as well as increase efficiencies and transparency across the productdevelopment life-cycle. Our customer engagement, clinical, and pharmacovigilance applications are designed to deliver customer engagement, safety and riskmanagement, and regulatory transparency.Other IndustriesWe offer software to a broad range of other types of companies and industries. For example, we sell our applications and platform to clients in transportation,retail, travel, energy, utilities, and other services. 7Table of ContentsCompetitionWe compete in the CRM (which includes marketing, sales, and customer service), BPM, Case Management, Decision Management, co-browsing, socialengagement, and mobile application development platform software markets, as well as in markets for the vertical applications we provide (e.g. KYC for FinancialServices, Pharmacovigilance for Life Sciences). These markets are intensely competitive, rapidly changing, and highly fragmented, as current competitors expandtheir product offerings and new companies enter the market. Competitors vary in size and in the scope and breadth of the products and services they offer. Weencounter competition from: • BPM vendors, including Service-Oriented Architecture (“SOA”) middleware vendors such as IBM, Oracle Corporation, Software AG, and TibcoSoftware Inc., and other BPM vendors such as Appian Corporation and the Cordys division of Open Text; • Case Management vendors such as the Documentum division of EMC Corporation, the FileNet division of IBM’s Information Management Group,and the BPM/Case Management division of Open Text; • CRM application vendors such as Salesforce.com, the Siebel and RightNow divisions of Oracle, the Microsoft Dynamics CRM division of Microsoft,and IBM’s Unica Marketing product; • Decision Management vendors including Business Rules Engine vendors such as the Operational Decision Management and SPSS divisions of IBM,the Blaze division of FICO, and Oracle Real-Time Decisions and vendors of solutions that leverage decision making in managing customerrelationships including IBM Omni-Channel Marketing, SAS Customer Intelligence, Salesforce Marketing Cloud and Adobe Marketing Cloud; • Companies that provide application specific software for the financial services, healthcare, insurance, and other specific markets such as GuidewireSoftware, Inc., the Detica NetReveal Division of BAE, SmartStream Technologies Ltd., SunGard, SAP, and the TriZetto division of Cognizant; • Mobile application platform vendors including Kony, IBM, SAP and Red Hat, as well as open source mobile technologies, including the jQueryMobile platform from the jQuery Foundation and Adobe PhoneGap; • Co-browsing software providers, including Oracle’s RightNow Cobrowse Cloud Service; • Social listening, text analytics, and natural language processing vendors, including Attensity, Visible Technologies, Conversocial, and Salesforce.com; • Professional service organizations that develop their own products or create custom software in conjunction with rendering consulting services; and • Clients’ in-house information technology departments, which may seek to modify their existing systems or develop their own proprietary systems.We have been most successful competing for clients whose businesses are characterized by a high degree of change, complexity, or regulation. We believethat the principal competitive factors within our market include: • Product adaptability, scalability, functionality, and performance; • Proven success in delivering cost-savings and efficiency improvements; • Proven success in enabling improved customer interactions; • 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 clients; 8Table of Contents • Ability to integrate with other products and technologies; • Customer service and support; • Product price; • Vendor reputation; and • Relationships with systems integrators.We believe we are competitively differentiated as our unified Pega 7 platform is designed to allow both client business and IT staff, using a single, intuitiveuser interface, to build and evolve enterprise applications in a fraction of the time it would take with the types of disjointed architectures and tools offered by ourcompetitors. In addition, our applications, built on the Pega 7 platform, provide the same level of flexibility and ability to adapt to our clients’ needs. We believewe compete favorably due to our expertise in our target industries and our long-standing client relationships. We believe we compete less favorably on the basis ofsome of these factors with respect to our larger competitors, many of which have greater sales, marketing, and financial resources, more extensive geographicalpresence, 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 targetindustries. See “Risk Factors—The market for our offerings is intensely and increasingly competitive, rapidly changing, and highly fragmented.” in Item 1A of thisAnnual Report on Form 10-K.Intellectual PropertyWe rely primarily on a combination of copyright, patent, trademark, and trade secrets laws, as well as confidentiality and intellectual property agreements toprotect our proprietary rights. We have obtained patents relating to our system architecture and products in strategic global markets. We enter into confidentiality,intellectual property ownership, and license agreements with our employees, partners, clients, and other third parties and control access to and ownership ofsoftware, services, documentation, and other proprietary information as means to protect our proprietary rights.Sales and marketingWe market our software and services primarily through a direct sales force. In addition, strategic partnerships with management consulting firms and majorsystems integrators are important to our sales efforts because they influence buying decisions, help us identify sales opportunities, and complement our softwareand services with their domain expertise and professional services capabilities. We also partner with technology providers and application developers.To support our sales efforts, we conduct a broad range of marketing programs, including awareness advertising, client and industry-targeted solutioncampaigns, trade shows, including our PegaWORLD user conference, solution seminars and Webinars, industry analyst and press relations, Web and digitalmarketing, community development, social media, and other direct and indirect marketing efforts. Our consulting staff, business partners, and other third partiesalso conduct joint and separate marketing campaigns that generate sales leads.Sales by geographySales to clients based outside of the United States of America (“U.S.”) represented approximately 45% of our total revenue during each of the last three fiscalyears. We have derived substantially all of our operating revenue from the sale and support of one group of similar products and services during each of the lastthree fiscal years. The majority of our long-lived assets were located within the U.S. at the end of each of the last three fiscal years. See Note 18, “GeographicInformation and Major Clients,” included in the Notes to Consolidated 9Table of ContentsFinancial Statements included in Item 8 of this Annual Report on Form 10-K. See “Risk Factors—We face risks from operations and clients based outside of theU.S.” in Item 1A of this Annual Report on Form 10-K.Research and developmentOur development organization is responsible for product architecture, core technology development, product testing, and quality assurance. Our productdevelopment priority is to continue expanding the capabilities of our technology. We intend to maintain and extend the support of our existing strategicapplications, and we may choose to invest in additional strategic applications which incorporate the latest business innovations. We also intend to maintain andextend the support of popular hardware platforms, operating systems, databases, and connectivity options to facilitate easy and rapid deployment in diverseinformation technology infrastructures. Our goal with all of our products is to enhance product capabilities, ease of implementation, long-term flexibility, and theability to provide improved client service.During 2015, 2014, and 2013, research and development expenses were approximately $126.4 million, $108.6 million, and $79.7 million, respectively. SeeItem 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K for further discussion. Weexpect that we will continue to commit significant resources to our product research and development in the future to maintain our leadership position.EmployeesAs of January 31, 2016, we had 3,333 employees worldwide, of which 1,453 were based in North America, 663 were based in Europe, and 1,217 were basedin Asia Pacific.Backlog of license, maintenance, and servicesAs of December 31, 2015, we had software license, maintenance, cloud, and services agreements with clients expected to result in future revenue(“backlog”) of approximately $580.9 million, of which we expect approximately $336.9 million to be recognized in 2016. As of December 31, 2014, we hadapproximately $540.3 million in backlog. Under some of these agreements, we must fulfill certain conditions prior to recognizing revenue, and there can be noassurance when, if ever, we will be able to satisfy all such conditions in each instance. Backlog may vary in any given period depending on the amount and timingof when arrangements are executed, as well as the mix between perpetual license, term license, and cloud arrangements. Business conditions could change and,therefore, backlog may not be a reliable indicator of future financial performance. See Item 7 “Management’s Discussion and Analysis of Financial Condition andResults of Operations” of this Annual Report on Form 10-K for more detail regarding backlog.Available InformationWe make available our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K, and amendments to thesereports, free of charge through our Website ( www.pega.com/about/investors ) as soon as reasonably practicable after we electronically file such material with, orfurnish 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 executiveofficers 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, arealso available on our Website. 10Table of ContentsITEM 1A.RISK FACTORSThe following important factors could cause our actual business and financial results to differ materially from those contained in forward-looking statementsmade in this Annual Report on Form 10-K or elsewhere by management from time to time.Factors relating to our financial resultsThe timing of our license revenue is difficult to predict accurately, which may cause our quarterly operating results to vary considerably. A change in thenumber or size of high value license arrangements, or a change in the mix between perpetual licenses, term licenses, and Pega Cloud ® subscriptions can cause ourrevenues to fluctuate materially from quarter to quarter. In the event that our clients choose term licenses or Pega Cloud subscriptions, we recognize the revenueover the license term or Pega Cloud subscription term, which may adversely affect our profitability in any period due to sales commissions being paid at the time ofsigning and the corresponding revenue being recognized over time. Other factors which may influence the predictability of our license revenue include: changes incustomer budgets and decision-making processes that could affect both the timing and size of transactions; the deferral of license revenue to future periods due tothe timing of the execution of an agreement or our ability to deliver the products or services; changes in our business model; and/or our ability to execute on ourmarketing and sales strategies.We budget for our selling and marketing, product development, and other expenses based on anticipated future revenue. If the timing or amount of revenuefails to meet our expectations in any given quarter, our financial performance is likely to be adversely affected because only small portions of expenses vary withrevenue. As a result, period-to-period comparisons of our operating results are not necessarily meaningful and should not be relied upon to predict futureperformance. If our revenues and operating results do not meet the expectations of our investors or securities analysts or fall below guidance we may provide to themarket or due to other factors discussed elsewhere in this section, the price of our common stock may decline.The number of our license arrangements has been increasing, and we may not be able to sustain this growth unless we and our partners can providesufficient high quality consulting services, training, and maintenance resources to enable our clients to realize significant business value from our software.Our clients typically request consulting services and training to assist them in implementing our products. Our clients also purchase maintenance on our products inalmost all cases. As a result, an increase in the number of license arrangements is likely to increase demand for consulting services, training, and maintenancerelating to our products. Given that the number of our license arrangements has been increasing, we will need to provide our clients with more consulting services,training, and maintenance to enable our clients to realize significant business value from our software. We have been increasingly enabling our partners and clientsthrough training to create an expanded universe of people that are skilled in the implementation of our products. However, if we and our partners are unable toprovide sufficient high quality consulting services, training, or maintenance resources to our clients, our clients may not realize sufficient business value from ourproducts to justify follow-on sales, which could impact our future financial performance. In addition, the growth required to meet the increased demand for ourconsulting services could strain our ability to deliver our services engagements at desired levels of profitability, thereby impacting our overall profitability andfinancial results.We frequently enter into a series of licenses that are focused on a specific purpose or area of operations. If we are not successful in obtaining follow-onbusiness from these clients, our financial performance could be adversely affected. We frequently enter into a series of licenses with our new clients that arefocused on a specific purpose or area of operations. Once a client has realized the value of our software, we work with the client to identify opportunities forfollow-on sales. However, we may not be successful in demonstrating this value to some clients, for reasons relating to the performance of our products, the qualityof the services and support we provide for our products, or external reasons. Also, certain of our smaller clients may have limited additional sales opportunitiesavailable. For any of these clients, we may not obtain follow-on sales or the follow- 11Table of Contentson sales may be delayed, and our license revenue could be limited. This could lower the total value of all transactions and adversely affect our financialperformance.Our consulting services revenue is dependent to a significant extent on closing new license transactions with clients. We derive a substantial portion ofour consulting services revenue from implementation of new software licenses with our clients, both from implementations that are led by our consulting servicesstaff and from implementations where we provide consulting to our partners and clients to support their implementations. Accordingly, it is imperative that weclose more license transactions with our clients if we are to maintain or grow our consulting services revenue.If we are unable to maintain vendor-specific objective evidence (“VSOE”) of fair value of our time and materials (“T&M”) consulting servicesarrangements, we may be required to delay the recognition of a portion of our revenue to future periods . We have established VSOE of fair value of our T&Mconsulting services in the Americas, Europe, and certain regions of Asia, based on the price charged when these services are sold separately. Significantcompetition within our industry has created pricing pressure on consulting services provided by technology companies. If we elect to discount our T&M consultingservices pricing or otherwise introduce variability in our T&M consulting services arrangements to attract or retain clients, this could lead to an insufficient numberof consistently priced T&M consulting services arrangements for us to maintain VSOE. If we do not have VSOE of fair value of our T&M consulting services, wemay be required to recognize all revenue for these consulting services arrangements, including any bundled license, maintenance, and other services revenue,ratably over the longer of the software maintenance period or the service period.Our financial results may be adversely affected if we are required to change certain estimates, judgments, and/or positions relative to our income andother taxes. In the ordinary course of conducting our global business enterprise, we cannot be certain of the ultimate tax outcome related to many transactions andcalculations. Some of these uncertainties arise as a consequence of positions we have taken regarding valuation of deferred tax assets, transfer pricing fortransactions with our subsidiaries, and potential challenges to nexus and tax credit estimates. We estimate our exposure to unfavorable outcomes related to theseuncertainties and estimate the probability of such outcomes. Future realization of our deferred tax assets ultimately depends on the existence of sufficient taxableincome within the available carryback or carryforward periods. We record a valuation allowance to reduce our deferred tax assets to an amount we believe is morelikely than not to be realized. If our taxable income is not consistent with our expectations or the timing of income is not within the applicable carryforward period,we may be required to establish a valuation allowance on all or a portion of these deferred tax assets. Changes in our valuation allowance impact income taxexpense in the period of adjustment. Although we believe our estimates are reasonable, no assurance can be given that the final tax outcome of these matters or ourcurrent 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 changethe recorded value of deferred tax assets, and adversely affect our financial results. We are also subject to non-income taxes such as payroll, sales, use, value-added,net worth, property, and goods and services taxes in the U.S. and in various foreign jurisdictions. We are regularly under audit by tax authorities with respect tothese non-income taxes and may have exposure to additional non-income tax liabilities which could have an adverse effect on our results of operations andfinancial condition.If it became necessary to repatriate any of our foreign cash balances to the United States, we may be subject to increased income taxes, other restrictions,and limitations. As of December 31, 2015, approximately $53.5 million of our cash and cash equivalents is held in our foreign subsidiaries. If we are unable toreinvest this cash outside of the U.S., we may have to repatriate some of our foreign cash to the U.S. which would increase our income tax liability. If it becamenecessary to repatriate these funds, we may be required to pay U.S. tax, net of any applicable foreign tax credits, upon repatriation. We consider the earnings of ourforeign subsidiaries to be permanently reinvested and, as a result, U.S. taxes on such earnings have not been provided. It is impractical to estimate the amount ofU.S. tax we could have to pay upon repatriation due to the complexity of the foreign tax credit calculations and other factors. 12Table of ContentsWe are investing heavily in sales and marketing and support in anticipation of a continued increase in license arrangements, and we may experiencedecreased profitability or losses if we are unsuccessful in increasing the value of our license arrangements in the future to balance our growth in expenses. Wehave been increasing our investment in sales and marketing to meet increasing demand for our software by hiring additional sales and marketing personnel. Weanticipate that we will need to provide our clients with more maintenance support as a result of this increase in demand, and also have been hiring additionalpersonnel in this area. These investments have resulted in increased fixed costs that do not vary with the level of revenue. If the increased demand for our productsdoes not continue, we could experience decreased profitability or losses as a result of these increased fixed costs. Conversely, if we are unable to hire sales andmarketing personnel to meet future demand, we may not be able to achieve our sales and profitability targets.Factors relating to our products and marketsWe will need to acquire or develop new products, evolve existing ones, address any defects or errors, and adapt to technology change . Technicaldevelopments, client requirements, programming languages, and industry standards change frequently in our markets. As a result, success in current markets andnew markets will depend upon our ability to enhance current products, address any product defects or errors, acquire or develop and introduce new products thatmeet client needs, keep pace with technology changes, respond to competitive products, and achieve market acceptance. Product development requires substantialinvestments for research, refinement, and testing. We may not have sufficient resources to make necessary product development investments. We may experiencetechnical or other difficulties that will delay or prevent the successful development, introduction, or implementation of new or enhanced products. We may alsoexperience technical or other difficulties in the integration of acquired technologies into our existing platform and applications. Inability to introduce or implementnew or enhanced products in a timely manner could result in loss of market share if competitors are able to provide solutions to meet customer needs before we do,give rise to unanticipated expenses related to further development or modification of acquired technologies as a result of integration issues, and adversely affectfuture financial performance.The market for our offerings is intensely and increasingly competitive, rapidly changing, and highly fragmented. We compete in the CRM sector, whichincludes marketing, sales, customer service, BPM, Case Management, Decision Management, co-browsing, social engagement, and mobile applicationdevelopment platform software markets, as well as in markets for the vertical applications we provide (e.g. KYC for Financial Services, Pharmacovigilance for LifeSciences). The markets for our software and related implementation, consulting, and training services are intensely competitive, rapidly changing, and highlyfragmented. We currently encounter significant competition from internal information systems departments of potential or existing clients that develop customsoftware. We also compete with companies that target the BPM, Case Management, Decision Management, co-browsing, social engagement, and mobileapplication development platform markets as well as professional service organizations that develop custom software in conjunction with rendering consultingservices. Competition for market share and pressure to reduce prices and make sales concessions are likely to increase. Many of our competitors, such as IBM,Oracle, and SAP, are large and have far greater resources and may be able to respond more quickly and efficiently to new or emerging technologies, programminglanguages, or standards or to changes in client requirements or preferences. Competitors may also be able to devote greater managerial and financial resources todevelop, promote, and distribute products and to provide related consulting and training services. There can be no assurance that we will be able to competesuccessfully 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. See “Business—Competition” in Item 1 of this Annual Report on Form 10-K.The continued uncertainties in international economies may negatively impact our sales to, and the collection of receivables from, our clients. Our salesto, and our collection of receivables from, our clients may be impacted by adverse changes in global economic conditions. Changes in global economic conditionscould impact the ability and willingness of our clients to make investments in technology, which in turn may delay or 13Table of Contentsreduce the number of purchases of our software and services. These factors could also impact the ability and willingness of these clients to pay their tradeobligations and honor their contractual commitments under their noncancellable term licenses. These clients may also become subject to increasingly restrictiveregulatory requirements, which could limit or delay their ability to proceed with new technology purchases and may result in longer sales cycles, increased pricecompetition, and reductions in sales of our products and services. The financial uncertainties facing many of our clients and the industries in which they operatecould negatively impact our business, operating results, and financial condition.We have historically sold to the financial services, healthcare, insurance, and communications markets, and rapid changes or consolidation in thesemarkets could affect the level of demand for our products. We have historically derived a significant portion of our revenue from clients in the financial services,healthcare, insurance, and communications 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 clients and their willingness to buy. In addition,clients’ purchasing patterns in these industries for large technology projects are somewhat discretionary. The financial services and insurance markets areundergoing intense domestic and international consolidation and financial turmoil, and consolidation has been occurring in the healthcare and communicationsmarkets. Consolidation may interrupt normal buying behaviors and increase the volatility of our operating results. In recent years, several of our clients have beenmerged or consolidated, and we expect this to continue in the near future. Future mergers or consolidations may cause a decline in revenues and adversely affectour future financial performance. All of these factors affect the level of demand for our products from clients in these industries, and could adversely affect ourbusiness, 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 supportactivities, and to product development efforts, including Pega Cloud hosting facilities. We rely on software and hardware vendors, large system integrators, andtechnology 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 ofwhich have significantly greater financial and marketing resources, will not develop or market products that compete with ours in the future or will not otherwiseend or limit their relationships with us. Further, the use of third-party hosting facilities requires us to rely on data security as it is provided by such third parties,which despite our due diligence may be or become less than adequate.We face risks from operations and clients based outside of the U.S. Sales to clients located outside of the U.S. represented approximately 45% of our totalrevenue in the last three fiscal years. We market products and render consulting and training services to clients based outside of the U.S. including clients based inCanada, Europe, Latin America, Asia, and Australia. We have established offices in North America, Europe (including Russia and Turkey), Asia (including India),and Australia. We believe that growth will necessitate expanded international operations, requiring a diversion of managerial attention and increased costs. Weanticipate hiring additional personnel to accommodate international growth, and we may also enter into agreements with local distributors, representatives, orresellers. 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, we may not be able to maintain or increase international market demand for our products. Additional risks inherent in our international businessactivities generally include: • laws and business practices favoring local competitors; • compliance with multiple, conflicting and changing governmental laws and regulations, including employment, tax, privacy and data privacy andprotection laws and regulations, increased tariffs and other trade barriers; 14Table of Contents • the costs of localizing products for local markets, including translation into foreign languages and associated expenses; • longer payment cycles and credit and collectability risk on our foreign trade receivables; • difficulties in enforcing contractual and intellectual property rights; • heightened fraud and anti-bribery awareness risks; • treatment of revenue from international sources and changes to tax codes, including being subject to foreign tax laws, being liable for payingwithholding income or other taxes in foreign jurisdictions, and other potentially adverse tax consequences (including restrictions on repatriatingearnings and the threat of “double taxation”); • managing our international operations, including increased accounting and internal control expenses; • heightened risks of political and economic instability; and • foreign currency exchange rate fluctuations and controls.There can be no assurance that one or more of these factors will not have a material adverse effect on our foreign operations, and, consequently, on ourbusiness, 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 portionof our business is conducted outside the U.S., we face exposure to adverse movements in foreign currency exchange rates. Our international sales are usuallydenominated in foreign currencies. The operating expenses of our foreign operations are also primarily denominated in foreign currencies, which partially offsetour foreign currency exposure on our international sales. Our results of operations and cash flows are subject to fluctuations due to changes in foreign currencyexchange rates, particularly changes in the British pound, Euro, Australian dollar, and Indian rupee, as compared to the U.S. dollar. These exposures may changeover time as business practices evolve, and they could have a material adverse impact on our financial results and cash flows. We use foreign currency forwardcontracts (“forward contracts”) to hedge our exposure to changes in foreign currency exchange rates associated with our foreign currency denominated cash,accounts receivable, and intercompany receivables and payables held by our U.S. operating company and Pegasystems Limited, its United Kingdom (“U.K.”)subsidiary. These forward contracts have terms not greater than six months and are intended to partially mitigate exposure to the foreign currency transaction gainsand losses. We do not enter into any hedging contracts for trading or speculative purposes. Our realized gain or loss with respect to foreign currency fluctuationswill generally depend on the size and type of cross-currency exposures that we enter into; the currency exchange rates associated with these exposures and changesin those rates; whether we have entered into forward contracts to offset these exposures; and other factors. All of these factors could materially impact ouroperating results, financial condition, and cash flows.Factors relating to our internal operations and potential liabilitiesWe 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 ofkey, highly skilled technical, managerial, consulting, sales, and marketing personnel, including our Chief Executive Officer who is also our founder and majoritystockholder. The loss of key personnel could adversely affect financial performance. We do not have any significant key-man life insurance on any officers oremployees and do not plan to obtain any. Our success will depend in large part on the ability to hire and retain qualified personnel, and rapidly replace and ramp upnew management. The number of potential employees who have the extensive knowledge of computer hardware and operating systems needed to develop, sell, andmaintain 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. 15Table of ContentsWe may not be able to achieve the key elements of our strategy and grow our business as anticipated. We currently intend to grow our business bypursuing strategic initiatives. Key elements of our strategy include utilizing our network of partner alliances to support our growth strategies and developing thetalent and organizational structure capable of supporting our growth targets. We may not be able to achieve one or more of our key initiatives. Our success dependson our ability to appropriately manage our expenses as we grow our organization; successfully execute our marketing and sales strategies; successfully incorporateacquired technologies into our unified Pega 7 platform; and develop new products or product enhancements. If we are not able to execute on these actions, ourbusiness may not grow as we anticipated, and our operating results could be adversely affected.We may experience significant errors or security flaws in our product and services, and could face privacy, product liability, and/or warranty claims as aresult. Despite quality testing prior to their release, software products frequently contain errors or security flaws, especially when first introduced or when newversions are released. Errors in our software products could affect the ability of our products to work with other hardware or software products, or could delay thedevelopment or release of new products or new versions of products. Additionally, the detection and correction of any security flaws can be time consuming andcostly. Errors or security flaws in our software could result in the inadvertent disclosure of confidential information or personal data relating to our clients,employees, or third parties. Software product errors and security flaws in our products or services could expose us to privacy, product liability, and/or warrantyclaims as well as harm our reputation, which could impact our future sales of products and services. Typically, we enter into license agreements that containprovisions 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 alimited 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 directclient. Furthermore, some of our licenses with our clients are governed by non-U.S. law, and there is a risk that foreign law might give us less or differentprotection. Although we have not experienced any material product liability claims to date, a product liability suit or action claiming a breach of warranty, whetheror 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 intellectual property and confidentiality agreements to protect our proprietary rights. We also try to control access toand distribution of our technologies and other proprietary information. We have obtained patents in strategically important global markets relating to thearchitecture of our systems. We cannot assure that such patents will not be challenged, invalidated, or circumvented or that rights granted thereunder or the claimscontained therein will provide us with competitive advantages. Moreover, despite our efforts to protect our proprietary rights, unauthorized parties may attempt tocopy aspects of our products or to obtain the use of information that we regard as proprietary. Although we generally enter into intellectual property andconfidentiality agreements with our employees and strategic partners, despite our efforts our former employees may seek employment with our business partners,customers, or competitors, and there can be no assurance that the confidential nature of our proprietary information will be maintained. In addition, the laws ofsome 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 protectingour proprietary rights will be adequate or that our competitors will not independently develop similar technology.Other companies or individuals have obtained proprietary rights covering a variety of designs, processes, and systems. There can be no assurance that thirdparties, including clients, will not claim infringement by us with respect to current or future products. Although we attempt to limit the amount and type of ourcontractual liability for infringement of the proprietary rights of third parties, and also assert ownership of work product and intellectual property rights asappropriate, there are often exceptions, and we cannot be assured that limitations will be applicable and enforceable in all cases. Even if limitations are found to beapplicable and enforceable, our liability to our clients for these types of claims could be material in amount given the size of certain of our transactions. We expectthat software product developers will increasingly be subject to infringement claims as 16Table of Contentsthe 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 and delivery delays, require us to enter into royalty or licensingagreements, or be precluded from making and selling the infringing products, if such proprietary rights are found to be valid. Royalty or licensing agreements, ifrequired, 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 financialcondition.We are subject to increasingly complex and burdensome U.S. and foreign laws and regulations, and any failure to comply with these laws andregulations could subject us to, among other things, penalties and legal expenses that could harm our reputation or have a material adverse effect on ourbusiness, financial condition and results of operations. We are subject to extensive federal, state, and foreign laws and regulations, including but not limited to theU.S. Foreign Corrupt Practices Act, the U.K. Bribery Act, data privacy and security laws, and similar laws and regulations. The Foreign Corrupt Practices Act, theU.K. Bribery Act and similar foreign anti-bribery laws generally prohibit companies and their intermediaries from making improper payments for the purpose ofobtaining or retaining business. Similar laws and regulations exist in many other countries throughout the world in which we do or intend to do business. Dataprivacy laws and regulations in Europe, Australia, Latin America and elsewhere are undergoing rapid transformation towards increased restrictions. For example,the European Court of Justice recently invalidated the U.S.-EU Safe Harbor framework that had been in place since 2000, which allowed companies to meet certainEuropean legal requirements for the transfer of personal data from the European Economic Area to the United States. While other legal mechanisms to lawfullytransfer such data remain, the invalidation of the U.S.-EU Safe Harbor framework may result in different European data protection regulators applying differingstandards for the transfer of personal data.We have developed and implemented a compliance program based on what we believe are current best practices, including the background checking of all ofour current partners and of prospective clients and partners, but we cannot guarantee that we, our employees, our consultants, or our contractors are or will be incompliance with all federal, state, and foreign regulations, particularly as we expand our operations outside of the U.S. If we or our representatives fail to complywith any of these laws or regulations, a range of fines, penalties, and/or other sanctions could be imposed on us, which could have a material adverse effect on ourbusiness, financial condition, and results of operations. Even if we are determined not to have violated these laws, government investigations into these issuestypically require the expenditure of significant resources and generate negative publicity, which could also have an adverse effect on our business, financialcondition, and results of operations. In addition, regulation of data privacy and security laws is increasing worldwide, including various restrictions on cross-borderaccess or transfer of data, including personal data of our employees, our clients, and customers of our clients. Compliance with such regulations may increase ourcosts and there is a risk of enforcement of such laws resulting in damage to our brand as well as financial penalties, which could be significant.We face risks related to outages, data losses, and disruptions of our online services if we fail to maintain an adequate operations infrastructure. Ourincreasing user traffic for Pega Cloud services demands more computing power. It requires that we maintain an Internet connectivity infrastructure that is robustand reliable within competitive and regulatory constraints that continue to evolve. Inefficiencies or operational failures, including temporary or permanent loss ofclient data, power outages, or telecommunications infrastructure outages, could diminish the quality of our user experience resulting in contractual liability, claimsby clients and other third parties, damage to our reputation, loss of current and potential clients, and harm to our operating results and financial condition.Security of our systems and of global client data is a growing challenge on many fronts. Cyber-attacks and security breaches may expose us to significantlegal and financial liabilities. Our Pega Cloud services involve the storage and transmission of clients’ personal data and other proprietary information, andsecurity breaches could expose us to a risk of loss of this information, litigation, and liability. High-profile security breaches at other companies have increased inrecent years, and security industry experts and government 17Table of Contentsofficials have warned about the risks of hackers and cyber-attackers targeting information technology products and businesses. Threats to Information Technology(“IT”) security can take a variety of forms. Individual hackers, groups of hackers, and sophisticated organizations including state-sponsored organizations ornation-states themselves, may take steps that pose threats to our clients and to our IT structure.Our security measures, and those of our clients, may be breached as a result of third-party actions, or that of employees, consultants, or others, includingintentional misconduct by computer hackers, system error, human error, technical flaws in our products, or otherwise. Because the techniques used to obtainunauthorized access or to sabotage systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate thesetechniques or to implement adequate preventative measures. While we have invested in the protection of our data and systems and of our clients’ data to reducethese risks, there can be no assurance that our efforts will prevent breaches. Security breaches could expose us and our clients to a risk of loss or misuse of thisinformation. Any security breach could result in a loss of confidence in the security of our service, damage our reputation, disrupt our business, lead to legalliability, and negatively impact our future sales. We carry data breach insurance coverage to mitigate the financial impact of such potential legal liability, thoughthis may prove insufficient in the event of a breach.Additionally, our Pega Cloud computing service offering allows clients to create and deploy Pega 7-based applications using an Internet-based infrastructure.This offering involves the hosting of clients’ applications which may contain confidential information, including personal and financial data regarding their endcustomers, on the servers of a third-party technology provider. We also rely on third-party systems and technology including encryption, virtualized infrastructure,and support. Because we do not control the transmissions between our clients and our third-party technology providers, the processing of data on the servers of thethird-party technology providers, or the internal controls maintained by the third-party technology providers that could prevent unauthorized access and provideappropriate data encryption, we cannot ensure the complete integrity or security of such transmissions processing, or controls. In addition, privacy and securityconcerns in some parts of the world may inhibit demand for our Pega Cloud offering or lead to requirements to provide our products or services in configurationsthat may increase the cost of serving such markets.In order to defend against security threats, we need to continuously engineer more secure products and services; enhance security and reliability features;improve the deployment of software updates to address security vulnerabilities; develop mitigation technologies that help to secure clients from attacks; andmaintain the digital security infrastructure that protects the integrity of our network, products, and services. The cost of these steps could negatively impact ouroperating margins.The acquisition of other businesses and technologies may present new risks. In the past, we have undertaken acquisitions and we continue to evaluate andconsider other potential strategic transactions, including domestic and international acquisitions of businesses, technologies, services, products, and other assets.These acquisitions, if undertaken, may involve significant new risks and uncertainties, including distraction of management attention away from our currentbusiness operations, insufficient new revenue to offset expenses, inadequate return on capital, integration challenges, new regulatory and/or legal requirements,new third-party intellectual property infringement claims related to the acquired technology and/or services, dilution of shareholder value, cross border legal issues,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 ourprofitability or operations. ITEM 1B.Unresolved Staff CommentsNone. ITEM 2.PropertiesOur principal administrative, sales, marketing, support, and research and development operations are located in Cambridge, Massachusetts in anapproximately 185,000 square foot leased facility. Our lease expires in 2023, 18Table of Contentssubject to our option to extend for two additional five-year periods. We also lease space for our other offices in North America, Europe, and the Asia Pacific underleases that expire at various dates through 2021. We periodically evaluate the adequacy of existing facilities and additional facilities in new cities, and we believethat additional or alternative space will be available as needed in the future on commercially reasonable terms.See Note 13 “Commitments and Contingencies,” in the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-Kfor more information about our lease commitments. ITEM 3.Legal ProceedingsNone. ITEM 4.Mine Safety DisclosuresNot applicable. 19Table of ContentsPART II ITEM 5.Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesStock SplitOn March 6, 2014, our Board of Directors approved a two-for-one stock split of our common stock, effected in the form of a common stock dividend (the“Stock Split”). On April 1, 2014, each stockholder of record at the close of business on March 20, 2014 (the “Record Date”) received as a dividend, one additionalshare of common stock, par value $0.01, for each share of common stock held on the Record Date. The number of common shares and per share amounts for allprior periods presented in this Annual Report on Form 10-K have been retroactively restated to reflect the Stock Split, except as otherwise noted.Market InformationOur common stock is quoted on the NASDAQ Global Select Market (“NASDAQ”) under the symbol “PEGA.” The following table sets forth the range ofhigh and low sales prices of our common stock on NASDAQ for each quarter in the years ended December 31: Common Stock Price (1) 2015 2014 High Low High Low First Quarter $23.44 $19.20 $24.85 $17.07 Second Quarter $24.09 $20.65 $21.79 $15.51 Third Quarter $27.91 $22.26 $23.38 $19.10 Fourth Quarter $30.23 $24.04 $21.95 $18.46 (1) The historical per share amounts presented above reflect the impact of the Stock Split. See “Stock Split” above.HoldersAs of February 11, 2016, we had approximately 23 stockholders of record and approximately 11,000 beneficial owners of our common stock.DividendsIn July 2006, we began paying a quarterly cash dividend of $0.03 per share of common stock. This represents $0.015 per share of common stock givingeffect to the Stock Split. On May 27, 2014, we announced an increase in our quarterly common stock cash dividend to $0.03 per share. Quarterly cash dividends areexpected to continue at $0.03 per share, subject to change or elimination at any time by our Board of Directors. 20Table of ContentsIssuer Purchases of Equity SecuritiesThe following table sets forth information regarding our repurchases of our common stock during the fourth quarter of 2015. Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Share Repurchase Program (1) Approximate Dollar Value of Shares That May Yet Be Purchased at Period End Under Publicly Announced Share Repurchased Programs (1) (in thousands) 10/1/2015 – 10/31/2015 99,948 $25.86 99,948 $43,485 11/1/2015 – 11/30/2015 41,290 $29.04 41,290 $42,286 12/1/2015 – 12/31/2015 62,459 $28.04 62,459 $40,534 Total 203,697 $27.17 (1) Since 2004, our Board of Directors has approved stock repurchase programs that have authorized the repurchase, in the aggregate, of up to $169 million ofour common stock.On June 4, 2015, we announced that our Board of Directors extended the expiration date of the current stock repurchase program (the “Current Program”) toJune 30, 2016 and authorized the Company to repurchase up to an additional $50 million of our stock between June 4, 2015 and June 30, 2016. Under the CurrentProgram, purchases may be made from time to time on the open market or in privately negotiated transactions. Shares may be repurchased in such amounts asmarket conditions warrant, subject to regulatory and other considerations. We have established a pre-arranged stock repurchase plan, intended to comply with therequirements of Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, and Rule 10b-18 of the Exchange Act (the “10b5-1 Plan”). All sharerepurchases under the Current Program during closed trading window periods will be made pursuant to the 10b5-1 Plan.We net settle the majority of our employee stock option exercises and restricted stock unit (“RSU”) vestings, which results in the withholding of shares tocover the option exercise price and the minimum statutory withholding tax obligations that we are required to pay in cash to the applicable taxing authorities onbehalf of our employees. We do not consider these transactions to be common stock repurchases. 21Table of ContentsStock Performance Graph and Cumulative Total Stockholder ReturnThe following performance graph represents a comparison of the cumulative total stockholder return (assuming the reinvestment of dividends) for a $100investment on December 31, 2010 in our common stock, the Total Return Index for the NASDAQ Composite (“NASDAQ Composite”), a broad market index, andthe Standard & Poors (“S&P”) North American Technology Sector -Software Index™ (“S&P NA Tech Software”), a published industry index. We paid dividendsof $0.12 per share during 2015, $0.09 per share during 2014, $0.045 per share during 2013, $0.075 per share during 2012, and $0.06 per share during 2011,respectively. The graph lines merely connect measurement dates and do not reflect fluctuations between those dates. 12/31/2010 12/31/2011 12/31/2012 12/31/2013 12/31/2014 12/31/2015 Pegasystems Inc. $100.00 $80.52 $62.38 $135.70 $115.21 $153.31 NASDAQ Composite $100.00 $99.17 $116.48 $163.21 $187.27 $200.31 S&P NA Tech Software $100.00 $93.15 $109.38 $143.40 $163.30 $183.70 22Table of ContentsITEM 6.Selected Financial DataThe selected financial data presented below has been derived from our audited consolidated financial statements. This data should be read in conjunctionwith “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, the consolidated financial statements, and accompanying notes. Year Ended December 31, (in thousands, except per share amounts) 2015 2014 2013 2012 2011 Consolidated Statements of Operations Data: Total revenue $682,695 $590,004 $508,954 $461,710 $416,675 Income from operations 64,661 51,539 58,097 31,426 10,494 Income before provision for income taxes 60,505 47,994 56,393 30,945 10,813 Net income 36,322 33,255 38,043 21,868 10,108 Earnings per share: Basic (1) $0.47 $0.44 $0.50 $0.29 $0.13 Diluted (1) $0.46 $0.42 $0.49 $0.28 $0.13 Cash dividends declared per common share $0.12 $0.105 $0.06 $0.06 $0.06 (1)The number of common shares and per share amounts have been retroactively restated for all prior periods presented to reflect the two-for-one commonstock split effected in the form of a common stock dividend distributed on April 1, 2014. See Item 5 “Market for Registrant’s Common Equity, RelatedStockholder Matters and Issuer Purchases of Equity Securities—Stock Split” of this Annual Report on Form 10-K for further discussion of the Stock Split. Year Ended December 31, (in thousands) 2015 2014 2013 2012 2011 Consolidated Balance Sheet Data: Total cash, cash equivalents, and marketable securities $219,078 $211,216 $156,692 $122,985 $111,432 Working capital 191,677 163,448 157,823 123,885 89,716 Intangible assets, net of accumulated amortization 33,418 45,664 56,574 58,232 69,369 Goodwill 46,776 46,860 43,469 20,451 20,451 Total assets 627,758 587,801 536,480 439,492 381,711 Total stockholders’ equity 322,859 294,705 271,788 236,479 208,756 The following items impact the comparability of our consolidated financial data: • Our acquisition of Antenna Software, Inc. in October 2013. • Foreign currency transaction (losses) gains of $(4.2) million, $(3.8) million, $(1.6) million, $0.8 million, and $(0.9) million, during the years endedDecember 31, 2015, 2014, 2013, 2012, and 2011, respectively. See Item 7A “Quantitative and Qualitative Disclosure about Market Risk” for furtherdiscussion of our foreign currency exchange rate risk. 23Table of ContentsITEM 7.Management’s Discussion and Analysis of Financial Condition and Results of OperationsBUSINESS OVERVIEWWe develop, market, license, and support strategic software applications for marketing, sales and onboarding, customer service, and operations, in addition tolicensing our Pega 7 platform for clients that wish to build and extend their own applications. Pega 7 assists our clients in building, deploying, and evolvingenterprise applications, creating an environment in which business and IT can collaborate to manage back office operations, front office sales, marketing, and/orcustomer service needs. We also provide consulting services, maintenance, and training for our software, as well as a variety of applications. Our applications andPega 7 can be deployed in the cloud or on-premises.Pega 7 and our related applications are used by our clients in the financial services, healthcare, insurance, communications and media, public sector,manufacturing, life sciences, and other markets. We sell our software directly, and also through a network of business and technology alliances. Our partnersinclude major systems integrators, management consulting firms, technology providers, and application developers.Our clients include Global 3000 companies and government agencies that seek to manage complex enterprise systems and customer service issues morenimbly and cost-effectively. Our strategy is to sell a client a series of licenses, each focused on a specific purpose or area of operations.In 2015, 2014, and 2013, sales to clients based outside of the United States of America (“U.S.”) represented approximately 45% of our total revenue. SeeNote 18, “Geographic Information and Major Clients,” included in the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report onForm 10-K for further detail on our geographic revenues.Our license revenue is primarily derived from sales of our applications in the areas of marketing, sales and onboarding, customer service, and operations, aswell our Pega 7 platform. Our consulting services revenue is primarily related to new license implementations. Our consulting services revenue may be lower infuture periods as our clients become enabled and our partners lead more projects. We offer training for our staff, clients, and partners at our regional trainingfacilities and at third-party facilities, including client sites. Our online training through PegaACADEMY provides an alternative way to learn our software in avirtual environment. We believe that this online training will continue to expand the number of trained experts at a faster pace.We continue to invest heavily in research and development to improve our software. Our research and development operations are primarily located in theU.S., India, and Poland. We also regularly evaluate acquisitions or investment opportunities in complementary businesses, services and technologies, andintellectual property rights in an effort to expand and enhance our product offerings. Year Ended December 31, Increase (Decrease) % Change (Dollars in thousands, except pershare amounts) 2015 2014 2013 2015 vs. 2014 2014 vs. 2013 2015 vs. 2014 2014 vs. 2013 Total revenue $682,695 $590,004 $508,954 $92,691 $81,050 16% 16% License revenue $275,588 $232,336 $191,876 $43,252 $40,460 19% 21% Diluted earnings per share $0.46 $0.42 $0.49 $0.04 $(0.07) 10% (14)% Cash flow provided by operating activities $62,528 $99,889 $80,703 $(37,361) $19,186 (37)% 24% 24Table of ContentsIn addition to the above key financial metrics, management also focuses on aggregate license and cloud backlog. We compute license and cloud backlog byadding billed deferred license and cloud revenue as recorded on the balance sheet and license and cloud commitments, which are not billed and not recorded on ourbalance sheet. License and cloud backlog may vary in any given period depending on the amount and timing of when arrangements are executed, as well as the mixbetween perpetual, term and cloud license arrangements. As of December 31, % Change (Dollars in thousands) 2015 2014 2013 2015 vs. 2014 2014 vs. 2013 Total billed deferred license and cloud revenue $63,412 $63,048 $64,267 1% (2)% Total off-balance sheet license and cloud commitments 356,388 301,409 283,099 18% 6% Total license and cloud backlog $419,800 $364,457 $347,366 15% 5% To grow our business, we intend to: • Lead the platform market for strategic business applications with a focus on mobile, analytics, and cloud; • Continue to grow market share with our leading, differentiated front-office applications: Marketing, Sales and Onboarding, and Customer Service; • Execute new-market growth initiatives, further expanding coverage within the Global 3000; and • Build out our digital platform and continue to invest in awareness marketing to support the way today’s clients want to buy.Whether or not we are successful depends, in part, on our ability to: • Successfully execute our marketing and sales strategies; • Appropriately manage our expenses as we grow our organization; • Develop new products or product enhancements; and • Successfully incorporate acquired technologies into our applications and unified Pega 7 platform.RESULTS OF OPERATIONS (Dollars in thousands) Year Ended December 31, % Change 2015 2014 2013 2015 vs. 2014 2014 vs. 2013 Total revenue $682,695 $590,004 $508,954 16% 16% Gross profit 469,249 404,910 351,548 16% 15% Total operating expenses 404,588 353,371 293,451 14% 20% Income from operations 64,661 51,539 58,097 25% (11)% Income before provision for income taxes 60,505 47,994 56,393 26% (15)% RevenueSoftware license revenue (Dollars in thousands) Year Ended December 31, % Change 2015 2014 2013 2015 vs. 2014 2014 vs. 2013 Perpetual licenses $166,305 60% $136,154 59% $122,644 64% 22% 11% Term licenses 101,604 37% 88,813 38% 62,711 33% 14% 42% Subscription 7,679 3% 7,369 3% 6,521 3% 4% 13% Total software license revenue $275,588 100% $232,336 100% $191,876 100% 19% 21% 25Table of ContentsThe mix between perpetual and term license arrangements executed in a particular period varies based on client needs. A change in the mix betweenperpetual and term license arrangements executed may cause our revenues to vary materially from period to period. A higher proportion of term licensearrangements executed would result in more license revenue being recognized over longer periods as payments become due or earlier if prepaid. Additionally,some of our perpetual license arrangements include extended payment terms or additional rights of use, which also result in the recognition of revenue over longerperiods. The aggregate value of new license agreements executed also fluctuates quarter to quarter.Subscription revenue primarily consists of the ratable recognition of license, maintenance, and bundled services revenue on license arrangements that includea right to successor products or unspecified future products. Subscription revenue does not include revenue from our Pega Cloud arrangements, which is includedin services revenue. The timing of client scheduled payments under subscription arrangements may limit the amount of revenue recognized in a reporting period.Consequently, our subscription revenue may vary materially quarter to quarter.2015 Compared to 2014The aggregate value of new license arrangements executed during 2015 significantly increased compared to 2014, primarily due to a higher number andhigher average value of arrangements executed in 2015. The higher average value was primarily due to three arrangements, each greater than $10 million, executedin 2015 compared to only one executed in 2014. During 2015 and 2014, approximately 74% and 82%, respectively, of the value of new license arrangements wereexecuted with existing clients.The increase in perpetual license revenue was primarily due to revenue recognized from the higher volume and higher average value of arrangementsexecuted in 2015 and the acceleration of the recognition of $4.6 million in revenue from an existing license arrangement which was being recognized on asubscription basis. The aggregate value of payments due under noncancellable perpetual licenses was $33.5 million as of December 31, 2015 compared to $31.3million as of December 31, 2014.The increase in term license revenue was primarily due to prepayments of two arrangements executed in 2015. The aggregate value of payments due undernoncancellable term licenses and our Pega Cloud arrangements grew to $322.8 million as of December 31, 2015 compared to $270.1 million as of December 31,2014. See the table of future cash receipts in Liquidity and Capital Resources—Cash Provided by Operating Activities.Subscription revenue is expected to decline in future periods due to the acceleration of the recognition of $4.6 million in revenue discussed above.2014 Compared to 2013The aggregate value of new license arrangements executed during 2014 increased compared to 2013 due to a higher number of license arrangementsexecuted in 2014. The increase in the aggregate value of license arrangements executed was primarily due to one perpetual license arrangement executed in thesecond quarter of 2014 for more than $10 million, partially offset by a decrease in the value of new license arrangements executed in the fourth quarter of 2014.During 2014 and 2013, approximately 82% and 80%, respectively, of the value of new license arrangements were executed with existing clients.The increase in perpetual license revenue was primarily due to the higher number and total value of license arrangements executed in 2014. The aggregatevalue of payments due under noncancellable perpetual licenses was $31.3 million as of December 31, 2014 compared to $30.7 million as of December 31, 2013.The increase in term license revenue was primarily due to term license arrangements executed in 2014 and the second half of 2013. The aggregate value ofpayments due under noncancellable term licenses and our Pega 26Table of ContentsCloud arrangements grew to $270.1 million as of December 31, 2014 compared to $252.4 million as of December 31, 2013. See the table of future cash receipts inLiquidity and Capital Resources—Cash Provided by Operating Activities.The increase in subscription revenue was primarily due to the timing of payments for a client arrangement.Maintenance revenue (Dollars in thousands) Year Ended December 31, % Change 2015 2014 2013 2015 vs. 2014 2014 vs. 2013 Maintenance $202,802 $186,239 $157,309 9% 18% The increases in maintenance revenue were primarily due to the growth in the aggregate value of the installed base of our software and continued strongrenewal rates.Services revenue (Dollars in thousands) Year Ended December 31, % Change 2015 2014 2013 2015 vs. 2014 2014 vs. 2013 Consulting services $167,704 82% $149,628 87% $145,780 91% 12% 3% Cloud 30,626 15% 16,614 10% 8,720 6% 84% 91% Training 5,975 3% 5,187 3% 5,269 3% 15% (2)% Total services $204,305 100% $171,429 100% $159,769 100% 19% 7% 2015 Compared to 2014Consulting services revenue represents revenue primarily from new license implementations. Our consulting services revenue may fluctuate in future periodsdepending on the mix of new implementation projects we perform as compared to those performed by our enabled clients or led by our partners. The increase inconsulting services revenue was due to the higher number of projects and billable hours in 2015 compared to 2014.Cloud revenue represents revenue from our Pega Cloud offerings. The increase in cloud revenue was primarily due to growth of our cloud client base.2014 Compared to 2013The increase in consulting services revenue was a result of revenue from Antenna and unusually low services revenue in the first quarter of 2013 mainlybecause many of our large fourth quarter 2012 license arrangements were for the purchase of additional usage, which did not require implementation services.The increase in cloud revenue was primarily due to growth of our cloud client base and cloud revenue from Antenna.Training revenue decreased slightly as a result of a higher number of clients taking courses through our PegaACADEMY self-service online training, whichhas a significantly lower average price per student as compared to our traditional instructor-led training. 27Table of ContentsGross Profit (Dollars in thousands) Year Ended December 31, % Change 2015 2014 2013 2015 vs. 2014 2014 vs. 2013 Software license $271,463 $227,377 $185,595 19% 23% Maintenance 180,899 166,225 142,037 9% 17% Services 16,887 11,308 23,916 49% (53)% Total gross profit $469,249 $404,910 $351,548 16% 15% Total gross profit % 69% 69% 69% Software license gross profit % 99% 98% 97% Maintenance gross profit % 89% 89% 90% Services gross profit % 8% 7% 15% 2015 Compared to 2014The increase in total gross profit was primarily due to increases in software license and maintenance revenue.The increase in services gross profit percent was primarily due to increased global professional services utilization rates in 2015 compared to 2014, partiallyoffset by increased software license costs.2014 Compared to 2013The increase in total gross profit was primarily due to increases in software license and maintenance revenue.The decrease in services gross profit percent was primarily due to increased subcontractor and employee-related costs associated with higher headcount,primarily related to Antenna. It was also due to two large implementation projects for which more revenue without any associated expenses was recognized in 2013than in 2014. The associated expenses were incurred in prior periods. In addition, European professional services utilization rates declined 8% in 2014 compared to2013, primarily due to the weakening overall economic conditions in Europe and the completion of a large project.Operating expensesAmortization of intangibles: (Dollars in thousands) Year Ended December 31, % Change 2015 2014 2013 2015 vs. 2014 2014 vs. 2013 Cost of revenue $5,392 $6,017 $6,443 (10)% (7)% Selling and marketing 6,127 6,022 5,174 2% 16% General and administrative 683 1,770 396 (61)% 347% $12,202 $13,809 $12,013 (12)% 15% 2015 Compared to 2014The decreases were due to the full amortization in 2014 of acquired technology and other intangibles from our 2010 acquisition of Chordiant and our 2013acquisition of Antenna. 28Table of Contents2014 Compared to 2013The increases were due to the amortization associated with $10.4 million of intangibles acquired from Antenna in October 2013.Selling and marketing (Dollars in thousands) Year Ended December 31, % Change 2015 2014 2013 2015 vs. 2014 2014 vs. 2013 Selling and marketing $241,387 $206,658 $181,094 17% 14% As a percent of total revenue 35% 35% 36% Selling and marketing headcount 750 661 598 13% 11% Selling and marketing expenses include compensation, benefits, and other headcount-related expenses associated with our selling and marketing personnel aswell as advertising, promotions, trade shows, seminars, and other programs. Selling and marketing expenses also include the amortization of customer relatedintangibles.The increases in headcount reflect our efforts to increase our sales capacity to target new accounts in existing industries as well as to expand coverage in newindustries and geographies, and to increase the number of our sales opportunities.2015 Compared to 2014The increase was primarily due to a $14 million increase in compensation and benefit expenses associated with higher headcount, an $11.4 million increasein sales and marketing programs expenses primarily related to our digital advertising and brand awareness campaigns, and a $10 million increase in salescommissions associated with the higher value of new license arrangements executed in 2015 compared to 2014.2014 Compared to 2013The increase was primarily due to a $14.2 million increase in compensation and benefit expenses associated with higher headcount, partially due to theAntenna acquisition, a $5.6 million increase in marketing and sales program expenses primarily related to PegaWORLD, our annual user conference, a $2.6 millionincrease in travel associated with the higher number of sales employees, and a $0.8 million increase in amortization associated with our Antenna-customer relatedintangibles.Effective January 1, 2014, we realigned the organizational structure of our product management and design team. As a result of this realignment, we changedthe classification of this team’s expenses from selling and marketing to research and development as the roles of the members of this team are now aligned with ourresearch and development efforts. The decrease caused by this realignment partially offset the increase in headcount as well as the overall increase in selling andmarketing expenses during 2014 compared to 2013.Research and development (Dollars in thousands) Year Ended December 31, % Change 2015 2014 2013 2015 vs. 2014 2014 vs. 2013 Research and development $126,374 $108,591 $79,726 16% 36% As a percent of total revenue 19% 18% 16% Research and development headcount 1,222 1,085 913 13% 19% Research and development expenses include compensation, benefits, contracted services, and other headcount-related expenses associated with the creationand development of our products as well as enhancements and engineering changes to existing products and integration of acquired technologies. 29Table of ContentsThe increases in headcount primarily reflect the growth in our India research facility. The increases in offshore headcount usually lower our averagecompensation expense per employee.2015 Compared to 2014The increase was primarily due to an $11.9 million increase in compensation and benefit expenses associated with higher headcount, a $1.4 million increasein outsourced hosting expenses, a $1.4 million increase in expendable equipment and software license expenses, and an $0.8 million increase in contractedprofessional services.2014 Compared to 2013The increase was primarily due to a $20.9 million increase in compensation and benefit expenses associated with higher headcount, inclusive of thecompensation and benefit expenses associated with Antenna and with our product management and design group included in research and development as a resultof the 2014 realignment of our organizational structure, a $2.3 million increase in computer and computer-related costs, and a $1.8 million increase in contractedprofessional services.General and administrative (Dollars in thousands) Year Ended December 31, % Change 2015 2014 2013 2015 vs. 2014 2014 vs. 2013 General and administrative $36,738 $37,442 $29,594 (2)% 27% As a percent of total revenue 5% 6% 6% General and administrative headcount 353 310 271 14% 14% General and administrative expenses include compensation, benefits, and other headcount-related expenses associated with finance, legal, corporategovernance, and other administrative headcount. They also include accounting, legal, and other professional consulting and administrative fees.The general and administrative headcount includes employees in human resources, information technology, and corporate services departments whose costsare allocated to our other functional departments.2015 Compared to 2014The decrease was primarily due to the recognition in the first quarter of 2015 of a $1.8 million benefit from the settlement of our indemnification claimsagainst the former Antenna shareholders and the $1.6 million benefit from the settlement of certain indirect tax liabilities, partially offset by a $2.2 million increasein compensation and benefit expenses associated with higher headcount.2014 Compared to 2013The increase was primarily due to a $2.6 million increase in compensation and benefits associated with higher headcount, a $2 million increase inprofessional fees primarily associated with legal and audit costs, and a $1.4 million increase in amortization associated with our trademark and non-competeintangible assets.Acquisition-relatedAcquisition-related costs are expensed as incurred and include direct and incremental costs associated with an impending or completed acquisition. During2015, 2014, and 2013, we incurred $0.1 million, $0.5 million, and $1.3 million, respectively, of acquisition-related costs, consisting primarily of professional feesassociated with our acquisition of Antenna and the acquisitions completed in 2014. 30Table of ContentsRestructuringThe restructuring expenses represent future lease payments and demising costs, net of estimated sublease income, for space acquired in connection with theAntenna acquisition. During the fourth quarter of 2013, we ceased use of some of this space as part of our integration of Antenna and recognized $1.7 million inexpenses. During the third quarter of 2014, we restructured the remaining space and revised our estimate of sublease income for the previously restructured space,recognizing $0.2 million in restructuring expenses. See Note 12 “Accrued Restructuring” in the Notes to Consolidated Financial Statements included in Item 8 ofthis Annual Report on Form 10-K for further discussion.Stock-based compensationWe recognize stock-based compensation expense associated with equity awards in our consolidated statements of operations based on the fair value of theseawards at the date of grant using the accelerated recognition method, while treating each vesting tranche as if it were an individual grant. (Dollars in thousands) Year Ended December 31, % Change 2015 2014 2013 2015 vs. 2014 2014 vs. 2013 Stock-based compensation: Cost of revenues $8,772 $5,335 $4,085 64% 31% Operating expenses 21,282 13,870 8,784 53% 58% Total stock-based compensation before tax 30,054 19,205 12,869 56% 49% Income tax benefit (8,098) (5,563) (3,918) 2015 Compared to 2014The increase was primarily due to the higher value of the 2014 annual periodic equity grant compared to the 2013 grant, which occurred in March 2015 and2014, respectively.2014 Compared to 2013The increase was primarily due to the timing of the 2013 and 2012 annual equity grants, which occurred in March 2014 and December 2012, respectively, aswell as the higher value of the 2013 annual equity grant, executive new hire grants made since September 30, 2013, and awards granted in connection with the 2014acquisitions.See Note 15 “Stock-Based Compensation” in the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K forfurther information on our stock-based awards.Non-operating income and (expenses), net (Dollars in thousands) Year Ended December 31, % Change 2015 2014 2013 2015 vs. 2014 2014 vs. 2013 Foreign currency transaction loss $(4,168) $(3,769) $(1,593) 11% 137% Interest income, net 1,056 683 524 55% 30% Other expense, net (1,044) (459) (635) 127% (28)% $(4,156) $(3,545) $(1,704) 17% 108% We have historically used forward contracts to manage our exposure to changes in foreign currency exchange rates associated with cash, accounts receivable,and intercompany receivables and payables held by Pegasystems Inc., our U.S. operating company, in currencies other than the U.S. dollar. 31Table of ContentsEffective April 1, 2015, our clients based outside the Americas began transacting with Pegasystems Limited, a U.K. subsidiary, which has the British poundas its functional currency. This reorganization resulted in increased cash, accounts receivable, and intercompany receivables and payables held by PegasystemsLimited in currencies other than the British pound.We did not enter into any forward contracts between March 2014 and June 2015. In the third quarter of 2015, as a result of this operational reorganization,we implemented our revised hedging program, under which we hedge our non-functional currency exposures for Pegasystems Inc. and Pegasystems Limited,utilizing forward contracts with terms not greater than six months.These forward contracts are not designated as hedging instruments. As a result, we record the fair value of the outstanding contracts at the end of thereporting period in our consolidated balance sheet, with any fluctuations in the value of these contracts recognized in other expense, net.The total change in the fair value of our foreign currency forward contracts recorded in other expense, net, during 2015, 2014, and 2013 was a loss of $1million, $0.5 million, and $0.7 million, respectively.See Note 4 “Derivative Instruments” in the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K fordiscussion on our use of forward contracts.Provision for income taxes2015 Compared to 2014The provision for income taxes represents current and future amounts owed for federal, state, and foreign taxes. During 2015 and 2014, we recorded a $24.2million and a $14.7 million provision, respectively, which resulted in an effective tax rate of 40.0% and 30.7%, respectively.Our effective income tax rate for 2015 increased above the statutory U.S. federal income tax rate primarily due to $2.6 million of permanent differencesrelated to nondeductible meals and entertainment expenses and foreign stock compensation and a $0.5 million unfavorable impact related to losses generated inforeign jurisdictions that are subject to tax at a rate lower than the U.S. statutory tax rate.Our effective income tax rate for 2014 was below the statutory U.S. federal income tax rate primarily due to a $2.4 million benefit related to the currentperiod domestic production activities deduction, a $1.8 million benefit related to income generated in foreign jurisdictions that is subject to tax at a rate lower thanthe U.S. statutory tax rate, and a $0.8 million benefit related to the 2014 federal research and experimentation (“R&E”) credit. These benefits were partially offsetby $1.8 million of permanent differences related to nondeductible meals and entertainment expenses and foreign stock compensation.As of December 31, 2015, we had approximately $24 million of total unrecognized tax benefits, which will decrease our effective tax rate if recognized. Weexpect that the changes in the unrecognized benefits within the next twelve months will be approximately $0.5 million, all of which relate to the expiration ofapplicable statute of limitations and will reduce our effective tax rate if recognized.2014 Compared to 2013During 2014 and 2013, we recorded a $14.7 million and an $18.4 million provision, respectively, which resulted in an effective tax rate of 30.7% and 32.5%,respectively.Our effective income tax rate for 2013 was below the statutory federal income tax rate due to a $2.1 million benefit related to the current period domesticproduction activities deduction, a $1.2 million benefit related to 32Table of Contentsincome generated in foreign jurisdictions that is subject to tax at a rate lower than the U.S. statutory tax rate, and a $1.6 million benefit related to the 2012 and 2013R&E credit. These benefits were partially offset by $1.4 million of permanent differences related to nondeductible meals and entertainment expenses, foreign stockcompensation, and transaction costs.As of December 31, 2014, we had approximately $43.4 million of total unrecognized tax benefits, of which $23.4 million would decrease our effective taxrate if recognized. The remaining $20 million of unrecognized tax benefits related to acquired net operating losses (“NOLs”) and R&E credits that are subject tolimitations on their use.LIQUIDITY AND CAPITAL RESOURCES (in thousands) Year Ended December 31, 2015 2014 2013 Cash provided by (used in): Operating activities $62,528 $99,889 $80,703 Investing activities (44,452) (37,657) (63,997) Financing activities (35,384) (24,032) (14,567) Effect of exchange rate on cash (4,251) (3,846) 567 Net (decrease) increase in cash and cash equivalents $(21,559) $34,354 $2,706 As of December 31, 2015 2014 2013 Total cash, cash equivalents, and marketable securities $219,078 $211,216 $156,692 The decrease in cash and cash equivalents during the year ended December 31, 2015 was driven by the increase in trade accounts receivable, largely due tothe timing of large license and annual maintenance billings, and the increase in cash used in investing and financing activities, primarily for purchases ofmarketable debt securities and share repurchases, respectively. The increases in cash and cash equivalents during the years ended December 31, 2014 and 2013were driven by the increases in cash provided by operating activities during each year. Cash provided by operating activities is our primary source of liquidity. Weuse this source to fund our capital expenditures and acquisitions, investments, dividend payments, and share repurchase program. We believe that our current cash,cash equivalents, and cash flow from operations will be sufficient to fund our operations and our share repurchase program for at least the next 12 months. Therecan be no assurance that changes in our plans or other events affecting our operations will not result in materially accelerated or unexpected cash requirements.We evaluate acquisition opportunities from time to time, which if pursued, could require use of our funds. In October, 2013, we acquired Antenna for $27.1million in cash, inclusive of $0.8 million in cash acquired, and $0.8 million which was paid in the first quarter of 2014 representing the remaining mergerconsideration related to the final working capital adjustment. During 2014, we completed three acquisitions for $6.3 million in cash, inclusive of $2.1 million incash acquired, and $1.1 million in additional cash consideration which was paid in 2015 to the selling shareholders of one of the three companies acquired in 2014.During 2015, we also paid $0.5 million in additional cash consideration to the selling shareholders of another one of the three companies acquired in 2014, basedon the achievement of certain performance milestones. We may be required to pay an additional $0.8 million in cash to the same selling shareholders based on theachievement of additional performance milestones through the end of 2016.As of December 31, 2015, approximately $53.5 million of our cash and cash equivalents was held in our foreign subsidiaries. If it becomes necessary torepatriate these funds, we may be required to pay U.S. tax, net of 33Table of Contentsany applicable foreign tax credits, upon repatriation. We consider the earnings of our foreign subsidiaries to be permanently reinvested and, as a result, U.S. taxeson such earnings are not provided. It is impractical to estimate the amount of U.S. tax we could have to pay upon repatriation due to the complexity of the foreigntax credit calculations. There can be no assurance that changes in our plans or other events affecting our operations will not result in materially accelerated orunexpected expenditures.Cash provided by operating activitiesThe primary drivers during 2015 were net income of $36.3 million, and a $17.7 million increase in deferred revenue primarily resulting from the differencein timing of billings and revenue recognition, partially offset by a $62.2 million increase in accounts receivable primarily due to the timing of license and annualmaintenance billings.The primary drivers during 2014 were net income of $33.3 million, a $13.4 million increase in accounts payable and accrued expenses primarily due to thetiming of income tax payments, and an $11.2 million increase in deferred revenue primarily resulting from the difference in timing of billings and revenuerecognition for annual maintenance.The primary drivers during 2013 were net income of $38 million and $18.2 million in net inflows from operating asset and liability changes primarily due tothe timing of payments for certain accrued expenses and additional tax liabilities associated with the Antenna acquisition.Future Cash Receipts from License and Cloud ArrangementsTotal contractual future cash receipts due from our existing license agreements was approximately $356.4 million as of December 31, 2015; $301.4 millionas of December 31, 2014; and $283.1 million as of December 31, 2013. The approximate timing of future cash receipts due as of December 31, 2015 aresummarized as follows: As of December 31, (in thousands) Contractual payments for term licenses not recorded on the balance sheet (1) Other contractual license payments not recorded on the balance sheet (2) Total 2016 $116,617 $20,379 $136,996 2017 78,323 8,414 86,737 2018 63,043 4,128 67,171 2019 40,204 623 40,827 2020 24,657 — 24,657 Total $322,844 $33,544 $356,388 (1) These amounts include contractual future cash receipts related to our on-premises term licenses and hosted Pega Cloud service offerings. The timing offuture revenue recognition may not coincide with the timing of the cash receipts.(2) These amounts include contractual future cash receipts related to perpetual licenses with extended payment terms and/or additional rights of use.Cash used in investing activitiesDuring 2015, cash used in investing activities was primarily for purchases of marketable debt securities for $75.7 million, partially offset by the proceedsreceived from sales, maturities and called marketable debt securities of $43.9 million. In 2015, we paid additional cash consideration of $1.1 million to the sellingshareholders of one of the three companies acquired in 2014 and $0.5 million to the selling shareholders of 34Table of Contentsanother one of the three companies acquired in 2014 based on the achievement of certain performance milestones. We also invested $11 million primarily inleasehold improvements for the build-out of our office in Hyderabad, India and purchases of computer equipment for our U.S. and India offices.During 2014, cash used in investing activities was primarily for purchases of marketable debt securities for $55.5 million, partially offset by the proceedsreceived from the maturities and called marketable debt securities of $33.2 million. We paid $3.9 million for acquisitions for 2014, net of cash acquired. We alsoinvested $11.5 million primarily in leasehold improvements for the build-out of our new India offices and purchases of computer equipment for our U.S. and Indiaoffices.During 2013, cash used in investing activities was primarily for purchases of marketable debt securities for $60.6 million, partially offset by the proceedsreceived from the maturities and called marketable debt securities of $27.8 million. We paid $25.6 million to acquire Antenna, net of cash acquired and apreliminary working capital adjustment. We also invested $5.6 million primarily in leasehold improvements and computer equipment for the build-out of our U.S.and India offices.Cash used in financing activitiesNet cash used in financing activities during 2015, 2014, and 2013 was primarily for repurchases of our common stock and the payment of our quarterlydividend. Since 2004, our Board of Directors has approved annual stock repurchase programs that have authorized the repurchase of up to $169 million of ourcommon stock. On June 4, 2015, we announced that our Board of Directors extended the expiration date of the current stock repurchase program to June 30, 2016and authorized the Company to repurchase up to an additional $50 million of our stock between June 4, 2015 and June 30, 2016 (the “Current Program”). As ofDecember 31, 2015, approximately $122.1 million had been repurchased, $40.5 million remained available for repurchase, and $6.4 million had expired. Purchasesunder these programs have been made on the open market.Common stock repurchasesThe following table is a summary of our repurchase activity under all of our stock repurchase programs: Year ended December 31, (Dollars in thousands) 2015 2014 2013 Shares Amount Shares Amount Shares Amount Prior year authorizations at January 1, $13,284 $14,433 $14,793 Authorizations 50,000 14,410 12,164 Repurchases paid 944,398 (22,530) 756,143 (15,264) 773,258 (12,370) Repurchases unsettled 7,836 (220) 13,983 (295) 6,282 (154) Authorized dollars remaining as of December 31, $40,534 $13,284 $14,433 In addition to the share repurchases made under our repurchase programs, we net settled the majority of our employee stock option exercises and RSUvestings, which resulted in the withholding of shares to cover the option exercise price and the minimum statutory tax withholding obligations.During 2015, 2014, and 2013, option and RSU holders net settled a total of 1,821,000 shares; 1,193,000 shares; and 861,000 shares, respectively, of whichonly 932,000 shares; 641,000 shares; and 432,000 shares, respectively, were issued to the option and RSU holders. The balance of the shares were surrendered to usto pay for the exercise price with respect to stock options and the applicable taxes for both options and RSUs. During 2015, 2014, and 2013, instead of receivingcash from the equity holders, we withheld shares with a value of $9.8 million, $6.1 million, and $7.4 million, respectively, for withholding taxes, and $11.9 million,$6.4 million, and $9 million, respectively, for the exercise price. 35Table of ContentsDividendsOn May 27, 2014, we announced an increase in our quarterly cash dividend from $0.015 to $0.03 per share. We declared quarterly dividends totaling $0.12per share, $0.105 per share, and $0.06 per share for the years ended December 31, 2015, 2014, and 2013, respectively. Our Board of Directors authorized theacceleration of the payment of the dividend declared in the fourth quarter 2012, otherwise payable in January 2013, to December 2012. Therefore, there was nodividend payment in the first quarter of 2013. For the years ended December 31, 2015, 2014, and 2013, we paid cash dividends of $9.2 million, $6.9 million, and$3.4 million, respectively. It is our current intention to pay a quarterly cash dividend of $0.03 per share, however, the Board of Directors may terminate or modifythis dividend program at any time without notice.Contractual obligationsAs of December 31, 2015, we had purchase obligations for customer support and marketing programs and payments under operating leases. Our leasearrangement for our office headquarters expires in 2023, subject to our option to extend for two additional five-year periods. We also lease space for our otheroffices under noncancellable operating leases that expire at various dates through 2021. Payments due by period (in thousands) Total 2016 2017 & 2018 2019 & 2020 2021 & Thereafter Other Purchase obligations (1) $3,050 $3,050 $— $— $— $— Liability for uncertain tax positions (2) 5,618 — — — — 5,618 Operating lease obligations (3) 87,424 13,087 26,158 21,575 26,604 — Total $96,092 $16,137 $26,158 $21,575 $26,604 $5,618 (1) Represents the fixed or minimum amounts due under purchase obligations for customer support and marketing programs.(2) As of December 31, 2015, our recorded liability for uncertain tax positions was approximately $5.6 million. We are unable to reasonably estimate the timingof the cash outflow due to uncertainties in the timing of the effective settlement of tax positions.(3) Includes deferred rent of approximately $1.6 million included in accrued expenses and approximately $9.6 million in other long-term liabilities in theaccompanying audited consolidated balance sheet as of December 31, 2015.CRITICAL ACCOUNTING ESTIMATES AND SIGNIFICANT JUDGMENTSManagement’s discussion and analysis of the financial condition and results of operations is based upon our consolidated financial statements, which havebeen prepared in accordance with accounting principles generally accepted in the U.S. and the rules and regulations of the SEC for annual financial reporting. Thepreparation 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 andbeliefs of what could occur in the future given available information.We believe that, of our significant accounting policies, which are described in Note 2, “Significant Accounting Policies,” in the Notes to ConsolidatedFinancial Statements included in Item 8 of this Annual Report on Form 10-K, the following accounting policies are most important to the portrayal of our financialcondition and require the most subjective judgment. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluatingour consolidated financial condition and results of operations. If actual results differ significantly from management’s estimates and projections, there could be amaterial effect on our financial statements. 36Table of ContentsRevenue recognitionOur revenue is derived primarily from software licenses, maintenance fees related to our software licenses, and consulting services. Our licensearrangements, whether involving a perpetual license or a term license, generally also contain multiple other elements, including consulting services, training, andsoftware maintenance services.Software revenue recognition requires judgment, including whether a software arrangement includes multiple elements, and if so, whether VSOE of fairvalue exists for those elements. The amount of consideration allocated to undelivered elements is based on the VSOE of fair value for those elements and isrecognized as those elements are delivered. Any remaining portion of the total arrangement fee is allocated to the software license—the first element delivered.Revenue is recognized for each element when all of the revenue recognition criteria have been met. Changes in the mix of the elements in a software arrangement,the ability to identify VSOE for those elements, the fair value of the respective elements, and changes to a product’s estimated life cycle could materially impactthe amount of earned and unearned revenue.Perpetual software license fees are recognized as revenue when the software is delivered, any acceptance required by the contract that is not perfunctory isobtained, no significant obligations or contingencies exist related to the software, all other undelivered elements in a multiple element arrangement possess VSOE,and all other revenue recognition criteria are met.Term software license fees are usually payable on a monthly, quarterly, or annual basis under license agreements that typically have a three to five-year termand may be renewed for additional terms at the client’s option. We recognize term license revenue over the term of the agreement as payments become due orearlier if prepaid, provided all other criteria for revenue recognition have been met.Subscription revenue primarily consists of license, maintenance, and bundled services revenue recognized on our license arrangements that include a right tounspecified future products, which is recognized ratably over the term of the subscription period.First-year maintenance typically is sold with the related software license and renewed on an annual basis thereafter. Maintenance revenue is deferred andrecognized ratably over the term of the support period, which is generally one year and subject to annual renewals. Perpetual software maintenance obligations arebased on separately stated renewal rates in the arrangement that are substantive and therefore represent VSOE of fair value. Term license arrangements includeseparately stated maintenance fees and we use stand-alone sales to determine VSOE of fair value.Our services revenue is comprised of fees for consulting services, including software implementation, training, reimbursable expenses, and for sales of ourPega Cloud ® as-a-platform offering (“Pega Cloud ® ”), which includes the Pega Cloud ® Dev/Test environment and the Pega Cloud ® Production environment.Consulting services may be provided on a “stand-alone” basis or bundled with a license and software maintenance services.Revenue from training services and consulting services under time and materials contracts is recognized as services are performed. We have VSOE of fairvalue for our training services and consulting services under time and materials contracts in the Americas, Europe, and certain regions of Asia.Consulting services may sometimes be provided on a fixed-price basis. We do not have VSOE of fair value for fixed-price services or time and materialsservices in certain geographical regions. When these services are part of a multiple element arrangement, and the services are not essential to the functionality ofthe software, and when services, including maintenance, are the only undelivered element, we recognize the revenue from the total arrangement ratably over thelonger of the software maintenance period or the service period. Revenue from fixed-price services that are not bundled with a software license is generallyrecognized ratably over the service period, which is typically less than four months. 37Table of ContentsRevenue from stand-alone sales of the Pega Cloud ® Dev/Test environment is recognized as services are performed because we have VSOE of fair value.Revenue from stand-alone sales of the Pega Cloud ® Production environment is recognized ratably over the term of the service. When implementationservices are sold together with our Pega Cloud ® offering and these services have stand-alone value to the client, we account for these services separately from thisoffering. Stand-alone value is established through the client’s ability to buy these services from many trained partner system integrators and from transactions soldindependently from the sale of Pega Cloud ® . Since these multiple-element arrangements are not software license sales, we apply a selling price hierarchy todetermine the fair value of each element in the arrangement. Under the selling price hierarchy, each element’s fair value is determined based on its VSOE, ifavailable. If VSOE does not exist, third-party evidence of fair value (“TPE”) will be considered, and estimated selling price (“ESP”) will be used if neither VSOEnor TPE is available. We generally do not have VSOE of our Pega Cloud ® offering and are not able to determine TPE as our sales strategy is customized to theneeds of our clients and our products or services are dissimilar to comparable products or services in the marketplace. In determining ESP, we apply significantjudgment as we weigh a variety of factors, based on the facts and circumstances of the arrangement. We typically arrive at an ESP for a service without VSOE orTPE by considering company-specific factors such as geographies, competitive landscape, and pricing practices used to establish bundled pricing and discounting.While we believe we can make reliable estimates regarding these matters, these estimates are inherently subjective. Accordingly, any changes in our assumptionsand judgments regarding our estimates of ESP could materially impact our financial statements.Goodwill and Intangible Assets ImpairmentOur goodwill and intangible assets result from our business acquisitions. Goodwill and intangible assets with indefinite useful lives are not amortized, but aretested for impairment at least annually or as circumstances indicate their value may no longer be recoverable. We do not carry any intangible assets with indefiniteuseful lives other than goodwill. We perform our annual goodwill impairment as of November 30th of each fiscal year. To assess if goodwill is impaired, we firstperform a qualitative assessment to determine whether further impairment testing is necessary. If, as a result of the qualitative assessment, we consider it more-likely-than-not that the fair value of our reporting unit is less than its carrying amount, we perform a quantitative impairment test in a two-step process. For the firststep, we screen for impairment, and if any possible impairment exists, we undertake a second step of measuring such impairment by performing discounted cashflow analysis. This analysis is based on cash flow assumptions that are consistent with the plans and estimates being used to manage our business. In the first step,we review the carrying amount of our reporting unit compared to the “fair value” of the reporting unit. An excess carrying value over fair value would indicate thatgoodwill may be impaired. If we determined that goodwill may be impaired, then we would compare the “implied fair value” to the carrying value of the goodwill.We periodically re-evaluate our business and have determined that we have one operating segment and one reporting unit. If our assumptions change in the future,we may be required to record impairment charges to reduce the carrying value of our goodwill. Changes in the valuation of goodwill could materially impact ouroperating results and financial position. We evaluate our intangible assets for impairment whenever events or changes in circumstances indicate that the carryingamount of such assets may not be recoverable. In evaluating potential impairment of these assets, we specifically consider whether any indicators of impairment arepresent, including, but not limited to: • whether there has been a significant adverse change in the business climate that affects the value of an asset; • whether there has been a significant change in the extent or manner in which an asset is used; and • whether there is an expectation that the asset will be sold or disposed of before the end of its originally estimated useful life. 38Table of ContentsIf indicators of impairment are present, we compare the estimated undiscounted cash flows that the specific asset is expected to generate to its carrying value.The key assumptions of the cash flow model involve significant subjectivity. If such assets are considered to be impaired, the impairment recognized is measuredby the amount by which the carrying amount of the asset exceeds its fair value.As of December 31, 2015, we had $46.8 million of goodwill and $33.4 million of acquired intangible assets. If our estimates or the related assumptionschange in the future, we may be required to record impairment charges to reduce the carrying value of these assets. Changes in the valuation of long-lived assetscould materially impact our operating results and financial position. To date, there have been no impairments of goodwill or intangible assets.Accounting for Income TaxesWe use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based ontemporary differences between the financial statement and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differencesare expected to reverse. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluatinguncertainties in the application of accounting principles and complex tax laws. Changes in tax laws or our interpretation of tax laws and the resolution of any taxaudits could significantly impact our financial statements.We regularly assess the need for a valuation allowance against our deferred tax assets. Future realization of our deferred tax assets ultimately depends on theexistence of sufficient taxable income within the available carryback or carryforward periods. Sources of taxable income include taxable income in prior carrybackyears, future reversals of existing taxable temporary differences, tax planning strategies, and future taxable income. We record a valuation allowance to reduce ourdeferred tax assets to an amount we believe is more likely than not to be realized. Changes in our valuation allowance impact income tax expense in the period ofadjustment. Our deferred tax valuation allowance requires significant judgment and uncertainties, including assumptions about future taxable income that are basedon historical and projected information.As of December 31, 2015, we had approximately $108.2 million of acquired Chordiant federal NOLs that are subject to annual use limitations under section382 of the Internal Revenue Code. Based on those limitations we anticipate using $82.4 million of the remaining NOLs by 2029. In addition, we had $0.4 million ofdeferred tax assets related to state NOLs as of December 31, 2015.We acquired approximately $39.6 million and $58.1 million of federal and foreign NOLs, respectively, in the Antenna transaction. We anticipate that wemay utilize $7.5 million of the acquired Antenna federal NOLs under the applicable section 382 limitation, and these losses are scheduled to expire in 2031. Avaluation allowance is recorded on the deferred tax assets in excess of the federal NOLs that are deemed recoverable under the preliminary limitation. With regardto the acquired foreign NOLs, a full valuation allowance has been recorded as of December 31, 2015 due to uncertainty regarding the availability of these NOLs tooffset future income generated by the related foreign businesses due to limitations under local country change in control provisions. As of December 31, 2015, theCompany had approximately $38.9 million of acquired Antenna federal NOLs, which are subject to annual use limitations under section 382. Based on thoselimitations, the Company anticipates using $6.6 million of the remaining NOLs by 2031.We assess our income tax positions and record tax benefits based upon management’s evaluation of the facts, circumstances, and information available at thereporting date. For those tax positions where it is more-likely-than-not that a tax benefit will be sustained, we record the largest amount of tax benefit with a greaterthan 50 percent likelihood of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information. For those incometax positions where it is not more-likely-than-not that a tax benefit will be sustained, no tax benefit is recognized in the financial statements. We classify liabilitiesfor uncertain tax 39Table of Contentspositions as non-current liabilities unless the uncertainty is expected to be resolved within one year. We classify interest and penalties on uncertain tax positions asincome tax expense.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 theordinary course of our business, there are transactions and calculations undertaken whose ultimate tax outcome cannot be certain. Some of these uncertainties ariseas a consequence of transfer pricing for transactions with our subsidiaries and nexus and tax credit estimates. In addition, the calculation of acquired tax attributesand the associated limitations are complex. We estimate our exposure to unfavorable outcomes related to these uncertainties and estimate the probability of suchoutcomes.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 ourhistorical income tax provisions, returns, and accruals. Such differences, or changes in estimates relating to potential differences, could have a material impact onour income tax provision and operating results in the period in which such a determination is made.See Note 16 “Income Taxes” in the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for furtherinformation.NEW ACCOUNTING PRONOUNCEMENTSNew Accounting Pronouncements are detailed in Note 2, “Significant Accounting Policies,” in the Notes to Consolidated Financial Statements included inItem 8 of this Annual Report on Form 10-K. ITEM 7A.Quantitative and Qualitative Disclosure about Market RiskMarket 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 primarilyrelated to fluctuations in foreign exchange rates and interest rates.Foreign currency exposureApproximately 45% of our total revenue was derived from sales to clients based outside of the U.S. in the last three fiscal years. Our international sales areusually denominated in foreign currencies. However, the operating expenses of our foreign operations are also primarily denominated in foreign currencies, whichpartially offset our foreign currency exposure. A decrease in the value of foreign currencies, particularly the British pound, the Euro, the Australian dollar, and theIndian rupee relative to the U.S. dollar, as well as the Euro and the Australian dollar relative to the British pound, could adversely impact our revenues andoperating results.Historically, our U.S. operating company invoiced most of our foreign clients in foreign currencies, so it held cash and receivables denominated in theseforeign currencies. Our U.S. operating company’s functional currency is the U.S. dollar. Therefore, when there are changes in the foreign currency exchange ratesversus the U.S. dollar, we recognize a foreign currency transaction gain or (loss) in our consolidated statements of operations. In addition, we have intercompanyaccounts that are eliminated in consolidation, but that expose us to foreign currency exchange rate fluctuations which are recorded as foreign currency transactiongains or (losses) in our consolidated statements of operations.Effective April 1, 2015, we restructured our operations with our clients based outside the Americas. These clients began transacting and contracting directlywith Pegasystems Limited, a United Kingdom subsidiary of Pegasystems Inc., which has the British pound as its functional currency. This reorganization resultedin increased cash, accounts receivable, and intercompany receivables and payables held by Pegasystems Limited in currencies other than the British pound. As aresult, our exposure to foreign currency exchange rate fluctuations in the U.S. dollar, the Euro, and the Australian dollar relative to the British pound increased,while our exposure 40Table of Contentsto foreign currency exchange rate fluctuations in the Euro and the Australian dollar relative to the U.S. dollar decreased.We have historically used forward contracts to manage our exposure to changes in foreign currency exchange rates associated with cash, accounts receivable,and intercompany receivables and payables held by Pegasystems Inc., our U.S. operating company, in currencies other than the U.S. dollar. We did not enter intoany forward contracts between March 2014 and June 2015. In the third quarter of 2015, as a result of this operational reorganization, we implemented our revisedhedging program, under which we hedge our non-functional currency exposures for Pegasystems Inc. and Pegasystems Limited, utilizing forward contracts withterms not greater than six months.The forward contracts are not designated as hedging instruments. As a result, we record the fair value of these contracts at the end of each reporting period inthe accompanying consolidated balance sheets as other current assets for unrealized gains and accrued expenses for unrealized losses, with any fluctuations in thevalue of these contracts recognized in other expense, net, in the accompanying consolidated statements of operations. The cash flows related to these forwardcontracts are classified as operating activities in the accompanying consolidated statements of cash flows. We do not enter into any hedging contracts for trading orspeculative purposes.As of December 31, 2015, the total notional amount of the Company’s outstanding forward contracts was $32.3 million, which included $9.4 million in U.S.dollar notional forward contracts; the U.S. dollar notional equivalent of $16.3 million in Euro forward contracts; and the U.S. dollar notional equivalent of $6.6million in Australian dollar forward contracts. The Company did not have any outstanding forward contracts as of December 31, 2014.The fair value of the Company’s outstanding forward contracts as of December 31, 2015 was as follows: (in thousands) Asset Derivatives Liability Derivatives Balance Sheet Location Fair Value Balance Sheet Location Fair Value Foreign currency forward contracts Other current assets $48 Accrued expenses $1,052 We entered into forward contracts with notional values as follows: Twelve Months Ended December 31, Foreign currency (in thousands) 2015 2014 2013 Euro €55,850 €21,900 €102,300 British pound £13,600 £26,500 £85,400 Australian dollar A$43,000 A$12,900 A$26,300 Indian rupee Rs1,100,000 Rs204,000 Rs690,000 United States dollar $77,900 $— $— The total change in the fair value of our forward contracts recorded in other expense, net, was as follows: Change in Fair Value in USD Twelve Months Ended December 31, (in thousands) 2015 2014 2013 Loss included in other expense, net $(1,047) $(532) $(747) The impact on net income of the gains and losses recorded on the foreign currency forward contracts, which is included in other expense, net, in theaccompanying consolidated statements of operations, and the foreign currency transaction gains and losses recorded on the remeasurement and settlement of theforeign currency denominated assets, which is included in foreign currency transaction loss in the accompanying consolidated 41Table of Contentsstatements of operations, was a net loss of approximately $5.2 million, $4.3 million, and $2.3 million for the years ended December 31, 2015, 2014 and 2013,respectively.Fluctuations in foreign currencies impact the amount of total assets and liabilities that we report for our foreign subsidiaries upon the translation of theseamounts into U.S. dollars. In particular, the amount of cash and cash equivalents that we report in U.S. dollars for a significant portion of the cash held by thesesubsidiaries is subject to translation variance caused by changes in foreign currency exchange rates as of the end of each reporting period, the offset of which isrecorded to accumulated other comprehensive loss in the accompanying consolidated balance sheet. If overall foreign currency exchange rates in comparison to theU.S. dollar uniformly weakened by 10%, the amount of cash and cash equivalents we would report in U.S. dollars would decrease by approximately $5.3 million,assuming constant foreign currency cash and cash equivalents balances.Interest rate exposureAs of December 31, 2015, we had $126.1 million of marketable debt securities, which consisted primarily of corporate and municipal bonds, with aweighted-average remaining maturity of 15 months. Due to the overall short-term remaining maturities of our marketable debt securities, our interest rate exposureis not significant. As of December 31, 2015, a 200 basis point increase in market interest rates would have reduced the fair value of our fixed rate marketable debtsecurities by approximately $3 million. 42Table of ContentsITEM 8.Financial Statements and Supplementary DataINDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Report of Independent Registered Public Accounting Firm 44 Consolidated Balance Sheets as of December 31, 2015 and 2014 45 Consolidated Statements of Operations for the years ended December 31, 2015, 2014, and 2013 46 Consolidated Statements of Comprehensive Income for the years ended December 31, 2015, 2014, and 2013 47 Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2015, 2014, and 2013 48 Consolidated Statements of Cash Flows for the years ended December 31, 2015, 2014, and 2013 49 Notes to Consolidated Financial Statements 50 43Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Board of Directors and Stockholders of Pegasystems Inc.Cambridge, MassachusettsWe have audited the accompanying consolidated balance sheets of Pegasystems, Inc. and subsidiaries (the “Company”) as of December 31, 2015 and 2014, and therelated consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period endedDecember 31, 2015. We also have audited the Company’s internal control over financial reporting as of December 31, 2015, based on criteria established inInternal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’smanagement is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of theeffectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Ourresponsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting 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 weplan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internalcontrol over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal controlover financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal controlbased on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our auditsprovide a reasonable basis for our opinions.A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principalfinancial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to providereasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance ofrecords that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance thattransactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receiptsand expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonableassurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on thefinancial 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 theinternal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or thatthe degree of compliance with the policies or procedures may deteriorate.In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pegasystems Inc. andsubsidiaries as of December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ended December 31,2015, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all materialrespects, effective internal control over financial reporting as of December 31, 2015, based on the criteria established in Internal Control—Integrated Framework(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission./s/ DELOITTE & TOUCHE LLPBoston, MassachusettsFebruary 25, 2016 44Table of ContentsPEGASYSTEMS INC.CONSOLIDATED BALANCE SHEETS(in thousands, except per share amounts) As of December 31, 2015 2014 ASSETS Current assets: Cash and cash equivalents $93,026 $114,585 Marketable securities 126,052 96,631 Total cash, cash equivalents, and marketable securities 219,078 211,216 Trade accounts receivable, net of allowance of $4,631 and $1,540 211,846 154,844 Deferred income taxes 12,380 12,974 Income taxes receivable 4,770 4,502 Other current assets 10,791 9,544 Total current assets 458,865 393,080 Property and equipment, net 31,319 30,156 Long-term deferred income taxes 53,350 69,258 Long-term other assets 4,030 2,783 Intangible assets, net 33,418 45,664 Goodwill 46,776 46,860 Total assets $627,758 $587,801 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable $12,675 $4,752 Accrued expenses 42,768 42,958 Accrued compensation and related expenses 55,872 47,250 Deferred revenue 155,873 134,672 Total current liabilities 267,188 229,632 Income taxes payable 5,618 24,896 Long-term deferred revenue 15,805 20,859 Other long-term liabilities 16,288 17,709 Total liabilities 304,899 293,096 Commitments and contingencies (Note 13) Stockholders’ equity: Preferred stock, $0.01 par value, 1,000 shares authorized; no shares issued and outstanding — — Common stock, $0.01 par value, 200,000 shares authorized; 76,488 shares and 76,357 shares issued and outstanding 765 764 Additional paid-in capital 145,418 141,495 Retained earnings 180,183 153,058 Accumulated other comprehensive loss: Net unrealized loss on available-for-sale marketable securities, net of tax (150) (65) Foreign currency translation adjustments (3,357) (547) Total stockholders’ equity 322,859 294,705 Total liabilities and stockholders’ equity $627,758 $587,801 See notes to consolidated financial statements. 45Table of ContentsPEGASYSTEMS INC.CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except per share amounts) Year ended December 31, 2015 2014 2013 Revenue: Software license $275,588 $232,336 $191,876 Maintenance 202,802 186,239 157,309 Services 204,305 171,429 159,769 Total revenue 682,695 590,004 508,954 Cost of revenue: Software license 4,125 4,959 6,281 Maintenance 21,903 20,014 15,272 Services 187,418 160,121 135,853 Total cost of revenue 213,446 185,094 157,406 Gross profit 469,249 404,910 351,548 Operating expenses: Selling and marketing 241,387 206,658 181,094 Research and development 126,374 108,591 79,726 General and administrative 36,738 37,442 29,594 Acquisition-related 89 488 1,306 Restructuring — 192 1,731 Total operating expenses 404,588 353,371 293,451 Income from operations 64,661 51,539 58,097 Foreign currency transaction loss (4,168) (3,769) (1,593) Interest income, net 1,056 683 524 Other expense, net (1,044) (459) (635) Income before provision for income taxes 60,505 47,994 56,393 Provision for income taxes 24,183 14,739 18,350 Net income $36,322 $33,255 $38,043 Earnings per share: Basic $0.47 $0.44 $0.50 Diluted $0.46 $0.42 $0.49 Weighted-average number of common shares outstanding Basic 76,507 76,327 75,946 Diluted 79,043 78,531 77,974 See notes to consolidated financial statements. 46Table of ContentsPEGASYSTEMS INC.CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(in thousands) Year ended December 31, 2015 2014 2013 Net income $36,322 $33,255 $38,043 Other comprehensive (loss) gain, net: Unrealized loss on available-for-sale marketable securities, net of tax (85) (142) (11) Foreign currency translation adjustments (2,810) (4,103) 469 Total other comprehensive (loss) gain, net (2,895) (4,245) 458 Comprehensive income $33,427 $29,010 $38,501 See notes to consolidated financial statements. 47Table of ContentsPEGASYSTEMS INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(in thousands, except per share amounts) Common Stock Additional Paid-In Capital Retained Earnings Accumulated Other Comprehensive(Loss) Income Total Stockholders’Equity Number of Shares Amount Balance at January 1, 2013 75,890 $758 $138,197 $94,349 $3,175 $236,479 Repurchase of common stock (780) (8) (12,516) — — (12,524) Issuance of common stock for share-based compensation plans 1,149 14 (5,694) — — (5,680) Issuance of stock under Employee Stock Purchase Plan 38 — 545 — — 545 Issuance of stock awards 27 — — — — — Stock-based compensation expense — — 12,869 — — 12,869 Tax benefit from exercise or vesting of equity awards, net of deferredtax asset deficiencies of $435 — — 6,164 — — 6,164 Cash dividends declared ($0.06 per share) — — — (4,566) — (4,566) Other comprehensive income — — — — 458 458 Net income — — — 38,043 — 38,043 Balance at December 31, 2013 76,324 $764 $139,565 $127,826 $3,633 $271,788 Repurchase of common stock (770) (8) (15,551) — — (15,559) Issuance of common stock for share-based compensation plans 742 8 (5,703) — — (5,695) Issuance of stock under Employee Stock Purchase Plan 32 — 568 — — 568 Issuance of stock awards 29 — — — — — Stock-based compensation expense — — 19,205 — — 19,205 Tax benefit from exercise or vesting of equity awards, net of deferredtax asset deficiencies of $77 — — 3,411 — — 3,411 Cash dividends declared ($0.105 per share) — — — (8,023) — (8,023) Other comprehensive loss — — — — (4,245) (4,245) Net income — — — 33,255 — 33,255 Balance at December 31, 2014 76,357 $764 $141,495 $153,058 $(612) $294,705 Repurchase of common stock (952) (10) (22,740) — — (22,750) Issuance of common stock for share-based compensation plans 1,028 11 (9,201) — — (9,190) Issuance of stock under Employee Stock Purchase Plan 24 — 550 — — 550 Issuance of stock awards 31 — — — — — Stock-based compensation expense — — 30,078 — — 30,078 Tax benefit from exercise or vesting of equity awards, net of deferredtax asset deficiencies of $105 — — 5,236 — — 5,236 Cash dividends declared ($0.12 per share) — — — (9,197) — (9,197) Other comprehensive loss — — — — (2,895) (2,895) Net income — — — 36,322 — 36,322 Balance at December 31, 2015 76,488 $765 $145,418 $180,183 $(3,507) $322,859 See notes to consolidated financial statements. 48Table of ContentsPEGASYSTEMS INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands) Year ended December 31, 2015 2014 2013 Operating activities: Net income $36,322 $33,255 $38,043 Adjustment to reconcile net income to cash provided by operating activities: Excess tax benefits from exercise or vesting of equity awards (5,275) (3,387) (6,435) Deferred income taxes (2,099) (13,896) (7,008) Depreciation and amortization 23,093 23,352 20,035 Amortization of investments 2,238 1,916 1,776 Stock-based compensation expense 30,054 19,205 12,869 Foreign currency transaction loss 4,168 3,769 1,593 Other non-cash 822 (747) 1,670 Change in operating assets and liabilities: Trade accounts receivable (62,235) 6,209 (28,316) Income taxes receivable and other current assets 3,223 2,776 7,076 Accounts payable and accrued expenses 16,572 13,356 5,794 Deferred revenue 17,668 11,173 26,362 Other long-term assets and liabilities (2,023) 2,908 7,244 Cash provided by operating activities 62,528 99,889 80,703 Investing activities: Purchases of marketable securities (75,702) (55,520) (60,648) Proceeds from maturities and called marketable securities 42,026 33,244 27,814 Sales of marketable securities 1,915 — — Payments for acquisitions, net of cash acquired (1,671) (3,918) (25,565) Investment in property and equipment (11,020) (11,463) (5,598) Cash used in investing activities (44,452) (37,657) (63,997) Financing activities: Issuance of common stock for share-based compensation plans 1,136 1,001 2,210 Excess tax benefits from exercise or vesting of equity awards 5,275 3,387 6,435 Dividend payments to shareholders (9,194) (6,874) (3,421) Common stock repurchases for tax withholdings for net settlement of equity awards (9,776) (6,128) (7,345) Common stock repurchases under share repurchase programs (22,825) (15,418) (12,446) Cash used in financing activities (35,384) (24,032) (14,567) Effect of exchange rate on cash and cash equivalents (4,251) (3,846) 567 Net (decrease) increase in cash and cash equivalents (21,559) 34,354 2,706 Cash and cash equivalents, beginning of year 114,585 80,231 77,525 Cash and cash equivalents, end of year $93,026 $114,585 $80,231 Supplemental disclosures: Income taxes paid $30,215 $14,722 $11,107 Non-cash investing and financing activity: Dividends payable $2,297 $2,294 $1,145 See notes to consolidated financial statements. 49Table of ContentsPEGASYSTEMS INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. BASIS OF PRESENTATION(a) BusinessThe Company develops, markets, licenses, and supports software to automate complex, changing business processes. The Company providesimplementation, consulting, training, technical support, and hosting services to facilitate the use of its software.(b) Management estimates and reportingThe preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S.”) requiresmanagement to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expenses during the periods presented. Actual results could differ from those estimates.Accounts with reported amounts based on significant estimates and judgments include revenue, deferred income taxes, income taxes payable, fair value of assetsacquired and liabilities assumed, intangible assets, goodwill, deferred revenue, and stock-based compensation.(c) Principles of consolidationThe consolidated financial statements include Pegasystems Inc. and its wholly owned subsidiaries. All intercompany accounts and transactions have beeneliminated in consolidation.(d) Stock splitOn March 6, 2014, the Company’s Board of Directors approved a two-for-one stock split of the Company’s common stock, effected in the form of a stockdividend (the “Stock Split”). On April 1, 2014, each stockholder of record at the close of business on March 20, 2014 (the “Record Date”) received as a dividend,one additional share of common stock, par value $.01, for each share of common stock held on the Record Date. All shares and amounts of common stock,additional paid-in capital, and per share amounts in the Company’s audited consolidated financial statements and in the accompanying notes for all periodspresented have been restated to reflect the Stock Split, except for the number of authorized shares of common stock.2. SIGNIFICANT ACCOUNTING POLICIES(a) Revenue recognitionThe Company’s revenue is derived primarily from software licenses, maintenance fees related to the Company’s software licenses, and consulting services.The Company’s license arrangements, whether involving a perpetual license or a term license, generally also contain multiple elements, including consultingservices, training, and software maintenance services.Software revenue recognition requires judgment, including whether a software arrangement includes multiple elements, and if so, whether vendor-specificobjective evidence (“VSOE”) of fair value exists for those elements. The amount of arrangement consideration allocated to undelivered elements is based on theVSOE of fair value for those elements and recognized as those elements are delivered. Any remaining portion of the total arrangement fee is allocated to thesoftware license—the first delivered element. Revenue is recognized for each element when all of the revenue recognition criteria have been met. Revenue isrecognized net of any taxes collected from customers and subsequently remitted to governmental authorities. 50Table of ContentsChanges in the mix of the elements in a software arrangement, the ability to identify VSOE for those elements, the fair value of the respective elements, andchanges to a product’s estimated life cycle could materially impact the amount of earned and unearned revenue.Before the Company can recognize revenue, the following four basic criteria must be met: • Persuasive evidence of an arrangement —As evidence of the existence of an arrangement, the Company uses a contract or purchase order signed bythe client and the Company for software, including cloud, and maintenance, and a statement of work for consulting services. In the event the client is areseller, the Company ensures a binding agreement exists between the reseller and end user of the software. • Delivery of product and services —The Company delivers its software electronically and/or ships it via disc media. Services are considered deliveredas the work is performed or, in the case of maintenance, over the contractual service period. • Fee is fixed or determinable —The Company assesses whether a fee is fixed or determinable at the onset of the arrangement. In addition, the Companyassesses whether contract modifications to an existing arrangement constitute a concession or whether extended payment terms exist. The Company’sagreements do not include a right of return. • Collection of fee is probable —The Company assesses the probability of collecting from each client at the onset of the arrangement based on a numberof factors, including the client’s payment history, its current creditworthiness, economic conditions in the client’s industry and geographic location,and general economic conditions. If, in the Company’s judgment, collection of a fee is not probable, revenue is recognized as cash is collected,provided all other conditions for revenue recognition have been met.Software license revenuesPerpetual software license fees are recognized as revenue when the software is delivered, any acceptance required by the contract that is not perfunctory isobtained, no significant obligations or contingencies exist related to the software, all other undelivered elements in a multiple element arrangement possess VSOE,and all other revenue recognition criteria are met.Term software license fees are usually payable on a monthly, quarterly, or annual basis under license agreements that typically have a three to five-year termand may be renewed for additional terms at the client’s option. The Company recognizes term license revenue over the term of the agreement as payments becomedue or earlier if prepaid, provided all other criteria for revenue recognition have been met.Subscription revenue primarily consists of license, maintenance, and bundled services revenue recognized on the Company’s license arrangements thatinclude a right to unspecified future products, which is recognized ratably over the term of the subscription period.Maintenance revenuesFirst-year maintenance typically is sold with the related software license and renewed on an annual basis thereafter. Maintenance revenue is deferred andrecognized ratably over the term of the support period, which is generally one year and subject to annual renewals. Perpetual software maintenance obligations arebased on separately stated renewal rates in the arrangement that are substantive and therefore represent VSOE of fair value. Term license arrangements includeseparately stated maintenance fees and the Company uses stand-alone sales to determine VSOE of fair value. 51Table of ContentsServices revenuesThe Company’s services revenue is comprised of fees for consulting services including software implementation, training, reimbursable expenses, and forsales of its Pega Cloud ® as-a-platform offering (“Pega Cloud ® ”), which includes the Pega Cloud ® Dev/Test environment and the Pega Cloud ® Productionenvironment. Consulting services may be provided on a “stand-alone” basis or bundled with a license and software maintenance services.Revenue from training services and consulting services under time and materials contracts is recognized as services are performed. The Company has VSOEof fair value for its training services and consulting services under time and materials contracts in the Americas, Europe, and certain regions of Asia.Consulting services may sometimes be provided on a fixed-price basis. The Company does not have VSOE of fair value for fixed-price services or time andmaterials services in certain geographical regions. When these services are part of a multiple element arrangement, and the services are not essential to thefunctionality of the software, and when services, including maintenance, are the only undelivered element, the Company recognizes the revenue from the totalarrangement ratably over the longer of the software maintenance period or the service period. Revenue from fixed-price services that are not bundled with asoftware license is generally recognized ratably over the service period, which is typically less than four months.Revenue from stand-alone sales of the Pega Cloud ® Dev/Test environment is recognized as services are performed because the Company has VSOE of fairvalue.Revenue from stand-alone sales of the Pega Cloud ® Production environment is recognized ratably over the term of the service. When implementationservices are sold together with the Company’s Pega Cloud ® offering and these services have stand-alone value to the client, the Company accounts for theseservices separately from this offering. Stand-alone value is established through the client’s ability to buy these services from many trained partner systemintegrators and from transactions sold independently from the sale of Pega Cloud ® . Since these multiple-element arrangements are not software license sales, theCompany applies a selling price hierarchy to determine the fair value of each element in the arrangement. Under the selling price hierarchy, each element’s fairvalue is determined based on its VSOE, if available. If VSOE does not exist, third-party evidence of fair value (“TPE”) will be considered, and estimated sellingprice (“ESP”) will be used if neither VSOE nor TPE is available. The Company generally does not have VSOE of its Pega Cloud ® offering and is not able todetermine TPE as its sales strategy is customized to the needs of its clients and the Company’s products and services are dissimilar to comparable products orservices in the marketplace. In determining ESP, the Company applies significant judgment as it weighs a variety of factors, based on the facts and circumstancesof the arrangement. The Company typically arrives at an ESP for a service without VSOE or TPE by considering company-specific factors such as geographies,competitive landscape, and pricing practices used to establish bundled pricing and discounting.Deferred revenueDeferred software license revenue typically results from client billings for which all of the criteria to recognize revenue have not been met. Deferredmaintenance revenue represents software license updates and product support contracts that are typically billed in advance and are recognized ratably over thesupport periods. Deferred services revenue represents advanced billings for consulting, hosting, and training services that are recognized as the services areperformed.(b) Fair value of financial instrumentsThe principal financial instruments held by the Company consist of cash equivalents, marketable securities, derivative instruments, accounts receivable, andaccounts payable, which are measured at fair value. See Note 3 52Table of Contents“Marketable Securities”, Note 4 “Derivative Instruments”, and Note 5 “Fair Value Measurements” for further discussion of financial instruments that are carried atfair value on a recurring basis.(c) Derivative instrumentsThe Company uses foreign currency forward contracts (“forward contracts”) to manage its exposures to changes in foreign currency exchange ratesassociated with its foreign currency denominated accounts receivable, intercompany receivables and payables, and cash. The foreign currency forward contractsutilized by the Company are not designated as hedging instruments and as a result, the Company records the fair value of these contracts at the end of eachreporting period in its consolidated balance sheet as other current assets for unrealized gains and accrued expenses for unrealized losses, with any fluctuations in thefair value of these contracts recognized in other expense, net, in its consolidated statement of operations. The cash flows related to these foreign currency forwardcontracts are classified as operating activities in the Company’s consolidated statements of cash flows. The fluctuations in the value of these foreign currencyforward contracts partially offset the gains and losses from the remeasurement or settlement of the foreign currency denominated cash, accounts receivable, andintercompany receivables and payables held by the U.S. operating company and its U.K. subsidiary, thus partly mitigating the volatility. Generally, the Companyenters into foreign currency forward contracts with terms of six months or less.(d) Property and equipmentProperty and equipment are recorded at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives ofthe assets, which are three years for computer equipment and five years for furniture and fixtures. Leasehold improvements are amortized over the lesser of theterm 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 incurred during theapplication development stage. Costs related to preliminary project activities and post implementation activities are expensed as incurred. The Company amortizescapitalized software costs generally over three to five years commencing on the date the software is placed into service. As of December 31, 2015, the Companyhad $1.1 million of capitalized costs for computer software developed for internal use that was not yet in service. During 2014 and 2013, the Company did notcapitalize any costs for computer software developed for internal use.(e) GoodwillGoodwill represents the residual purchase price paid in a business combination after the fair value of all identified assets and liabilities have been recorded.Goodwill is not amortized. The Company operates as a single reporting unit. The Company performed its qualitative assessment as of November 30, 2015, 2014,and 2013, and concluded it was not more likely than not that the fair value of its reporting unit was less than their carrying value.(f) Intangible and long-lived assetsAll of the Company’s intangible assets are amortized using the straight-line method over their estimated useful life. The Company evaluates its long-livedtangible and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable.Impairment is assessed by comparing the undiscounted cash flows expected to be generated by the intangible asset to its carrying value. If impairment exists, theCompany calculates the impairment by comparing the carrying value of the intangible asset to its fair value as determined by discounted expected cash flows. TheCompany did not record any impairments in 2015, 2014, or 2013. 53Table of Contents(g) Business combinationsThe Company uses its best estimates and assumptions to accurately assign fair value to the tangible and intangible assets acquired and liabilities assumed atthe acquisition date. The Company’s estimates are inherently uncertain and subject to refinement. During the measurement period, which may be up to one yearfrom the acquisition date, the Company may record adjustments to the fair value of these tangible and intangible assets acquired and liabilities assumed, with thecorresponding offset to goodwill. In addition, uncertain tax positions and tax-related valuation allowances are initially established in connection with a businesscombination as of the acquisition date. The Company continues to collect information and reevaluates these estimates and assumptions quarterly and records anyadjustments to the Company’s preliminary estimates to goodwill provided that the Company is within the measurement period. Upon the conclusion of themeasurement period or final determination of the fair value of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments arerecorded to the Company’s consolidated statements of operations.(h) Research and development and software costsResearch and development costs are expensed as incurred. Capitalization of computer software developed for resale begins upon the establishment oftechnological feasibility, generally demonstrated by a working model or an operative version of the computer software product. Such costs have not been materialto date as technological feasibility is established within a short time frame from the software’s general availability and, as a result, no costs were capitalized in2015, 2014, or 2013.(i) Stock-based compensationThe Company recognizes stock-based compensation expense associated with equity awards based on the fair value of these awards at the grant date. Stock-based compensation is recognized over the requisite service period, which is generally the vesting period of the equity award, and is adjusted each period foranticipated forfeitures. See Note 15 “Stock-based Compensation” for discussion of the Company’s key assumptions included in determining the fair value of itsequity awards at grant date.(j) Acquisition-related expensesAcquisition-related costs are expensed as incurred and include direct and incremental costs associated with an impending or completed acquisition. During2015, 2014, and 2013, $0.1 million, $0.5 million, and $1.3 million, respectively, of acquisition-related costs were primarily professional fees associated with theCompany’s acquisition of Antenna Software, Inc. (“Antenna”) and the acquisitions completed in 2014.(k) Restructuring expensesRestructuring expenses are recorded when a plan of restructuring is in place and management has committed to execution of the plan. To the extent that arestructuring plan provides employee benefits for services rendered in future periods beyond a minimum period, the costs are recognized over the requisite serviceperiod. In 2014 and 2013, restructuring costs include future lease payments and demising costs, net of estimated sublease income, for the elimination of spacewithin one facility related to the integration of Antenna. See Note 12 “Accrued Restructuring” for further detail.(l) Foreign currency translationThe translation of assets and liabilities for the majority of the Company’s foreign subsidiaries are made at period-end exchange rates, while revenue andexpense accounts are translated at the average exchange rates during the period transactions occurred. The resulting translation adjustments are reflected inaccumulated other comprehensive income. The Company’s India subsidiary, as well as all foreign Antenna subsidiaries, use the 54Table of ContentsU.S. dollar as its functional currency, therefore, its monetary assets and liabilities are remeasured at current rates and its non-monetary assets are recorded athistorical exchange rates. Realized and unrealized exchange gains or losses from transactions and remeasurement adjustments are reflected in foreign currencytransaction loss, in the accompanying consolidated statements of operations.(m) Accounting for income taxesThe Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined basedon temporary differences between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differencesare expected to reverse. The Company regularly assesses the need for a valuation allowance against its deferred tax assets. Future realization of the Company’sdeferred tax assets ultimately depends on the existence of sufficient taxable income within the available carryback or carryforward periods. Sources of taxableincome include taxable income in prior carryback years, future reversals of existing taxable temporary differences, tax planning strategies, and future taxableincome. The Company records a valuation allowance to reduce its deferred tax assets to an amount it believes is more-likely-than-not to be realized. Changes in thevaluation allowance impacts income tax expense in the period of adjustment. The Company’s deferred tax valuation allowance requires significant judgment anduncertainties, including assumptions about future taxable income that are based on historical and projected information. The Company recognizes excess taxbenefits when they are realized, through a reduction in income taxes payable using the with-and-without stock option method.The Company assesses its income tax positions and records tax benefits based upon management’s evaluation of the facts, circumstances, and informationavailable at the reporting date. For those tax positions where it is more-likely-than-not that a tax benefit will be sustained, the Company records the largest amountof tax benefit with a greater than 50 percent likelihood of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevantinformation. For those income tax positions where it is not more-likely-than-not that a tax benefit will be sustained, no tax benefit is recognized in the financialstatements. The Company classifies liabilities for uncertain tax positions as non-current liabilities unless the uncertainty is expected to be resolved within one year.The Company classifies interest and penalties on uncertain tax positions as income tax expense.As a global company, the Company uses significant judgment to calculate and provide for income taxes in each of the tax jurisdictions in which it operates.In the ordinary course of the Company’s business, there are transactions and calculations undertaken whose ultimate tax outcome cannot be certain. Some of theseuncertainties arise as a consequence of transfer pricing for transactions with the Company’s subsidiaries and nexus and tax credit estimates. In addition, thecalculation of acquired tax attributes and the associated limitations are complex. See Note 16 “Income Taxes” for further information. The Company estimates itsexposure to unfavorable outcomes related to these uncertainties and estimates the probability of such outcomes.(n) Advertising expenseAdvertising costs are expensed as incurred. Advertising costs were $9.8 million, $1.4 million, and $0.3 million during the years ended December 31, 2015,2014, and 2013, respectively.(o) New accounting pronouncementsBalance Sheet Classification of Deferred Taxes: In November 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting StandardsUpdate (“ASU”) No. 2015-17, “Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes.” The guidance requires that deferred income taxliabilities and assets be classified as noncurrent in a classified balance sheet. ASU 2015-17 is effective for annual periods beginning after December 15, 2016, andinterim periods within those annual periods. Early adoption is permitted. The effective date for the Company will be January 1, 2017. The Company does notexpect this ASU to have a material impact on its consolidated financial statements. 55Table of ContentsSimplifying the Accounting for Measurement-Period Adjustments: In September 2015, the FASB issued ASU No. 2015-16, “Simplifying the Accountingfor Measurement-Period Adjustments”. This ASU amends guidance for business combinations to simplify the presentation of adjustments to the initial purchaseprice allocation identified during the measurement period of a business combination. ASU 2015-16 requires that an acquirer in a business combination recognizeadjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined, andeliminates the requirement to retrospectively account for adjustments made to provisional amounts recognized in a business combination. For public businessentities, the amendments in the ASU are effective for fiscal years beginning after December 31, 2015, including interim periods with those fiscal years. Theeffective date for the Company was January 1, 2016. The Company does not expect the adoption of this ASU will have a material impact on its consolidatedfinancial statements.Revenue from Contracts with Customers: In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. ThisASU amends the guidance for revenue recognition to replace numerous, industry-specific requirements and converges areas under this topic with those of theInternational Financial Reporting Standards. This ASU implements a five-step process for customer contract revenue recognition that focuses on transfer of control,as opposed to transfer of risk and rewards. This ASU also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenues and cashflows from contracts with customers. Other major provisions include ensuring the time value of money is considered in the transaction price, and allowingestimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. This ASU originally had an effective date for theCompany of January 1, 2017. In August 2015, the FASB issued ASU No. 2015-14, “Revenue from Contracts with Customers (Topic 606) Deferral of the EffectiveDate,” which defers the effective date by one year while providing the option to adopt the standard on the original effective date. The new effective date for theCompany will be January 1, 2018. The Company has not yet selected a transition method and is currently evaluating the effect that this ASU will have on itsconsolidated financial statements and related disclosures.3. MARKETABLE SECURITIES (in thousands) December 31, 2015 AmortizedCost UnrealizedGains UnrealizedLosses FairValue Marketable securities: Municipal bonds $57,394 $7 $(66) $57,335 Corporate bonds 66,960 2 (147) 66,815 Certificates of deposit 1,903 — (1) 1,902 Marketable securities $126,257 $9 $(214) $126,052 (in thousands) December 31, 2014 AmortizedCost UnrealizedGains UnrealizedLosses Fair Value Marketable securities: Municipal bonds $27,820 $52 $(17) $27,855 Corporate bonds 65,487 5 (144) 65,348 Certificates of deposit 3,428 2 (2) 3,428 Marketable securities $96,735 $59 $(163) $96,631 The Company considers debt securities with maturities of three months or less from the purchase date to be cash equivalents. Interest is recorded whenearned. All of the Company’s investments are classified as available-for-sale and are carried at fair value with unrealized gains and losses considered to be otherthan temporary in nature recorded as a component of accumulated other comprehensive loss, net of related income taxes. The Company reviews all investments forreductions in fair value that are other-than-temporary. When such 56Table of Contentsreductions occur, the cost of the investment is adjusted to fair value through recording a loss on investments in the consolidated statements of operations. Gains andlosses on investments are calculated on the basis of specific identification. As of December 31, 2015, the Company did not hold any investments with unrealizedgains and losses considered to be other than temporary.As of December 31, 2015, remaining maturities of marketable debt securities ranged from January 2016 to January 2019, with a weighted-average remainingmaturity of approximately 15 months.4. DERIVATIVE INSTRUMENTSThe Company has historically used forward contracts to manage its exposure to changes in foreign currency exchange rates associated with its foreigncurrency denominated cash, accounts receivable, and intercompany receivables and payables held by its U.S. operating company.Effective April 1, 2015, the Company restructured its operations with its clients based outside the Americas. These clients began transacting withPegasystems Limited, a United Kingdom subsidiary of Pegasystems Inc., which has the British pound as its functional currency. This reorganization resulted inincreased cash, accounts receivable, and intercompany receivables and payables held by Pegasystems Limited in currencies other than the British pound. As aresult, the Company’s exposure to foreign currency exchange rate fluctuations in the U.S. dollar, the Euro, and the Australian dollar relative to the British poundincreased, while its exposure to foreign currency exchange rate fluctuations in the Euro and the Australian dollar relative to the U.S. dollar decreased.The Company did not enter into any forward contracts between March 2014 and June 2015. In July 2015, as a result of its operational reorganization, theCompany implemented its revised hedging program under which it hedges its non-functional currency exposures for Pegasystems Inc. and Pegasystems Limited.As of December 31, 2015, the total notional amount of the Company’s outstanding forward contracts was $32.3 million. The Company did not have anyoutstanding forward contracts as of December 31, 2014.The fair value of the Company’s outstanding forward contracts as of December 31, 2015 was as follows: (in thousands) Asset Derivatives Liability Derivatives Balance Sheet Location Fair Value Balance Sheet Location Fair Value Foreign currency forward contracts Other current assets $48 Accrued expenses $1,052 The Company entered into forward contracts with notional values as follows: Year Ended December 31, Currency (in thousands) 2015 2014 2013 Euro €55,850 €21,900 €102,300 British pound £13,600 £26,500 £85,400 Australian dollar A$43,000 A$12,900 A$26,300 Indian rupee Rs1,100,000 Rs204,000 Rs690,000 United States dollar $77,900 $— $— Change in Fair Value in USD Year Ended December 31, (in thousands) 2015 2014 2013 Loss from the change in the fair value of forward contracts included in other expense, net $(1,047) $(532) $(747) Foreign currency transaction losses from the remeasurement of foreign currency assets and liabilities (4,168) (3,769) (1,593) 57Table of Contents5. FAIR VALUE MEASUREMENTSAssets and Liabilities Measured at Fair Value on a Recurring BasisThe Company records its marketable securities and forward contracts at fair value on a recurring basis. Fair value is an exit price, representing the amountthat would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants based on assumptions thatmarket participants would use in pricing an asset or liability. As a basis for classifying the fair value measurements, a three-tier fair value hierarchy, whichclassifies the fair value measurements based on the inputs used in measuring fair value, was established as follows: (Level 1) observable inputs such as quotedprices in active markets for identical assets or liabilities; (Level 2) significant other inputs that are observable either directly or indirectly; and (Level 3) significantunobservable inputs on which there is little or no market data, which require the Company to develop its own assumptions. This hierarchy requires the Company touse observable market data, when available, and to minimize the use of unobservable inputs when determining fair value.The Company’s money market funds are classified within Level 1 of the fair value hierarchy. The Company’s investments classified within Level 2 of thefair value hierarchy are valued based on a market approach using quoted prices, when available, or matrix pricing compiled by third party pricing vendors, usingobservable market inputs such as interest rates, yield curves, and credit risk. The Company’s foreign currency forward contracts which are all classified withinLevel 2 of the fair value hierarchy are valued based on the notional amounts and rates under the contracts and observable market inputs such as currency exchangerates and credit risk. If applicable, the Company will recognize transfers into and out of levels within the fair value hierarchy at the end of the reporting period inwhich the actual event or change in circumstance occurs. There were no transfers of investments between Level 1 and Level 2 during the year ended December 31,2015.The Company’s assets and liabilities measured at fair value on a recurring basis consisted of the followings: (in thousands) December 31,2015 Quoted Prices in Active Markets for Identical Assets(Level 1) Significant Other ObservableInputs (Level 2) Fair Value Assets: Money market funds $573 $573 $— Marketable securities: Municipal bonds $57,335 $— $57,335 Corporate bonds 66,815 — 66,815 Certificates of deposit 1,902 — 1,902 Total marketable securities $126,052 $— $126,052 Foreign currency forward contracts $48 $— $48 Fair Value Liabilities: Foreign currency forward contracts $1,052 $— $1,052 (in thousands) December 31,2014 Quoted Prices in Active Markets for Identical Assets(Level 1) Significant Other ObservableInputs (Level 2) Fair Value Assets: Money market funds $2,295 $ 2,295 $— Marketable securities: Municipal bonds $27,855 $— $27,855 Corporate bonds 65,348 — 65,348 Certificates of deposit 3,428 — 3,428 Total marketable securities $96,631 $— $96,631 $98,926 $2,295 $96,631 58Table of ContentsAssets Measured at Fair Value on a Nonrecurring BasisAssets recorded at fair value on a nonrecurring basis, such as property and equipment, and intangible assets are recognized at fair value when they areimpaired. During 2015, 2014, and 2013, the Company did not recognize any impairments on its assets measured at fair value on a nonrecurring basis.6. TRADE ACCOUNTS RECEIVABLE, NET OF ALLOWANCEUnbilled trade accounts receivable primarily relates to services earned under time and materials arrangements and to license, maintenance, and cloudarrangements that have commenced or been delivered in excess of scheduled invoicing. December 31, (in thousands) 2015 2014 Trade accounts receivable $190,820 $128,757 Unbilled accounts receivable 25,657 27,627 Total accounts receivable 216,477 156,384 Allowance for sales credit memos (4,631) (1,540) $211,846 $154,844 The Company records an allowance for estimates of potential sales credit memos when the related revenue is recorded and reviews this allowanceperiodically. The following reflects the activity of the allowance for sales credit memos: Year Ended December 31, (in thousands) 2015 2014 2013 Balance at beginning of year $1,540 $1,997 $963 Provision for credit memos 8,005 2,164 5,374 Credit memos issued (4,914) (2,621) (4,340) $4,631 $1,540 $1,997 7. PROPERTY AND EQUIPMENT December 31, (in thousands) 2015 2014 Leasehold improvements $29,501 $27,672 Computer equipment 18,369 15,295 Furniture and fixtures 5,211 5,321 Computer software purchased 5,847 3,750 Computer software developed for internal use 721 721 Fixed assets in progress 2,173 918 61,822 53,677 Less: accumulated depreciation and amortization (30,503) (23,521) Property and equipment, net $31,319 $30,156 Depreciation expense was approximately $10.6 million, $9.3 million, and $8.2 million, for the years ended December 31, 2015, 2014, and 2013, respectively. 59Table of Contents8. ACQUISITIONSAcquisitions completed in 2014:The Company completed three acquisitions during the year ended December 31, 2014, which were determined to be immaterial, both individually and in theaggregate, for $6.3 million in cash consideration, inclusive of $2.1 million in cash acquired, and $1.1 million in additional cash consideration which was paid in2015. During 2015, the Company also paid $0.5 million in additional cash consideration to the selling shareholders of another one of the three companies acquiredin 2014 and up to $0.8 million may be payable based on the achievement of certain performance milestones through the end of 2016.Acquisitions completed in 2013:AntennaOn October 9, 2013, the Company acquired Antenna, a leading provider of mobile application development platforms. The Company acquired all of theoutstanding capital stock of Antenna in a cash merger for $27.1 million, including the final working capital adjustment to the purchase price, which was paid by theCompany in the first quarter of 2014. During 2014 and 2013, the Company incurred direct and incremental expenses associated with the transaction of $0.3 millionand $1.3 million, respectively, which were primarily professional fees. The Company has included the financial results of Antenna in its consolidated financialstatements from the date of acquisition.As of December 31, 2014, as a result of the final purchase price allocation, the Company recognized $23 million of goodwill, which is nondeductible for taxpurposes. A summary of the final purchase price allocation for the acquisition of Antenna is as follows: (in thousands) Total purchase consideration: Cash $27,141 Allocation of the purchase consideration: Cash $783 Accounts receivable, net of allowance 4,184 Other assets 3,951 Property and equipment 655 Deferred tax assets, net 2,638 Identifiable intangible assets 10,355 Goodwill 23,018 Accounts payable (1,396) Accrued liabilities (12,861) Deferred revenue (4,186) Net assets acquired $27,141 Pro forma Information (Unaudited)The following pro forma financial information presents the combined results of operations of the Company and Antenna as if the acquisition had occurred onJanuary 1, 2013 after giving effect to certain pro forma adjustments. The pro forma adjustments reflected herein include only those adjustments that are directlyattributable to the Antenna acquisition, factually supportable, and expected to have a continuing impact on the Company. These pro forma adjustments include anet increase in amortization expense to eliminate historical amortization of Antenna intangible assets and to record amortization expense for the $10.4 million ofacquired identifiable intangibles, a decrease in interest income as a result of the cash paid for the acquisition, a decrease in 60Table of Contentsinterest expense as a result of the repayment of all Antenna outstanding debt in connection with the acquisition, and the elimination of approximately $1.3 millionof acquisition-related costs, including transaction costs incurred by the Company and Antenna. The pro forma financial information does not reflect anyadjustments for anticipated synergies resulting from the acquisition and is not necessarily indicative of the operating results that would have actually occurred hadthe transaction been consummated on January 1, 2013. Pro Forma Year Ended December 31, 2013 (in thousands, except per share amounts) Revenue $532,978 Net income $35,814 Net income per basic share (1) $0.47 Net income per diluted share (1) $0.46 (1) The per share amounts have been retroactively restated for all prior periods presented to reflect the Company’s two-for-one common stock split effected inthe form of a common stock dividend distributed on April 1, 2014. See Note 1 “Basis of Presentation” (d) for further discussion of the Stock Split.9. GOODWILL AND OTHER INTANGIBLE ASSETSAs discussed in Note 18 “Geographic Information and Major Clients”, the Company operates in one reportable segment, Digital Enterprise BusinessSolutions, and has one reporting unit.The following table presents the changes in the carrying amount of goodwill: Year Ended December 31, (in thousands) 2015 2014 2013 Balance as of January 1, $46,860 $43,469 $20,451 Purchase price adjustments to goodwill retroactively applied (1) — — 6,006 Goodwill acquired during the year — 3,431 17,012 Translation adjustments (84) (40) — Balance as of December 31, $46,776 $46,860 $43,469 (1)The purchase price adjustments identified during 2014 have been retroactively applied as of December 31, 2013.Intangible assets are recorded at cost and are amortized using the straight-line method over their estimated useful lives. (in thousands) Range of Useful Lives Cost AccumulatedAmortization Net bookvalue December 31, 2015 Customer related intangibles 4-9 years $49,546 $(30,465) $19,081 Technology 3-9 years 48,342 (34,282) 14,060 Other intangibles 3 years 5,361 (5,084) 277 Total $103,249 $(69,831) $33,418 December 31, 2014 Customer related intangibles 4-9 years $49,590 $(24,338) $25,252 Technology 3-9 years 48,342 (28,890) 19,452 Other intangibles 1-3 years 5,361 (4,401) 960 Total $103,293 $(57,629) $45,664 61Table of ContentsAmortization expense of acquired intangibles was reflected in the Company’s consolidated statements of operations as follows: Year Ended December 31, (in thousands) 2015 2014 2013 Amortization expense: Cost of revenue $5,392 $6,017 $6,443 Selling and marketing 6,127 6,022 5,174 General and administrative 683 1,770 396 Total amortization expense $12,202 $13,809 $12,013 As of December 31, 2015, future estimated amortization expense is as follows: (in thousands) Future estimated amortization expense 2016 $11,517 2017 9,818 2018 8,819 2019 3,027 2020 and thereafter 237 $33,418 10. ACCRUED EXPENSES December 31, (in thousands) 2015 2014 Partner commissions $3,319 $2,441 Other taxes 10,070 10,970 Employee reimbursable expenses 1,426 1,474 Dividends payable 2,297 2,294 Professional services contractor fees 4,580 2,297 Self-insurance health and dental claims 2,129 2,115 Professional fees 2,937 2,444 Short-term deferred rent 1,600 1,446 Income taxes payable 5,464 8,966 Acquisition-related expenses and merger consideration 834 2,702 Restructuring 394 461 Marketing and sales program expenses 1,397 1,914 Cloud hosting expenses 1,370 516 Foreign currency forward contracts 1,052 — Fixed assets in progress 1,632 144 Other 2,267 2,774 $42,768 $42,958 62Table of Contents11. DEFERRED REVENUE December 31, (in thousands) 2015 2014 Software license $40,886 $38,961 Maintenance 95,262 83,467 Cloud 8,948 4,209 Services 10,777 8,035 Current deferred revenue 155,873 134,672 Software license 12,389 19,878 Maintenance and services 2,227 981 Cloud 1,189 — Long-term deferred revenue 15,805 20,859 $171,678 $155,531 12. ACCRUED RESTRUCTURINGDuring the fourth quarter of 2013, in connection with the Company’s evaluation of its combined facilities with Antenna, the Company approved a plan toeliminate space within one facility. The Company ceased use of this space during the fourth quarter of 2013 and recognized $1.7 million of restructuring expenses.During the third quarter of 2014, the Company restructured the remaining space within the same facility, revised its restructuring estimate, and recognized $0.2million in additional restructuring expense. These restructuring expenses represent future lease payments and demising costs, net of estimated sublease income forthis space. The lease expires in 2021.A summary of the restructuring activity is as follows: (in thousands) Antenna personneland facilities restructuring Total Balance as of January 1, 2013 $— $441 Restructuring costs 1,731 1,731 Cash payments — (441) Other (140) (140) Balance as of December 31, 2013 $1,591 $1,591 Restructuring costs 192 192 Cash payments (476) (476) Other (128) (128) Balance as of December 31, 2014 $1,179 $1,179 Restructuring costs — — Cash payments (186) (186) Balance as of December 31, 2015 $993 $993 December 31, (in thousands) 2015 2014 Reported as: Accrued expenses $394 $461 Other long-term liabilities 599 718 $993 $1,179 63Table of Contents13. COMMITMENTS AND CONTINGENCIESCommitmentsThe Company leases space for its offices under noncancellable operating leases that expire at various dates through 2023.As of December 31, 2015, the Company’s future minimum rental payments required under operating leases with noncancellable terms in excess of one yearwere as follows: (in thousands) For the calendar year Operating Leases (1) 2016 $13,087 2017 13,101 2018 13,057 2019 11,281 2020 10,294 2021 & Thereafter 26,604 $87,424 (1) Operating leases include future minimum rent payments, net of estimated sublease income for facilities that the Company has vacated pursuant to itsrestructuring activities, as discussed in Note 12.Rent expense under operating leases is recognized on a straight-line basis to account for scheduled rent increases and landlord tenant allowances. Inconnection with the Company’s amended lease for its office headquarters dated November 11, 2014, the Company has a landlord tenant allowance totalingapproximately $9.4 million, of which $8.4 million was used and reimbursed to the Company as of December 31, 2012 and will be amortized as a reduction to rentexpense on a straight-line basis over the term of the lease. Total rent expense under operating leases was approximately $12.3 million, $12.5 million, and $11.7million for the years ended December 31, 2015, 2014 and 2013, respectively.ContingenciesThe Company is a party in various contractual disputes, litigation and potential claims arising in the ordinary course of business. The Company does notbelieve that the resolution of these matters will have a material adverse effect on its financial position or results of operations.14. STOCKHOLDERS’ EQUITY(a) Preferred stockThe 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 hasthe 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 thestockholders. The issuance of preferred stock could decrease the amount of earnings and assets available for distribution to holders of common stock, and may havethe 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 31,2015.(b) Common stockThe Company has 200,000,000 authorized shares of common stock, $0.01 par value per share, of which 76,488,000 shares were issued and outstanding atDecember 31, 2015. 64Table of ContentsSince 2004, the Company’s Board of Directors has approved stock repurchase programs that have authorized the Company to repurchase in the aggregate upto $169 million of its common stock. On June 4, 2015, the Company announced that its Board of Directors extended the expiration date of the current stockrepurchase program to June 30, 2016 and authorized the Company to repurchase up to an additional $50 million of its stock between June 4, 2015 and June 30,2016. Purchases under these programs have been made on the open market. The following table is a summary of the Company’s repurchase activity under all of theCompany’s repurchase programs for the years ended December 31: Year Ended December 31, 2015 2014 2013 (Dollars in thousands) Shares Amount Shares Amount Shares Amount Prior year authorizations at January 1, $13,284 $14,433 $14,793 Authorizations 50,000 14,410 12,164 Repurchases paid 944,398 (22,530) 756,143 (15,264) 773,258 (12,370) Repurchases unsettled 7,836 (220) 13,983 (295) 6,282 (154) Authorized dollars remaining as of December 31, $40,534 $13,284 $14,433 (c) DividendsOn May 27, 2014, the Company announced an increase in its quarterly common stock cash dividend from $0.015 to $0.03 per share, on a post-split basis.The Company declared quarterly dividends totaling $0.12 per share, $0.105 per share, and $0.06 per share, on a post-split basis, for the years ended December 31,2015, 2014, and 2013, respectively. The Company’s Board of Directors authorized the acceleration of the payment of the dividend declared in the fourth quarter2012, otherwise payable in January 2013, to December 2012. Therefore, there was no dividend payment in the first quarter of 2013. For the years endedDecember 31, 2015, 2014, and 2013, the Company paid cash dividends of $9.2 million, $6.9 million, and $3.4 million, respectively. It is the Company’s currentintention to pay a quarterly cash dividend of $0.03 per share, however, the Board of Directors may terminate or modify this dividend program at any time withoutnotice.15. STOCK-BASED COMPENSATIONThe majority of the Company’s stock-based compensation arrangements vest over either a four or five year vesting schedule and the Company’s stockoptions have a ten-year term. The Company recognizes stock-based compensation using the accelerated recognition method, treating each vesting tranche as if itwere an individual grant.The Company periodically grants stock options and restricted stock units (“RSUs”) for a fixed number of shares upon vesting 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 grant date. RSUs deliver to therecipient 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 atshare issuance. The Company values its RSUs at the fair value of its common stock on the grant date, which is the closing price of its common stock on the grantdate, 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, theCompany withholds shares of common stock in an amount sufficient to cover the minimum statutory tax withholding obligations and issues shares of its commonstock for the remaining amount.Employees may elect to receive 50% of their target incentive compensation under the Company’s Corporate Incentive Compensation Plan (the “CICP”) inthe form of RSUs instead of cash. If elected by an employee, the 65Table of Contentsequity 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 RSUsgranted is determined by dividing 50% of the employee’s target incentive opportunity by 85% of the closing price of its common stock on the grant date, less thepresent value of expected dividends. If elected, the award vests 100% on the CICP payout date of the following year for all participants. Vesting is conditionedupon the performance conditions of the CICP and on continued employment; if threshold funding does not occur, the equity grant will be cancelled. The Companyconsiders vesting to be probable on the grant date and recognizes the associated stock-based compensation expense over the requisite service period beginning onthe grant date and ending on the vest date.The Company grants options that allow for the settlement of vested stock options on a net share basis (“net settled stock options”). With net settled stockoptions, the employee does not surrender any cash or shares upon exercise. Rather, the Company withholds the number of shares to cover the option exercise priceand the minimum statutory tax withholding obligations from the shares that would otherwise be issued upon exercise. The exercise of stock options on a net sharebasis results in fewer shares issued by the Company.Share-Based Compensation Plans:(a) Amended and Restated 2004 Long-Term Incentive PlanIn 2004, the Company adopted the 2004 Long-Term Incentive Plan (the “2004 Plan”) to provide employees, non-employee Directors, and consultants withopportunities to purchase stock through incentive stock options and non-qualified stock options. In addition to options, eligible participants under the 2004 Planmay be granted stock purchase rights and other stock-based awards. In July 2011, the Company’s stockholders approved the Pegasystems Inc. Amended andRestated 2004 Long-Term Incentive Plan (the “Restated 2004 Plan”), which increased the number of shares authorized for issuance under the plan to 24,000,000,giving effect to the Stock Split, and extended the term of the plan to 2021. Since 2006, the Company has granted to each non-employee director of the Companyunrestricted shares of common stock on an annual basis in consideration of their board service. The number of unrestricted shares granted to each non-employeedirector was equal to $119,000, $95,000, and $70,000, divided by the fair market value of the Company’s common stock on the grant dates, for 2015, 2014, and2013, respectively. As of December 31, 2015, approximately 9,130,000 shares were subject to outstanding options and stock-based awards under the Restated 2004Plan.(b) 2006 Employee Stock Purchase PlanIn 2006, the Company adopted the 2006 Employee Stock Purchase Plan (the “2006 ESPP”) pursuant to which the Company’s employees are entitled topurchase up to an aggregate of 1,000,000 shares, giving effect to the Stock Split, of common stock at a price equal to at least 85% of the fair market value of theCompany’s common stock on either the commencement date or completion date for offerings under the plan, whichever is less, or such higher price as theCompany’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 priceat 95% of the fair market value on the completion date of the offering period. As a result, the 2006 ESPP is non-compensatory and is tax qualified. Therefore, as ofDecember 31, 2015, no compensation expense related to shares issued under the plan had been recognized. In October 2012, the Company’s Board of Directorsamended the term of the 2006 ESPP such that it will continue until there are no shares remaining to be issued under the plan or until the plan is terminated by theBoard of Directors, whichever occurs first. As of December 31, 2015, approximately 331,000 shares had been issued thereunder.Shares reservedAs of December 31, 2015, there were approximately 6,880,000 shares remaining for issuance for future equity grants under the Company’s stock plans,consisting of approximately 6,211,000 shares under the Restated 2004 Plan and approximately 669,000 shares under the 2006 ESPP. 66Table of ContentsEquity grants, assumptions and activityDuring 2015, the Company issued approximately 1,053,000 shares to its employees under the Company’s share-based compensation plans andapproximately 31,000 shares to the non-employee members of its Board of Directors.The following table presents the stock-based compensation expense included in the Company’s consolidated statements of operations: Year ended December 31, (in thousands) 2015 2014 2013 Stock-based compensation expense: Cost of revenues $8,772 $5,335 $4,085 Operating expenses 21,282 13,870 8,784 Total stock-based compensation before tax 30,054 19,205 12,869 Income tax benefit (8,098) (5,563) (3,918) Stock OptionsThe Company estimates the fair value of stock options using a Black-Scholes option valuation model. Key inputs used to estimate the fair value of stockoptions 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 expectedterm, the risk-free interest rate over the option’s expected term, and the Company’s expected annual dividend yield. The amount of stock-based compensationrecognized during a period is based on the value of the awards that are ultimately expected to vest. Forfeitures are estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from those estimates. Ultimately, the Company recognizes the actual expense over the vesting periodonly for the shares that vest. The weighted-average grant-date fair value for stock options granted in 2015, 2014, and 2013, was $7.62, $7.58 and $6.72 per share,respectively.The weighted-average assumptions used in the Black-Scholes option valuation model are as follows: Year ended December 31, 2015 2014 2013 Expected annual volatility (1) 45% 47% 49% Expected term in years (2) 4.5 4.4 4.5 Risk-free interest rate (3) 1.34% 1.33% 1.02% Expected annual dividend yield (4) 0.68% 0.44% 0.42% (1) The expected annual volatility for each grant is determined based on the average of historical daily price changes of the Company’s common stock over aperiod 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 terminationbehavior.(3) The risk-free interest rate is based on the yield of U.S. Treasury securities with a maturity that is commensurate with the expected option term at the time ofgrant.(4) The expected annual dividend yield is based on the weighted-average of the dividend yield assumptions used for options granted during the applicableperiod. The expected annual dividend has historically been based on the expected dividend of $0.06 per share, per year ($0.015 per share, per quarter times 4quarters), on a post-split basis, divided by the average stock price. On May 27, 2014, the Company announced an increase in its quarterly cash dividend from$0.015 to $0.03 per share. Thus, for grants made after this date, 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. 67Table of ContentsThe Company elected to adopt the alternative transition method (“short cut method”) in calculating its historical pool of windfall tax benefits in regards to itsshare-based compensation.The following table summarizes the combined stock option activity under the Company’s stock option plans for the year ended December 31, 2015: Shares (in thousands) Weighted-average exercise price Weighted-average remaining contractual term (in years) Aggregate intrinsic value (in thousands) Options outstanding as of January 1, 2015 6,100 $12.99 Granted 2,265 20.99 Exercised (1,255) 9.95 Forfeited/Cancelled (547) 16.79 Options outstanding as of December 31, 2015 6,563 $16.01 Vested and expected to vest as December 31, 2015 5,405 $9.49 7.2 $97,357 Exercisable as of December 31, 2015 2,418 $12.48 5.7 $36,317 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 atexercise) in 2015, 2014, and 2013 was $18.6 million, $13.2 million and $20.6 million, respectively. The aggregate intrinsic value of stock options outstanding andexercisable as of December 31, 2015 is based on the difference between the closing price of the Company’s stock of $27.50 on December 31, 2015 and the exerciseprice of the applicable stock options.As of December 31, 2015, the Company had unrecognized stock-based compensation expense related to the unvested portion of stock options ofapproximately $10.7 million that is expected to be recognized as expense over a weighted-average period of approximately 2.2 years.RSUsThe weighted-average grant-date fair value for RSUs granted in 2015, 2014, and 2013 was $20.49, $19.88, and $16.06, respectively. The following tablesummarizes the combined RSU activity for periodic grants and the CICP under the Restated 2004 Plan for the year ended December 31, 2015: Shares (in thousands) Weighted- Average Grant-Date Fair Value Aggregate Intrinsic Value (in thousands) Nonvested as of January 1, 2015 1,718 $18.90 Granted 1,868 20.49 Vested (662) 18.72 Forfeited (317) 19.36 Nonvested as of December 31, 2015 2,607 $20.03 $71,684 Expected to vest as of December 31, 2015 1,970 $20.03 $54,169 The RSUs associated with periodic grants vest over five years with 20% vesting after one year and the remaining 80% vesting in equal quarterly installmentsover the remaining four years. Approximately 256,000 RSUs granted in connection with the 2015 CICP are expected to vest 100% in March 2016. 68Table of ContentsThe fair value of RSUs vested in 2015, 2014, and 2013 was $14.9 million, $8.0 million, and $7.3 million, respectively. The aggregate intrinsic value of RSUsoutstanding and expected to vest as of December 31, 2015 is based on the closing price of the Company’s stock of $27.50 on December 31, 2015.As of December 31, 2015, the Company had approximately $19.9 million of unrecognized stock-based compensation expense related to all unvested RSUsthat is expected to be recognized as expense over a weighted-average period of approximately 2.1 years.16. INCOME TAXESEffective tax rateThe components of income before provision for income taxes are as follows for the years ended December 31: (in thousands) 2015 2014 2013 Domestic $63,124 $36,485 $47,054 Foreign (2,619) 11,509 9,339 Total income before provision $60,505 $47,994 $56,393 The components of the provision for income taxes are as follows for the years ended December 31: (in thousands) 2015 2014 2013 Current: Federal $17,864 $22,488 $20,277 State 4,565 2,952 2,054 Foreign 3,853 3,195 3,027 Total current provision 26,282 28,635 25,358 Deferred: Federal 2,075 (11,972) (6,069) State (466) (1,209) (634) Foreign (3,708) (715) (305) Total deferred expense (benefit) (2,099) (13,896) (7,008) Total provision $24,183 $14,739 $18,350 The effective income tax rate differed from the statutory federal income tax rate due to the following: 2015 2014 2013 Statutory federal income tax rate 35.0% 35.0% 35.0% Valuation allowance 0.7 0.5 — Transaction costs — — 0.4 State income taxes, net of federal benefit and tax credits 4.6 1.8 1.4 Permanent differences 1.1 1.3 1.0 Domestic production activities (3.1) (4.9) (3.8) Federal research and experimentation credits (1.2) (1.7) (2.8) Tax effects of foreign activities 2.0 (2.2) (1.9) Tax-exempt income (0.1) (0.1) (0.1) Provision to return adjustments 0.3 — 0.8 Non-deductible compensation 3.3 2.5 1.2 Provision for uncertain tax positions (2.6) (0.7) 1.5 Other — (0.8) (0.2) Effective income tax rate 40.0% 30.7% 32.5% 69Table of ContentsDeferred income taxesDeferred income taxes reflect the tax attributes and tax effects of temporary differences between the carrying amounts of assets and liabilities for financialreporting purposes and the amounts used for income tax purposes. Significant components of net deferred tax assets and liabilities are as follows: (in thousands) 2015 2014 Deferred tax assets: Net operating loss carryforwards $65,601 $86,770 Accruals and reserves 30,322 24,393 Software revenue 6,608 13,199 Depreciation 5,327 4,655 Tax credit carryforwards 6,686 6,028 Other 58 38 Total deferred tax assets 114,602 135,083 Less valuation allowances (35,509) (35,620) Total net deferred tax assets $79,093 $99,463 Deferred tax liabilities: Intangibles $(13,363) $(17,231) Total deferred tax liabilities (13,363) (17,231) Total net deferred income taxes $65,730 $82,232 Reported as: Current net deferred tax asset $12,380 $12,974 Long-term net deferred income tax assets 53,350 69,258 Total net deferred income taxes $65,730 $82,232 The Company regularly assesses the need for a valuation allowance against its deferred tax assets. In making that assessment, the Company considers bothpositive and negative evidence related to the likelihood of realization of the deferred tax assets to determine, based on the weight of available evidence, whether itis more-likely-than-not that some or all of the deferred tax assets will not be realized. This determination requires significant judgment, including assumptionsabout future taxable income that are based on historical and projected information. There were no material adjustments to the Company’s valuation allowanceposition during 2015 and 2014. The $0.1 million net change in the valuation allowance during the period primarily relates to a $0.5 million decrease for movementsin foreign exchange rates, partially offset by a $0.4 million increase in the assessment regarding the utilization of state tax credits.The Company acquired approximately $39.6 million and $58.1 million of federal and foreign net operating losses (“NOLs”), respectively, in the Antennaacquisition. The Company has determined that it may utilize $7.5 million of the acquired Antenna federal NOLs under the applicable section 382 limitation, andthese losses are scheduled to expire through 2031. A valuation allowance is recorded on the deferred tax assets in excess of the federal NOLs that are deemedrecoverable under the limitation. With regard to the acquired foreign NOLs, a full valuation allowance has been recorded as of December 31, 2015 due touncertainty regarding the availability of these NOLs to offset future income generated by the related foreign businesses due to limitations under local countrychange in control provisions. As of December 31, 2015, the Company had approximately $38.9 million of acquired Antenna federal NOLs, which are subject toannual use limitations under section 382. Based on those limitations, the Company anticipates using $6.6 million of the remaining NOLs by 2031.As of December 31, 2015, the Company had approximately $108.2 million of acquired Chordiant federal NOLs, which are subject to annual use limitationsunder section 382. Based on those limitations, the Company 70Table of Contentsanticipates using $82.4 million of the remaining NOLs by 2029. In addition, the Company has $0.4 million of deferred tax assets related to state NOLs as ofDecember 31, 2015.As of December 31, 2015, the Company had available $7 million of state tax research and experimentation (“R&E”) credits expiring in the years 2016through 2030 and $0.4 million of investment tax credits, which have an unlimited carryover.The Company’s India subsidiary is a development center in an area designated as a Special Economic Zone (“SEZ”) and is entitled to a tax holiday in India.The tax holiday reduces or eliminates income tax in that country and is scheduled to expire in 2022. For the years ended December 31, 2015, 2014, and 2013, theeffect of the income tax holiday was to reduce the overall income tax provision by approximately $0.9 million, $0.8 million, and $0.5 million, respectively. Thebenefit of the tax holiday on net income per share (diluted) was $0.01 for each of the years ended December 31, 2015, 2014, and 2013.In 2015, the Company reduced its income tax payable by $5.3 million for the tax benefit realized from the exercise, sale or vesting of equity awards.Undistributed earnings of the Company’s foreign subsidiaries amounted to approximately $27.9 million as of December 31, 2015. The Company has notprovided any additional federal or state income taxes or foreign withholding taxes on the undistributed earnings as such earnings have been indefinitely reinvestedin the business. It is impractical to estimate the amount of tax the Company could have to pay upon repatriation due to the complexity of foreign tax creditcalculations and because the Company considers its earnings permanently reinvested.Uncertain tax benefits and other considerationsA reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows: (in thousands) 2015 2014 2013 Balance as of January 1, $43,396 $40,929 $26,317 Additions based on tax positions related to the current year 817 4,041 4,320 Additions for tax positions of prior years 183 285 350 (Reductions) Additions for acquired uncertain tax benefits — (716) 10,268 Reductions for tax positions of prior years (19,855) (853) (50) Reductions for a lapse of the applicable statute of limitations (569) (290) (276) Balance as of December 31, $23,972 $43,396 $40,929 As of December 31, 2015, the Company had approximately $24 million of total unrecognized tax benefits, which would decrease the Company’s effectivetax rate if recognized. The $19.9 million reduction for tax positions of prior years primarily relates to the release of limitations on acquired NOLs, which did notimpact the Company’s effective tax rate in 2015. The Company expects that the changes in the unrecognized benefits within the next twelve months will beapproximately $0.5 million, all of which relate to the expiration of applicable statute of limitations and would reduce the Company’s effective tax rate ifrecognized.For the years ended December 31, 2015, 2014, and 2013, the reductions for tax positions of prior years were related to the lapse in the applicable statute oflimitations, revision of purchase accounting estimates, settlements of audits, and the impact for foreign currency exchange rates.The Company recognizes interest accrued and penalties related to unrecognized tax benefits in the income tax provision. For the year ended December 31,2015, the Company recognized a reduction of interest expense of 71Table of Contentsapproximately $0.6 million. For each of the years ended December 31, 2014 and 2013, the Company recognized interest expense of approximately $0.3 million.For the years ended December 31, 2015, 2014, and 2013, the Company did not recognize any significant penalties. As of December 31, 2015, 2014 and 2013, theCompany had accrued approximately $1.2 million, 1.5 million, and $1.1 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, local, orforeign income tax examinations by tax authorities for years before 2014. The Company is generally not subject to U.S. federal, state, or local, or foreign incometax examinations by tax authorities for the years before 2012. With few exceptions, the statute of limitations remains open in all jurisdictions for the tax years 2012to the present.17. EARNINGS PER SHAREBasic earnings per share is computed using the weighted-average number of common shares outstanding during the applicable period. Diluted earnings pershare is computed using the weighted-average number of common shares outstanding during the applicable period, plus the dilutive effect of outstanding optionsand RSUs, using the treasury stock method and the average market price of the Company’s common stock during the applicable period. Certain shares related tosome of the Company’s outstanding stock options and RSUs were excluded from the computation of diluted earnings per share because they were antidilutive inthe periods presented, but could be dilutive in the future. Year Ended December 31, (in thousands, except per share amounts) 2015 2014 2013 Basic Net income $36,322 $33,255 $38,043 Weighted-average common shares outstanding 76,507 76,327 75,946 Earnings per share, basic $0.47 $0.44 $0.50 Diluted Net income $36,322 $33,255 $38,043 Weighted-average common shares outstanding 76,507 76,327 75,946 Weighted-average effect of dilutive securities: Stock options 1,601 1,698 1,626 RSUs 935 506 402 Effect of assumed exercise of stock options and RSUs 2,536 2,204 2,028 Weighted-average common shares outstanding, assuming dilution 79,043 78,531 77,974 Earnings per share, diluted $0.46 $0.42 $0.49 Outstanding options, warrants and RSUs excluded as impact would be antidilutive 182 98 226 18. GEOGRAPHIC INFORMATION AND MAJOR CLIENTSOperating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by thechief operating decision maker (“CODM”) in deciding how to allocate resources and in assessing performance.The Company develops and licenses its strategic software applications and Pega 7 platform, and provides consulting services, maintenance, and trainingrelated to its offerings. The Company derives substantially all of its revenue from the sale and support of one group of similar products and services—software thatprovides 72Table of Contentsbusiness process solutions in the enterprise applications market. To assess performance, the Company’s CODM, who is the chief executive officer, reviewsfinancial information on a consolidated basis. Therefore, the Company determined it has one reportable segment—Digital Enterprise Business Solutions, and onereporting unit.The Company’s international revenue is from clients based outside of the U.S. The Company derived its revenue from the following geographic areas: Year ended December 31, (Dollars in thousands) 2015 2014 2013 U.S. $379,936 56% $327,154 55% $278,945 55% Other Americas 57,892 8% 32,642 6% 18,942 4% United Kingdom 96,314 14% 93,923 16% 83,134 16% Other EMEA (1) 87,240 13% 87,050 15% 82,743 16% Asia Pacific 61,313 9% 49,235 8% 45,190 9% $682,695 100% $590,004 100% $508,954 100% (1) Includes Europe other than the UK, the Middle East and Africa, (“Other EMEA”).Long-lived assets related to the Company’s U.S. and international operations were as follows: December 31, (Dollars in thousands) 2015 2014 U.S. $17,600 56% $18,276 61% India 10,530 34% 8,943 29% International, other 3,189 10% 2,937 10% $31,319 100% $30,156 100% There were no clients accounting for 10% or more of the Company’s total revenue in 2015, 2014, and 2013. There was one client accounting for 10% ormore of the Company’s total outstanding trade receivables as of December 31, 2015, as listed below. The Company’s financial services, healthcare, and insuranceclients as a group represent a significant amount of the Company’s revenues and receivables. However, the Company determined this concentration did not have amaterial impact on its allowance for sales credit memos as of December 31, 2015. December 31, (Dollars in thousands) 2015 2014 Trade receivables, net of allowances $211,846 $154,844 Client A 10% n/a Marketable securities are another financial instrument that potentially subject the Company to a concentration of credit risk. See Note 3 “MarketableSecurities” and Note 5 “Fair Value Measurements” for further discussion.19. EMPLOYEE BENEFIT PLANSThe Company sponsors a 401(k) defined contribution retirement plan for qualifying employees pursuant to which the Company makes discretionarymatching contributions. The Company’s expense under the plan totaled approximately $4.1 million in 2015, $3.4 million in 2014, and $2.9 million in 2013. Inaddition, the Company has defined contribution plans for qualifying international employees and contributions expensed under those plans totaled approximately$6.4 million in 2015, $5.1 million in 2014, and $3.7 million in 2013. 73Table of Contents20. SELECTED QUARTERLY INFORMATION (UNAUDITED) 2015 (in thousands, except per share amounts) 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Revenue $153,918 $162,019 $162,403 $204,355 Gross profit 103,859 107,238 106,962 151,190 Income from operations 11,909 5,250 10,711 36,791 Income before provision for income taxes 9,260 4,501 10,246 36,498 Net income 5,935 3,104 6,325 20,958 Net earnings per share, basic $0.08 $0.04 $0.08 $0.27 Net earnings per share, diluted $0.08 $0.04 $0.08 $0.26 2014 (in thousands, except per share amounts) 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Revenue $140,464 $142,985 $137,631 $168,924 Gross profit 94,551 96,294 91,249 122,816 Income from operations 14,627 2,222 4,997 29,693 Income before provision for income taxes 14,541 2,387 2,352 28,714 Net income 9,765 1,504 1,882 20,104 Net earnings per share, basic $0.13 $0.02 $0.02 $0.27 Net earnings per share, diluted $0.12 $0.02 $0.02 $0.26 74Table of ContentsITEM 9.Changes In and Disagreements with Accountants on Accounting and Financial DisclosureNone. ITEM 9A.Controls and Procedures(a) Evaluation of Disclosure Controls and Procedures.Our management, with the participation of our Chief Executive Officer, or CEO, and Chief Accounting Officer, or CAO, evaluated the effectiveness of ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of December 31, 2015. In designing andevaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures. Based on this evaluation, our CEO and CAO concluded that our disclosure controls and procedures were effective as ofDecember 31, 2015.(b) Management’s Report on and Changes in 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 CAO, we conductedan evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2015 based on the framework in the updated Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) on May 14, 2013. Based on thisevaluation, management has concluded that (i) our disclosure controls and procedures were effective as of December 31, 2015 and (ii) no change in our internalcontrol over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act) occurred during the quarter ended December 31,2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.Deloitte & Touche LLP, our independent registered public accounting firm which also audited our consolidated financial statements, has issued an attestationreport on our internal control over financial reporting, which is included on page 44 in Item 8 Financial Statements and Supplementary Data. ITEM 9B.Other InformationNone. 75Table of ContentsPART III ITEM 10.Directors, Executive Officers, and Corporate GovernanceExcept as set forth below, the information required by this Item is contained in our proxy statement for our 2016 annual stockholders meeting (the “2016proxy statement”) under the heading “Election of Directors,” and is incorporated herein by reference. Information relating to certain filings on Forms 3, 4, and 5 iscontained in our 2016 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 407(c) (3), 407(d) (4), and 407(d) (5) of Regulation S-K relating to an audit committee financial expert, theidentification of the audit committee of our Board of Directors and procedures of security holders to recommend nominees to our Board of Directors is contained inthe 2016 proxy statement under the heading “Corporate Governance” and is incorporated herein by reference.We have adopted a written code of conduct that applies to our Board of Directors and all of our employees, including our principal executive officer,principal financial officer, principal accounting officer, or persons performing similar functions. A copy of our code of conduct can be found on our Website,www.pega.com. We intend to satisfy the disclosure requirements under Item 5.05 of Form 8-K and under the applicable the NASDAQ Global Select Market rulesby posting such information on our Website in accordance with such requirements.EXECUTIVE OFFICERSThe names of our executive officers and certain information about them are set forth below as of February 1, 2016:Alan Trefler, age 59, a founder of Pegasystems, serves as Chief Executive Officer and Chairman and has been a Director since we organized in 1983. Prior to1983, he managed an electronic funds transfer product for TMI Systems Corporation, a software and services company. Mr. Trefler holds a B.A. degree inEconomics and Computer Science from Dartmouth College.Efstathios Kouninis , age 54 , joined Pegasystems in April 2008 as Vice President of Finance. The Board of Directors appointed Mr. Kouninis as theCompany’s Chief Accounting Officer in May 2008 and Treasurer in January 2014. From February 2006 to April 2008, Mr. Kouninis served as Chief FinancialOfficer 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 B.S. from theUniversity of Massachusetts, a Post Baccalaureate in Accounting, and a M.S. in taxation from Bentley College.Douglas Kra, age 53 , joined Pegasystems in November 2004 as Vice President of Global Services. In January 2010, Mr. Kra was promoted to Senior VicePresident of Global Services. In July 2014, the Company re-organized its sales and consulting services functions under one responsibility for specific geographicregions, and Mr. Kra was promoted to Senior Vice President of Global Customer Success for international regions. From 2002 to 2004, Mr. Kra served as VicePresident at eLoyalty Corp., a consulting company specializing in customer relationship management. From 2000 to 2001, Mr. Kra served as President of ZeferCorp., 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. inComputer Science from Brandeis University and an M.B.A. in finance from the New York University Stern School of Business.Michael Pyle , age 61 , joined Pegasystems in 1985 and has served as Senior Vice President of Engineering since August 2000. Including his positions withPegasystems, Mr. Pyle’s professional background encompasses more than thirty years of software development and managerial experience throughout Europe andthe U.S. Mr. Pyle completed his B.C.S. specializing in Computer Science and Systems Programming at the Civil Service College in London. 76Table of ContentsLeon Trefler, age 55, joined Pegasystems in April 1998 as an Account Executive for Strategic Business Development. Since then he has held various seniorsales management positions across the Company and in Channel Sales. In 2002, he launched the commercialization of PegaRULES Process Commander, thepredecessor to Pega 7. From April 2007 to January 2010, Mr. Trefler served as Vice President of Sales, North America and in January 2010, Mr. Trefler waspromoted to Senior Vice President of Sales. In July 2014, the Company re-organized its sales and consulting services functions under one responsibility for specificgeographic regions, and Mr. Trefler was promoted to Senior Vice President of Global Customer Success for the Americas region. Mr. Trefler holds a B.A. degreefrom Dartmouth College.Alan Trefler and Leon Trefler are brothers. There are no other family relationships among any of our executive officers or Directors. ITEM 11.Executive CompensationThe information required by this item is contained in the 2016 proxy statement under the headings “Director Compensation”, “Compensation Discussion andAnalysis”, and “Executive Compensation” and is incorporated herein by reference. ITEM 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersInformation required by this item with respect to stock ownership of certain beneficial owners and management is contained in the 2016 proxy statementunder the heading “Security Ownership of Certain Beneficial Owners and Management” and is incorporated herein by reference.Equity Compensation Plan InformationThe following table provides certain information with respect to our equity compensation plans in effect as of December 31, 2015: (a) (b) (c) (In thousands, except per share amounts) Number of shares of common stock to be issued upon exercise of outstanding stock options and vesting of RSUs (3) Weighted-average exercise price per share of outstanding stock options (4) Number of shares of Common stock Remaining available For future issuance (excluding those in Column (a)) (5) Equity compensation plans approved bystockholders (1) 9,130 $16.04 6,880 Equity compensation plans not approved bystockholders (2) 40 $11.28 — (1) We currently maintain two equity compensation plans: the Amended and Restated 2004 Long-Term Incentive Plan (the “Restated 2004 Plan”) and the 2006Employee Stock Purchase Plan as amended, (the “2006 ESPP”). In addition to the issuance of stock options, the Restated 2004 Plan allows for the issuanceof stock purchase rights and other stock-based awards, including RSUs. Since 2006, the Company has granted unrestricted shares of its common stock to itsnon-employee directors under the Restated 2004 Plan. Our stockholders previously approved each of these plans and all amendments that were subject tostockholder approval. See Note 15 “Stock-Based Compensation” included in the Notes to Consolidated Financial Statements included in Item 8 of thisAnnual Report on Form 10-K for further information and description of our equity compensation plans.(2) These stock options were assumed in connection with our acquisition of Chordiant in 2010 and were originally granted under the Chordiant Software, Inc.2005 Equity Incentive Plan (the “2005 Plan”). No additional awards were or may be granted under the 2005 Plan following the date of acquisition. This plan 77Table of Contents was not approved by our stockholders since it was adopted on the date of acquisition. In connection with our acquisition of Chordiant, all outstanding equityawards issued under the 2005 Plan with an exercise price of $3.00, on a post-split basis, or lower were assumed by us and converted into the right to receive0.13 shares of Pegasystems common stock for every one share of Chordiant common stock covered by such awards. All other outstanding equity awardsissued under the 2005 Plan were cancelled.The 2005 Plan was approved by Chordiant’s stockholders and provided for the grant of incentive stock options, nonstatutory stock options, stock purchaseawards, RSAs, RSUs, and other forms of equity compensation. Awards granted under the 2005 Plan generally expire four to ten years after the grant date andgenerally become exercisable over a period of two to four years, with either yearly or monthly vesting. (3) The number of shares of common stock issued upon exercise of vested stock options and vesting of RSUs will be less than 9,170,000 because of the “netsettlement” feature of most of these stock options and RSUs. This feature enables the employee to satisfy the cost to exercise (in the case of stock options)and, if applicable, taxes due (in the case of stock options and RSUs) by surrendering shares to the Company based on the fair value of the shares at theexercise date (in the case of stock options) or vesting date (in the case of RSUs), instead of selling all of the shares on the open market to satisfy theseobligations. The settlement of vested stock options and vested RSUs on a net share basis will result in fewer shares issued by the Company. During 2015,stock option and RSU holders net settled stock options and RSUs representing the right to purchase a total of 1,821,000 shares, of which only 932,000 wereissued to the stock option and RSU holders and the balance of the shares were surrendered to the Company to pay for the exercise price and the applicabletaxes.(4) The weighted-average exercise price does not take into account the shares issuable upon vesting of outstanding RSUs, which have no exercise price.(5) Includes approximately 669,000 shares remaining available for issuance as of December 31, 2015 under the 2006 ESPP. ITEM 13.Certain Relationships and Related Transactions, and Director IndependenceThe information required by this item is contained in the 2016 proxy statement under the headings “Certain Relationships and Related Transactions” and“Determination of Independence” and is incorporated herein by reference. ITEM 14.Principal Accounting Fees and ServicesThe information required by this item is contained in the 2016 proxy statement under the heading “Independent Registered Public Accounting Firm Fees andServices” and is incorporated herein by reference. 78Table of ContentsPART IV ITEM 15.Exhibits, Financial Statement Schedules(a) The following are filed as part of this Annual Report on Form 10-K:(1) Financial StatementsThe following consolidated financial statements are included in Item 8: Page Consolidated Balance Sheets as of December 31, 2015 and 2014 45 Consolidated Statements of Operations for the years ended December 31, 2015, 2014, and 2013 46 Consolidated Statements of Comprehensive Income for the years ended December 31, 2015, 2014, and 2013 47 Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2015, 2014, and 2013 48 Consolidated Statements of Cash Flows for the years ended December 31, 2015, 2014, and 2013 49 (b) ExhibitsThe 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 SchedulesAll financial statement schedules are omitted because the required information is not present or not present in sufficient amounts to require submission of theschedule or because the information is reflected in the consolidated financial statements or notes thereto. 79Table of ContentsSignaturesPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report onForm 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. PEGASYSTEMS INC.By: /s/ EFSTATHIOS KOUNINIS Efstathios Kouninis Vice President of Finance and Chief Accounting Officer(Principal Accounting Officer)Date: February 25, 2016Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below on February 25,2016 by the following persons on behalf of the Registrant and in the capacities indicated. Signature Title/ S / ALAN TREFLERAlan Trefler Chief Executive Officer and Chairman(Principal Executive Officer)/ S / EFSTATHIOS KOUNINISEfstathios Kouninis Vice President of Finance and Chief Accounting Officer (Principal AccountingOfficer)/ S / RICHARD JONESRichard Jones Director/ S / PETER GYENESPeter Gyenes Director/ S / STEVEN KAPLANSteven Kaplan Director/ S / JAMES O’HALLORANJames O’Halloran Director/ S / LARRY WEBERLarry Weber Director/ S / WILLIAM WYMANWilliam Wyman Director 80Table of ContentsEXHIBIT INDEX Exhibit No. Description 2.1 Agreement and Plan of Merger, dated as of October 9, 2013, by and among Pegasystems Inc., Aries Merger Sub, Inc., Antenna Software, Inc.and Shareholder Representative Services LLC, solely in its capacity as representative of Stockholders thereunder. (Filed as Exhibit 2.1 to theRegistrant’s October 11, 2013 Form 8-K and incorporated herein by reference.) 3.1 Restated Articles of Organization of the Registrant and Amendments thereto. (Filed as Exhibit 3.1 to the Registrant’s September 30, 2014 Form10-Q and incorporated herein by reference.) 3.2 Amended and Restated Bylaws of Pegasystems Inc. (Filed as Exhibit 3.1 to the Registrant’s December 17, 2013 Form 8-K and incorporatedherein 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 2004 Long-Term Incentive Plan, dated May 18, 2011 (Filed as Appendix A within the Registrant’s 2011 ProxyStatement, filed May 23, 2011 and incorporated herein by reference). 10.2++ Form of Employee Stock Option Agreement, as amended on December 15, 2009. (Filed as Exhibit 10.8 to the Registrant’s 2009 Form 10-K andincorporated herein by reference.) 10.3++ Form of Restricted Stock Unit Agreement, as amended on December 15, 2009. (Filed as Exhibit 10.9 to the Registrant’s 2009 Form 10-K andincorporated herein by reference.) 10.4++ Form of Non-Employee Director Stock Option Agreement. (Filed as Exhibit 10.2 to the Registrant’s September 30, 2004 Form 10-Q andincorporated herein by reference.) 10.5++ 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 andincorporated herein by reference.) 10.6 Form of Director Indemnification Agreement. (Filed as Exhibit 99.1 to the Registrant’s April 11, 2005 Form 8-K and incorporated herein byreference.) 10.7++ Amendment to Stock Option Agreement between the Registrant and Richard H. Jones dated December 29, 2006. (Filed as Exhibit 99.1 to theRegistrant’s January 4, 2007 Form 8-K and incorporated herein by reference.) 10.8 Lease Agreement, dated June 29, 2011 between Charles Park One, LLC and Pegasystems Inc. for premises at One Charles Park (Filed asExhibit 99.1 to the Registrant’s Form 8-K/A filed on July 6, 2011 and incorporated herein by reference.) 10.9++ 2006 Employee Stock Purchase Plan, as amended on October 25, 2012. (Filed as Exhibit 10.24 to the Registrant’s 2012 Form 10-K andincorporated herein by reference.) 10.10++ 2014 Section 16 Officer/FLT Member Corporate Incentive Compensation Plan. (Filed as Exhibit 99.1 to the Registrant’s February 18, 2014Form 8-K and incorporated herein by reference.) 10.11++ 2014 Section 16 Executive Officers Base Salaries and Target Bonus Payments. (Filed as Exhibit 99.2 to the Registrant’s February 18, 2014Form 8-K and incorporated herein by reference.) 10.12++ Compensation program for non-employee members of the Registrant’s Board of Directors. (Filed as Exhibit 10.1 to the Registrant’s June 30,2014 Form 10-Q and incorporated herein by reference.) 10.13++ 2015 Section 16 Officer/FLT Member Corporate Incentive Compensation Plan. (Filed as Exhibit 99.1 to the Registrant’s February 3, 2015Form 8-K and incorporated herein by reference.) 81Table of ContentsEXHIBIT INDEX—(CONTINUED) Exhibit No. Description 10.14++ 2015 Section 16 Executive Officers Base Salaries and Target Bonus Payments. (Filed as Exhibit 99.2 to the Registrant’s February 3, 2015 Form8-K and incorporated herein by reference.) 10.15++ Compensation program for non-employee members of the Registrant’s Board of Directors, effective August 6, 2015. (Filed as Exhibit 10.1 tothe Registrant’s September 30, 2015 Form 10-Q and incorporated herein by reference.) 10.16 First Amendment to Lease Agreement dated November 11, 2014 between Charles Park One, LLC and Pegasystems Inc. (Filed as Exhibit 10.1to the Registrant’s September 30, 2015 Form 10-Q 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 Accounting Officer.+32 Certification pursuant to 18 U.S.C. Section 1350 of the Chief Executive Officer and the Chief Accounting Officer.101.INS** XBRL Instance document.101.SCH** XBRL Taxonomy Extension Schema Document.101.CAL** XBRL Taxonomy Calculation Linkbase Document.101.DEF** XBRL Taxonomy Extension Definition Linkbase Document.101.LAB** XBRL Taxonomy Label Linkbase Document.101.PRE** XBRL Taxonomy Presentation Linkbase Document. ++Management contracts and compensatory plan or arrangements required to be filed pursuant to Item 15(b) of Form 10-K.+Filed herewith**Submitted electronically herewithAttached as Exhibit 101 to this report are the following formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheets as ofDecember 31, 2015 and December 31, 2014, (ii) Consolidated Statements of Operations for the years ended December 31, 2015, 2014 and 2013,(iii) Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2015, 2014 and 2013, (iv) Consolidated Statements ofStockholders’ Equity (v) Consolidated Statements of Cash Flows for the years ended December 31, 2015, 2014 and 2013, and (vi) Notes to ConsolidatedFinancial Statements. 82Exhibit 21.1SUBSIDIARIES OF PEGASYSTEMS INC. Name of Subsidiary State or Jurisdiction of EntityAntenna Canada, Inc. CanadaAntenna Software India Private Ltd. IndiaAntenna Software, LLC DelawareAntenna Volantis Ltd. United KingdomAntenna Volantis Mobile Systems Private Ltd. IndiaAntenna Volantis, Inc. OregonPegasystems AG SwitzerlandPegasystems Bermuda Limited BermudaPegasystems Bilgi Teknolojileri Anonim Şirketi TurkeyPegasystems BV NetherlandsPegasystems Canada Inc. CanadaPegasystems France, S.A.R.L. FrancePegasystems GmbH GermanyPegasystems Investment Inc. MassachusettsPega Japan K.K. JapanPegasystems Limited United KingdomPegasystems Mauritius MauritiusPegasystems PTE Limited SingaporePegasystems PTY Limited AustraliaPegasystems Rus LLC RussiaPEGASYSTEMS Software (Beijing) Co., Limited ChinaPegasystems Sp. Z o.o. PolandPegasystems Spain, S.L. SpainPegasystems Worldwide Inc. MassachusettsPegasystems Worldwide India Private Limited IndiaRPA Antenna Inc. New JerseyPegasystems Thailand Limited ThailandExhibit 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe consent to the incorporation by reference in Registration Statements Nos. 333-09305, 333-53746, 333-89707, 333-104788, 333-116660, 333-135596, 333-166287, 333-166544 and 333-176810 on Form S-8 of our report dated February 26, 2015, relating to the financial statements and financial statement schedules ofPegasystems Inc., and the effectiveness of Pegasystems Inc.’s internal control over financial reporting, appearing in this Annual Report on Form 10-K ofPegasystems Inc. for the year ended December 31, 2015./s/ DELOITTE & TOUCHE LLPBoston, MassachusettsFebruary 25, 2016Exhibit 31.1CERTIFICATIONI, Alan Trefler, certify that: 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 thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by thisreport; 3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial 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 inExchange 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, toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within thoseentities, 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 oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements forexternal 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 theeffectiveness 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 recentfiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely tomaterially 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 theregistrant’s auditors and the audit committee of the 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 reasonablylikely 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 internalcontrol over financial reporting.Dated: February 25, 2016 /s/ ALAN TREFLERAlan TreflerChairman and Chief Executive Officer(Principal Executive Officer)Exhibit 31.2CERTIFICATIONI, Efstathios Kouninis, certify that: 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 thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by thisreport; 3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial 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 inExchange 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, toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within thoseentities, 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 oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements forexternal 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 theeffectiveness 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 recentfiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely tomaterially 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 theregistrant’s auditors and the audit committee of the 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 reasonablylikely 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 internalcontrol over financial reporting.Dated: February 25, 2016 /s/ EFSTATHIOS KOUNINISEfstathios KouninisVice President of Finance and Chief Accounting Officer(Principal Accounting Officer)Exhibit 32CERTIFICATION PURSUANT TO SECTION 1350, AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002In connection with the Annual Report of Pegasystems Inc. (the Company) on Form 10-K for the year ended December 31, 2015 as filed with the Securities andExchange Commission on the date hereof (the “Report”), Alan Trefler, Chairman and Chief Executive Officer of Pegasystems Inc., and Efstathios Kouninis, VicePresident of Finance and Chief Accounting Officer of Pegasystems Inc., each certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 ofthe Sarbanes-Oxley Act of 2002, that: 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 TREFLERAlan TreflerChairman and Chief Executive Officer(Principal Executive Officer)/s/ EFSTATHIOS KOUNINISEfstathios KouninisVice President of Finance and Chief Accounting Officer(Principal Accounting Officer)Dated: February 25, 2016

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