As filed with the Securities and Exchange Commission on June 19, 1996
Registration No. 333-03807
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
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PEGASYSTEMS INC.
(Exact name of Registrant as specified in its charter)
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Massachusetts 7389 04-2787865
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer Identification Number)
incorporation or organization) Classification Code Number)
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101 Main Street, Cambridge, Massachusetts 02142 (617) 374-9600
(Address and Telephone Number of Registrant's Principal Executive Offices)
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ALAN TREFLER
President
PEGASYSTEMS INC.
101 Main Street
Cambridge, Massachusetts 02142
(617) 374-9600
(Name, Address and Telephone Number of Agent for Service)
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Copies to:
ROBERT V. JAHRLING III, ESQ. MARK G. BORDEN, ESQ.
Choate, Hall & Stewart JEFFREY A. STEIN, ESQ.
Exchange Place Hale and Dorr
53 State Street 60 State Street
Boston, Massachusetts 02109-2891 Boston, Massachusetts 02109-1816
(617) 248-5000 (617) 526-6000
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Approximate date of commencement of proposed sale to the public: As soon as
practicable after this Registration Statement becomes effective.
If any of the securities being registered on this form are being offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [ ]
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The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until this Registration Statement shall become
effective on such date as the Securities and Exchange Commission, acting
pursuant to said Section 8(a), may determine.
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PEGASYSTEMS INC.
CROSS-REFERENCE SHEET
Pursuant to Item 501(b) of Regulation S-K
Showing Location in Prospectus of Information
Required by Part I of Form S-1
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Registration Statement Item and Caption Location in Prospectus
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1. Forepart of the Registration Statement and Outside front cover page of Prospectus
Outside Front Cover Page of Prospectus
2. Inside Front and Outside Back Cover Pages of Inside front and outside back cover pages of
Prospectus Prospectus; Additional Information
3. Summary Information, Risk Factors and Ratio of Prospectus Summary; Risk Factors
Earnings to Fixed Charges
4. Use of Proceeds Use of Proceeds
5. Determination of Offering Price Outside front cover page; Underwriting
6. Dilution Dilution
7. Selling Security Holders Principal and Selling Stockholders
8. Plan of Distribution Outside front cover page; Underwriting
9. Description of Securities to be Registered Description of Capital Stock
10. Interests of Named Experts and Counsel Legal Matters; Experts
11. Information with Respect to the Registrant Prospectus Summary; Risk Factors; Use of
Proceeds; Dividend Policy; Capitalization;
Dilution; Selected Consolidated Financial Data;
Management's Discussion and Analysis of
Financial Condition and Results of Operations;
Business; Management; Certain Transactions;
Principal and Selling Stockholders; Description
of Capital Stock; Shares Eligible for Future
Sale; Consolidated Financial Statements
12. Disclosure of Commission Position on Not Applicable
Indemnification for Securities Act
Liabilities
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Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This prospectus shall not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these securities
in any State in which such offer, solicitation or sale would be unlawful prior
to registration or qualification under the securities laws of any such State.
SUBJECT TO COMPLETION, DATED JUNE 19, 1996
3,400,000 Shares
[Pegasystems Inc. Logo]
Common Stock
(par value $.01 per share)
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Of the 3,400,000 shares of Common Stock offered hereby, 2,700,000 are being
sold by Pegasystems Inc. ("Pegasystems" or the "Company") and 700,000 shares are
being sold by the Selling Stockholders. See "Principal and Selling
Stockholders." The Company will not receive any of the proceeds from the sale of
shares by the Selling Stockholders.
Prior to this offering, there has been no public market for the Common Stock
of the Company. It is currently estimated that the initial public offering price
per share will be between $12.00 and $14.00. For factors to be considered in
determining the initial public offering price, see "Underwriting."
See "Risk Factors" beginning on page 5 for certain considerations relevant to
an investment in the Common Stock.
Application has been made to have the Common Stock approved for quotation on the
Nasdaq National Market under the symbol "PEGA."
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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Initial Public Underwriting Proceeds to Proceeds to Selling
Offering Price Discount (1) Company (2) Stockholders
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Per Share $ $ $ $
Total (3) $ $ $ $
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(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933. See "Underwriting."
(2) Before deducting expenses of the offering payable by the Company,
estimated to be $600,000.
(3) The Company has granted to the Underwriters an option for 30 days to
purchase up to an additional 510,000 shares at the initial offering price
per share, less the underwriting discount, solely to cover
over-allotments, if any. If such option is exercised in full, the total
initial public offering price, underwriting discount and proceeds to
Company will be $ , $ and $ , respectively. See
"Underwriting."
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The shares offered hereby are offered by the several Underwriters, as
specified herein, subject to receipt and acceptance by them and subject to their
right to reject any order in whole or in part. It is expected that delivery of
the shares of Common Stock offered hereby will be made at the offices of
Goldman, Sachs & Co., New York, New York, on or about , 1996.
Goldman, Sachs & Co.
Cowen & Company
Montgomery Securities
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The date of this Prospectus is , 1996.
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IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF
THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, IN THE
OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.
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P. 24--Illustration omitted:
Illustration, set over a map of the world, of the Company's three-tier,
client/server environment. A central server is connected to three satellite
servers, with rules and code replicated on all servers.
Foldout: Illustration omitted:
Illustration of the Pegasystems' "service backbone." A circle, revolving around
customers, is divided into six segments corresponding to the customer service
management functions supported by the Company's products, each segment
containing labeled icons representing examples of such functions. In the
"receiving" segment are icons representing computer inbound faxes, PegaView-ACE
and Internet connections, high speed computer network links and shows computer
screens demonstrating PegaView-ACE and Internet access; in the "reporting"
segment, icons representing productivity, service and quality management,
relational database interfaces and opportunity analysis; in the "resolving"
segment, icons representing advisor checklists, system-driven processing and
multi-currency accounting; in the "responding" icon, outbound faxes, internet
electronic mail and personalized letters and automated followups; in the
"researching" segment, icons representing on-line disks, micrographics and
virtual archive opticals and tapes; and in the "routing" segment, prioritization
and queuing, rule-driven workflow, electronic baskets and clustered work.
Inside cover: Illustration omitted:
Illustration of dispersed departments of an organization interacting with
customers contacting the organization through various means, each such
department connected to the organization's integrated service backbone, which is
represented by a circle divided into six segments corresponding to the customer
management functions supported by the Company's products support (receiving,
reporting, resolving, responding, researching and routing).
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and the Consolidated Financial Statements and Notes thereto
appearing elsewhere in this Prospectus. Investors should carefully consider the
information set forth under the heading "Risk Factors."
The Company
Pegasystems develops customer service management software to automate
customer interactions across transaction-intensive enterprises. Many of the
world's largest banks, mutual funds and credit card organizations use the
Company's solutions to integrate, automate, standardize and manage a broad array
of mission-critical customer service activities, including account set-up,
record retrieval, correspondence, disputes, investigations and adjustments. The
Company's systems can be used by thousands of concurrent users to manage
customer interactions and to generate billions of dollars a day in resulting
transactions. Work processes initiated by the Company's systems are driven by a
highly adaptable "rule base" defined by the user-organization for its specific
needs. The rule base facilitates a high level of consistency in customer
interactions, yet drives different processes depending on the customer profile
or the nature of the request. The Company's open, multi-tier, client/server
systems operate on a broad variety of platforms, including UNIX, Windows/NT and
IBM/MVS. The Company offers consulting, training and support services to
facilitate the use of its solutions.
Intensifying competition is forcing businesses to reduce costs while focusing
on customer service management as an important means of differentiation. Due to
the volume and precise nature of their transactions, it is especially critical
for financial services organizations to implement cost-effective systems to
manage customer interactions accurately and efficiently. The Company's solutions
provide a service backbone that drives intelligent processing and seamlessly
integrates an organization's geographically dispersed and product specific
service operations and isolated computer systems. By bridging these "islands of
automation" within large organizations, the Company's solutions increase the
efficiency of service representatives and enable organizations to address
multiple customer needs during a single contact.
The Company's objective is to become the leading provider of mission-critical
client/server customer service management software to organizations performing a
high volume of complex interactions with demanding customers. To achieve this
objective, the Company is pursuing a number of strategies, including expanding
its marketing to additional business units within its existing customers;
leveraging its relationships and expertise with large financial services
organizations to penetrate the medium-sized financial services market; targeting
markets outside of financial services which have similar customer service
management needs; and developing standard product templates to facilitate the
more rapid implementation of its solutions.
The Company markets its software and services primarily through a direct
sales force which consisted of six people as of April 30, 1996. The Company
intends to increase substantially the size of its sales force, which will be
necessary if the Company is to achieve significant revenue growth in the future.
The Company was incorporated in the Commonwealth of Massachusetts in April
1983 and has been profitable in each quarter since the first quarter of 1985.
The Company's principal executive offices are located at 101 Main Street,
Cambridge, Massachusetts 02142, and its telephone number is (617) 374-9600.
Pegasystems, PegaCARD, PegaCLAIMS, PegaSHARES, PegaTRACE, PegaINDEX,
PegaPRISM, PegaREELAY, PegaSEARCH, PegaVIEW-ACE, PegaSTAR, Integrated Service
Backbone, Service Excellence Through Automation, and Virtual Archive are
trademarks of the Company. This Prospectus also includes trademarks of companies
other than the Company.
3
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The Offering
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Common Stock offered by the Company 2,700,000 shares
Common Stock offered by the Selling Stockholders 700,000 shares
Common Stock to be outstanding after the offering 26,290,800 shares (1)
Use of proceeds by the Company For general corporate purposes, including working
capital, product development, capital expenditures
and possible acquisitions. See "Use of Proceeds."
Proposed Nasdaq National Market symbol PEGA
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(1) Based on the number of shares of Common Stock outstanding on May 13, 1996,
plus 100,800 shares of Common Stock issuable upon exercise of stock options
to be exercised immediately prior to the closing of this offering. Excludes
2,308,200 shares of Common Stock issuable upon exercise of stock options
outstanding as of May 13, 1996, at a weighted average exercise price of
$2.60 per share, of which options to purchase 487,950 shares were then
exercisable. See "Capitalization" and "Management--Stock Plans."
Summary Consolidated Financial Data
(in thousands, except per share data)
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Three Months
Ended
Year ended December 31, March 31,
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1993 1994 1995 1995 1996
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Consolidated Statement of Income
Data:
Total revenue $10,212 $16,263 $22,247 $ 4,005 $ 4,941
Income from operations 793 2,236 3,257 66 456
License interest income 1,305 1,457 1,486 370 368
Net income 1,233 2,193 2,878 263 486
Net income per common and common
equivalent share $ 0.05 $ 0.09 $ 0.11 $ 0.01 $ 0.02
Weighted average number of common and
common equivalent shares
outstanding 24,231 24,102 25,551 25,600 25,505
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March 31, 1996
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Actual As adjusted (1)
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Consolidated Balance Sheet Data:
Cash and cash equivalents $ 2,644 $33,318
Working capital 6,952 38,356
Long-term license installments, net 11,444 11,444
Total assets 26,555 57,228
Long-term debt 672 --
Stockholders' equity 15,136 47,212
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(1) Gives effect to (i) the sale of the 2,700,000 shares of Common Stock offered
by the Company hereby at an assumed initial public offering price of $13.00
per share, after deducting the estimated underwriting discount and offering
expenses payable by the Company, and gives effect to the anticipated
application of the net proceeds therefrom, and (ii) the exercise of stock
options to purchase 100,800 shares of Common Stock at an exercise price of
approximately $0.33 per share, which exercise will occur immediately prior
to the closing of this offering. See "Use of Proceeds" and "Capitalization."
Unless otherwise indicated herein, all information in this Prospectus (i) has
been adjusted to give effect to a 15-for-1 split of the outstanding Common
Stock, in the form of a stock dividend, effective December 9, 1994, (ii) has
been adjusted to give effect to an amendment and restatement of the Company's
Articles of Organization (the "Restated Articles") to become effective
immediately prior to this offering, providing for, among other things, the
creation of a new undesignated class of Preferred Stock, (iii) has been adjusted
to give effect to a 3-for-1 split of the outstanding Common Stock, in the form
of a stock dividend, to be effective immediately prior to this offering, and
(iv) assumes no exercise of the Underwriters' over-allotment option. See
"Description of Capital Stock" and "Underwriting."
4
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RISK FACTORS
In addition to the other information contained in this Prospectus, the
following risk factors should be carefully considered in evaluating an
investment in the Common Stock offered by this Prospectus.
Potential Fluctuations in Quarterly Results; Seasonality
The Company's revenue and operating results have varied considerably in the
past, and are likely to vary considerably in the future. Such fluctuations may
be particularly pronounced because a significant portion of the Company's
revenue in any quarter is attributable to product acceptances or license
renewals by a relatively small number of customers, and reflects the Company's
policy of recognizing license fee revenue upon product acceptance or license
renewal in an amount equal to the present value of the total committed license
payments due during the initial license term or renewal period, as the case may
be. Product acceptance is preceded by an implementation period, typically
ranging from three to six months but in some cases significantly longer, and by
a lengthy sales cycle. The Company's sales cycle is subject to a number of
significant risks over which the Company has little or no control, including
customers' budgeting constraints and internal authorization reviews. Product
implementation may be delayed for a variety of reasons including unforeseen
technical problems and changes dictated by the customer in the scope or schedule
of the implementation. Other factors contributing to fluctuations in the
Company's revenue and operating results include changes in the level of
operating expenses, demand for the Company's products and services, the
introduction of new products and product enhancements by the Company and its
competitors, competitive conditions in the industry and general economic
conditions. The Company budgets its product development and other expenses
anticipating future revenue. If revenue falls below expectations, the Company's
business, operating results and financial condition are likely to be materially
and adversely affected because only a small portion of the Company's expenses
vary with its revenue. As a result, the Company believes that period-to-period
comparisons of its operating results are not necessarily meaningful and should
not be relied upon to predict future performance. There can be no assurance that
the Company will be able to maintain profitability on an annual or quarterly
basis.
The Company's business has experienced and may continue to experience
significant seasonality. In recent years the Company has recognized a greater
percentage of its revenue in its third and fourth quarters than in the first and
second quarters due to the Company's sales commission structure and the impact
of that structure on the timing of product acceptances and license renewals by
customers. This pattern is reinforced by the Company's maintenance contracts,
which entitle customers to, among other things, a fixed number of hours of
service per calendar year. Once the annual allotment of service hours is
exhausted, customers pay for additional services on an hourly basis, typically
resulting in higher services revenue in the Company's second, third and fourth
quarters.
Due to the foregoing factors, it is likely that in some future quarters the
Company's operating results will fall below the expectations of the Company,
market analysts and investors. In such event, the price of the Company's Common
Stock would likely be materially and adversely affected. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Dependence on New Products; Rapid Technological Change; Product Development
and Implementation Risks
The market for customer management software and related consulting and
training services is subject to rapid technological change, changing customer
needs and preferences, frequent new product introductions, and evolving
programming languages and industry standards that may render existing products
and services obsolete. The Company's position in its current market or other
markets that it may enter could be eroded rapidly by product advances. The life
cycles of the Company's products are difficult to estimate, and the Company's
growth and future performance will depend in part upon its ability to enhance
existing products, and to develop and introduce new products that keep pace with
technological advancements, meet changing customer requirements, respond to
competitive products, and achieve market acceptance. The Company's product
development efforts require and are expected to continue to require substantial
investments by the Company for research, refinement and testing, and there can
be no assurance that the Company will have the resources sufficient to make such
investments. The Company has in the past experienced developmental delays, and
there can be no assurance that the
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Company will not experience difficulties which would delay or prevent the
successful development, introduction or implementation of new or enhanced
products. In addition, there can be no assurance that such products will meet
the requirements of the marketplace and achieve market acceptance, or that the
Company's current or future products will conform to changing industry
requirements. If the Company is unable for technological or other reasons to
develop, introduce or implement new or enhanced products in a timely and
effective manner, the Company's business, operating results and financial
condition could be materially and adversely affected.
Products as complex as the Company's may contain errors that may be detected
at any point in the products' life cycles. In the past, the Company has
discovered certain errors in its products and has experienced shipping delays
while such errors were corrected. Such errors have also required the Company to
ship corrected products to existing customers. There can be no assurance that
errors will not be found in the future resulting in the loss of, or delay in,
market acceptance and/or sales and revenue, diversion of development resources,
injury to the Company's reputation, or increased service and warranty costs, any
of which could have a material adverse effect on the Company's business,
operating results and financial condition. See "Business--Products" and
"--Product Development."
Computing Platform Shift; Compatibility with Third Party Relational Databases
The majority of large financial services organizations have traditionally
used IBM MVS or Digital Equipment Corporation VMS systems for transaction
processing. Increasingly, however, such organizations are migrating towards more
open UNIX and Windows/NT server operating systems to meet their transaction
processing requirements. Responding to this trend, and while continuing to
support its core IBM and Digital Equipment Corporation platforms, the Company
commenced efforts in 1992 to evolve versions of its products to use the C++
programming language and run on a variety of open platforms. In December 1995,
for the first time one of the new C++ versions of the Company's products was
used in production by a customer of the Company. The Company has since shipped
new C++ versions of its products for use on RS 6000/AIX and Windows/NT platforms
and has brought two RS 6000/AIX C++ systems into initial production use. The
Company is actively working with customers to bring additional installations of
these products into production. There can be no assurance that the new versions
of the Company's products will meet the requirements of the marketplace and
achieve market acceptance, or that organizations will not migrate to other
computing platforms not supported by the Company. Moreover, there can be no
assurance that, notwithstanding the benefits of the new versions of the
Company's products, some of the Company's existing customers may choose not to
migrate to UNIX and Windows/NT systems. In such event, the Company may be
required to support both the old and new versions of its products, which could
have a material adverse effect on its business, operating results and financial
condition.
The Company believes that the compatibility of customer service management
software systems with popular relational databases is an important factor in the
purchase decision of many organizations. Consequently, the Company recently
developed (and will shortly ship) Windows/NT and RS 6000/AIX versions of its
software capable of storing work items in Oracle relational databases, and is
working to develop similar capabilities for other versions of its software with
other third party relational databases, such as Microsoft's SQL Server. There
can be no assurance that the Company will not experience difficulties which
would delay or prevent the successful development or introduction of these
additional capabilities. Any such difficulty could have a material and adverse
effect on the Company's business, operating results and financial condition. See
"Business--Product Development."
Dependence on the Financial Services Market; Industry Consolidation
The Company has derived all of its revenue to date from customers in the
financial services market, and the Company's future growth depends, in large
part, upon increased sales to this market. The financial condition of the
Company's customers and their willingness to pay for the Company's products and
services are affected by competitive pressures, decreasing operating margins
within the industry, currency fluctuations, active geographic expansion and
deregulation. The Company believes that its customers'
6
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purchasing patterns are somewhat discretionary. As a result, demand for the
Company's products and services could be affected by the condition of the
financial services market or a deterioration in economic or market conditions
generally.
The financial services market is undergoing intense domestic and
international consolidation. In recent years, several customers of the Company
have been merged or consolidated out of independent existence, and there is no
assurance that the Company will not experience declines in revenue occasioned,
in whole or in part, by future mergers or consolidations. Any decline in the
demand for the Company's products would have a material, adverse effect on the
Company's business, operating results and financial condition. See
"Business--Customers."
Uncertainty of Growth into other Markets
As part of its growth strategy the Company is exploring the possibility of
applying its technology to the customer service management requirements of
markets other than financial services, such as insurance, medical, utilities and
retail. The Company believes that in connection with such efforts it will be
necessary for the Company to hire additional personnel with expertise in these
other markets. There can be no assurance that the Company will be successful in
adapting its technology to these other markets or in attracting and retaining
personnel with the necessary industry expertise. The inability of the Company to
penetrate these other markets could have a material adverse effect on its
business, operating results and financial condition. See "Business--Business
Strategy."
Risks of Customer License Non-Renewal
To date, a substantial majority of the Company's licenses have been renewed
upon expiration. Revenue attributable to license renewals accounted for 32%, 26%
and 28% of the Company's total revenue in 1993, 1994 and 1995, respectively, and
in each period was attributable to a relatively small number of customers. There
can be no assurance that a substantial majority of the Company's customers will
continue to renew expiring licenses; any such non-renewal would require the
Company to obtain revenue from other sources in order to achieve its revenue
targets. A decrease in the Company's license renewal rate without offsetting
revenue from other sources would have a material adverse effect on the Company's
business, results of operations and financial condition. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
"Business--Customers" and Notes 1 and 8 of Notes to Consolidated Financial
Statements.
Control by Existing Stockholders
Upon completion of this offering, Alan Trefler, the Company's President and a
member of its Board of Directors, will own approximately 84% of the Company's
outstanding Common Stock (83% if the over- allotment option granted to the
Underwriters is exercised in full). As of May 13, 1996, there were outstanding
options to purchase 2,409,000 shares of the Company's Common Stock, of which
options to purchase 588,750 shares were then exercisable. Assuming the exercise
of all such outstanding options, Mr. Trefler would own approximately 77% of the
outstanding Common Stock (76% if the over-allotment option granted to the
Underwriters is exercised in full). There can be no assurance that any such
stock options will be exercised. Accordingly, Mr. Trefler will be able to
control the Company through his ability to determine the outcome of elections of
the Company's directors, amend the Company's Restated Articles of Organization
and Restated By-laws and take certain other actions requiring the vote or
consent of stockholders of the Company. This concentration of ownership may have
the effect of delaying or preventing a change in control of the Company. See
"Principal and Selling Stockholders."
Dependence on Key Personnel
The Company's future success depends to a significant extent on Mr. Trefler,
its other executive officers and certain technical, managerial, consulting,
sales and marketing personnel. The loss of the services of any of these
individuals or group of individuals could have a material adverse effect on the
Company's business, operating results and financial condition. None of the
Company's executive officers has entered into an employment contract with the
Company, although each is subject to a non-disclosure and non-competition
agreement with the Company. The Company does not have, and is not contemplating
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securing, any significant amount of key-man life insurance on any of its
executive officers or other key employees. The Company believes that its future
success also will depend significantly upon its ability to attract, motivate and
retain additional highly skilled technical, managerial, consulting, sales and
marketing personnel. In particular, delays in hiring qualified sales personnel
would adversely affect the Company's operating results due to the substantial
time period between the identification of new customers and the successful
implementation and acceptance of the Company's products by those customers.
Because developing, selling and maintaining the Company's products requires
extensive knowledge of computer hardware and operating systems, programming
languages and application software, the number of qualified potential employees
is limited. Moreover, competition for such personnel is intense, and there can
be no assurance that the Company will be successful in attracting and retaining
the personnel it requires to continue to grow and operate profitably.
Intense Competition
The market for customer service management software and related consulting
and training services is relatively new, intensely competitive and highly
fragmented. The Company encounters significant competition from internal
information systems departments of potential or existing customers that develop
custom software. The Company also competes with companies that target the
customer interaction or workflow markets, and professional services
organizations that develop custom software in conjunction with rendering
consulting services. Such competitors vary in size and in the scope and breadth
of products and services offered. The Company anticipates increased competition
for market share and pressure to reduce prices and make sales concessions, which
could materially and adversely affect the Company's business, operating results
and financial condition.
Many of the Company's competitors have greater resources than the Company,
and may be able to respond more quickly and efficiently to new or emerging
technologies, programming languages or standards, or to changes in customer
requirements or preferences. Many of the Company's competitors can devote
greater managerial or financial resources than the Company can to develop,
promote and distribute customer service management software products and provide
related consulting and training services. There can be no assurance that the
Company's current or future competitors will not develop products or services
which may be superior in one or more respects to the Company's or which may gain
greater market acceptance. Some of the Company's competitors have established or
may establish cooperative arrangements or strategic alliances among themselves
or with third parties, thus enhancing their abilities to compete with the
Company. It is likely that new competitors will emerge and rapidly acquire
market share. There can be no assurance that the Company will be able to compete
successfully against current or future competitors or that the competitive
pressures faced by the Company will not materially and adversely affect its
business, operating results and financial condition. See
"Business--Competition."
Management of Growth
The growth in the size, geographic scope and complexity of the Company's
business and the expansion of its product offerings and customer base have
placed and are expected to continue to place a significant strain on the
Company's management, operations and capital needs. The Company's continued
growth, if any, will require it to hire, train and retain many employees both in
the United States and abroad, particularly additional sales and financial
personnel, and will also require the Company to enhance its financial and
managerial controls and reporting systems. There is no assurance that the
Company can manage its growth effectively or that the Company will be able to
attract and retain the necessary personnel to meet its business challenges. If
the Company is unable to manage its growth effectively, the Company's business,
operating results and financial condition could be materially and adversely
affected. See "Business--Business Strategy" and "--Sales and Marketing."
Risks Associated with International Operations; Currency and Other Risks
Sales to customers headquartered outside of the United States represented
approximately 24% and 10% of the Company's total revenue in 1994 and 1995,
respectively. The Company, in part through its wholly-owned subsidiary based in
the United Kingdom, markets products and renders consulting and training
services to customers based in Canada, the United Kingdom, France, Switzerland,
Ireland and
8
<PAGE>
Luxembourg. The Company is in negotiations with potential customers based in
other foreign countries, and may establish a physical presence in continental
Europe, Australia or elsewhere in the Pacific Rim. The Company believes that its
continued growth will necessitate expanded international operations requiring a
diversion of managerial attention and financial resources. The Company
anticipates hiring additional personnel to accommodate international growth, and
the Company may also enter into agreements with local distributors,
representatives or resellers. If the Company is unable to do one or more of
these things in a timely manner, the Company's growth, if any, in its foreign
operations will be restricted, and the Company's business, operating results and
financial condition could be materially and adversely affected.
In addition, there can be no assurance that the Company will be able to
maintain or increase international market demand for its products. Most of the
Company's international sales are denominated in U.S. dollars. Accordingly, any
appreciation of the value of the U.S. dollar relative to the currencies of those
countries in which the Company distributes its products may place the Company at
a competitive disadvantage by effectively making its products more expensive as
compared to those of its competitors.
Additional risks inherent in the Company's international business activities
generally include unexpected changes in regulatory requirements, increased
tariffs and other trade barriers, the costs of localizing products for local
markets and complying with local business customs, longer accounts receivable
patterns and difficulties in collecting foreign accounts receivable,
difficulties in enforcing contractual and intellectual property rights,
heightened risks of political and economic instability, the possibility of
nationalization or expropriation of industries or properties, difficulties in
managing international operations, potentially adverse tax consequences
(including restrictions on repatriating earnings and the threat of "double
taxation"), enhanced accounting and internal control expenses, and the burden of
complying with a wide variety of foreign laws. There can be no assurance that
one or more of these factors will not have a material adverse effect on the
Company's foreign operations, and, consequentially, the Company's business,
operating results and financial condition. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business--Sales
and Marketing."
Dependence upon Proprietary Rights; Risks of Infringement
The Company's success is heavily dependent upon its ability to protect its
proprietary technology. To protect its proprietary rights, the Company relies on
a combination of copyright, trademark and trade secret laws, as well as
confidentiality agreements. The Company also has one United States patent
application pending. However, existing patent, copyright, trademark and trade
secret laws afford only limited protection. In addition, many countries' laws do
not protect the Company's proprietary rights to the same extent as do the laws
of the United States. Accordingly, there can be no assurance that the Company
will be able to protect its proprietary rights against unauthorized third party
copying, use or exploitation, any of which could have a material adverse effect
on the Company's business, operating results and financial condition.
Attempts may be made to copy or reverse engineer aspects of the Company's
products, or to obtain, use or exploit information or methods which the Company
deems proprietary. Additionally, there can be no assurance that the Company's
customers and others will not develop products which infringe upon the Company's
rights, or that compete with the Company's products. Policing the use of the
Company's products is difficult and expensive, and there is no assurance that
such efforts would prove effective. Litigation or other action may be necessary
in the future to enforce the Company's proprietary rights, to seek and confirm
patent protection for the Company's technologies, or to determine the validity
and scope of the proprietary rights of others. The Company expects that its
software products may increasingly be subject to claims as the number of
products and competitors in the Company's markets grows and the functionality of
such products overlaps. Such litigation or proceedings, whether or not
meritorious, could result in substantial costs and diversions of resources and
management's attention, and could have a material adverse impact on the
Company's business, operating results and financial condition. See
"Business--Intellectual Property and Licenses."
9
<PAGE>
Reliance on Certain Relationships
The Company has a number of third party relationships that are significant to
its sales, marketing and support activities and product development efforts. The
Company relies upon relational database management systems applications and
development tool vendors, software and hardware vendors, and consultants to
provide marketing and sales opportunities for the Company's direct sales force,
and strengthen its product offerings through the use of industry-standard tools
and utilities. The Company's strategy in entering into these relationships is to
keep pace with the technological and marketing developments of major software
vendors, and to acquire technical assistance for the Company's product
development efforts. There can be no assurance that these companies, most of
which have significantly greater financial and marketing resources than the
Company, will not develop or market software products which compete with the
Company's products in the future or will not otherwise discontinue their
relationships with or support of the Company. The failure of the Company to
maintain its existing relationships, or to establish new relationships in the
future, because of a divergence of interests, acquisition of one or more of
these third parties, or for any other reason, could have a material adverse
effect on the Company's business, results of operations and financial condition.
Product Liability; Warranty Claims
The Company's license agreements with its customers typically contain
provisions intended to limit the nature and extent of the Company's liability
for product liability claims or claims arising from breaches of warranties.
There is no assurance that such limitations would withstand judicial scrutiny or
that they would bind a party not in direct privity with the Company.
Furthermore, some of the Company's licenses with its customers are governed by
laws other than those of the United States, and there is no assurance that
purported limitations on liability would be enforced were foreign law to govern.
Although the Company has not experienced any material product liability claims
to date, the license and support of products by the Company and the
incorporation of third party products and components may entail the risk of such
claims. A product liability suit or action claiming a breach of warranty,
whether or not meritorious, could result in substantial costs and a diversion of
management's attention and the Company's resources, which costs and diversion
could have a material adverse effect on the Company's business, operating
results and financial condition. Additionally, a suit alleging a product defect
or a breach of an express or implied warranty, if successful, may also have an
adverse precedential effect on other or future actions.
Lack of Prior Dividends; No Plans to Pay Dividends in the Foreseeable Future
The Company has never declared or paid cash dividends and does not anticipate
paying cash dividends in the foreseeable future. The Company's current bank line
prohibits payment of dividends without the bank's consent.
Immediate and Substantial Dilution
Purchasers of shares of Common Stock offered hereby will suffer an
immediate and substantial dilution in the net tangible book value of $11.22
per share of the Common Stock from the initial public offering price. See
"Dilution" and "Capitalization."
Potential Adverse Effects of Anti-Takeover Provisions; Possible Issuance of
Preferred Stock
The Company's Restated Articles of Organization (the "Restated Articles") and
Restated By-Laws contain provisions that may make it more difficult for a third
party to acquire, or discourage acquisition bids for, the Company. The Restated
Articles and Restated By-Laws provide that a stockholder seeking to have
business conducted at a meeting of stockholders must give notice to the Company
not less than 90 days prior to the scheduled meeting. The Restated By-Laws
further provide that a special stockholders meeting may be called by the
president or the Board of Directors or upon the request of stockholders holding
at least 40% of the voting power of the Company. The Restated Articles and
Restated By-Laws provide for a classified Board of Directors, and for the
removal of directors only for cause upon the affirmative vote of the holders of
at least 80% of the shares entitled to vote. Moreover, upon completion of this
offering, the Company will be subject to an anti-takeover provision of the
Massachusetts General Laws which prohibits, subject to certain exceptions, a
holder of 5% or more of the outstanding voting stock of a corporation from
engaging in certain transactions with the corporation, including a merger or
stock
10
<PAGE>
or asset sale. These provisions could limit the price that certain investors
might be willing to pay in the future for shares of the Company's Common Stock
and may have the effect of preventing changes in the management of the Company.
In addition, shares of the Company's Preferred Stock may be issued in the future
without further stockholder approval and upon such terms and conditions, and
having such rights, privileges and preferences, as the Board of Directors may
determine. The rights of the holders of Common Stock will be subject to, and may
be adversely affected by, the rights of any holders of Preferred Stock that may
be issued in the future. The issuance of Preferred Stock, while providing
desirable flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of making it more difficult for a
third party to acquire, or discouraging a third party from acquiring, a majority
of the outstanding voting stock of the Company. The Company has no present plans
to issue any shares of Preferred Stock. See "Description of Capital Stock."
Shares Eligible for Future Sale
Sales of substantial amounts of shares of Common Stock in the public market
following this offering could adversely affect the market price of the Common
Stock. On the date of this Prospectus, in addition to the 3,400,000 shares
offered hereby, 12,000 shares of Common Stock will be eligible for future sale
in the public market pursuant to Rule 144(k) under the Securities Act of 1933,
as amended (the "Securities Act"). Beginning 90 days after the date of this
Prospectus, an additional 139,500 shares will become eligible for sale in the
public market, pursuant to Rules 144 and 701 under the Securities Act. Upon the
expiration of lock-up agreements between certain stockholders of the Company and
the representatives of the Underwriters 180 days after the date of this
Prospectus, an additional 22,739,300 shares will become eligible for sale in the
public market, subject to the provisions of Rule 144 under the Securities Act.
The representatives of the Underwriters may waive some or all of the provisions
of such lock-up agreements on a case-by-case or general basis, all without
notice to the Company, its stockholders or any market on which the Common Stock
may then be trading. See "Shares Eligible for Future Sale" and "Underwriting."
Shortly after the date of this Prospectus, the Company intends to file a Form
S-8 registration statement under the Securities Act registering approximately
5,750,000 shares of Common Stock issuable under the Company's stock plans. As of
May 13, 1996, giving effect to the exercise of options for the purchase of
100,800 shares immediately prior to the closing of this offering, options to
purchase a total of 2,308,200 shares were outstanding (of which 487,950 were
then exercisable) and 3,341,000 shares were reserved for future issuance under
such stock plans. See "Shares Eligible for Future Sale."
No Prior Trading Market; Potential Volatility of Stock Price
Prior to this offering, there has been no public market for the Company's
Common Stock, and there can be no assurance that an active trading market will
develop or be sustained after this offering. The initial public offering price
to be negotiated between the Company, the Selling Stockholders and the
representatives of the Underwriters may not be indicative of prices that will
prevail in the trading market. See "Underwriting" for a discussion of the
factors to be considered in determining the initial public offering price. The
market price of the Company's Common Stock could be subject to wide fluctuations
in response to quarter-to-quarter variations in operating results, the gain or
loss of significant contracts, announcements of technological developments or
new products by the Company and its competitors, changes in earnings estimates
by analysts, market conditions in the industry and general economic conditions.
In addition, the stock market has experienced volatility that has particularly
affected the market prices for the stock of many technology companies and that
often has been unrelated to the operating performance of such companies. These
market fluctuations may adversely affect the market price of the Company's
Common Stock. See "Underwriting."
11
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 2,700,000 shares of
Common Stock offered by the Company pursuant to this offering are estimated to
be $32,043,000 ($38,209,000 if the Underwriters' over-allotment option is
exercised in full), assuming an initial public offering price of $13.00 per
share and after deducting the estimated underwriting discount and offering
expenses payable by the Company. The principal purposes of this offering are to
increase the Company's equity capital, to create a public market for the Common
Stock, to increase the visibility of the Company in the marketplace and to
facilitate future access by the Company to public equity markets.
The Company anticipates using the net proceeds from this offering to repay
the Company's existing bank indebtedness and for general corporate purposes. At
March 31, 1996, the Company's bank indebtedness consisted of four term
promissory notes in the aggregate principal amount of $1,402,000, which are due
December 1996 ($155,000), November 1997 ($211,000), June 1998 ($885,000) and
December 1998 ($151,000). Interest accrues on such loans at the bank's prime
rate (8.25% at March 31, 1996) plus 0.5% per annum. The proceeds of such loans
were used by the Company primarily to acquire capital equipment.
The Company may seek acquisitions of businesses, products and technologies
that are complementary to those of the Company, and a portion of the net
proceeds may be used for such acquisitions. While the Company engages from time
to time in discussions with respect to potential acquisitions, the Company has
no plans, commitments or agreements with respect to any such acquisitions as of
the date of this Prospectus, and there can be no assurance that any such
acquisitions will be made. Pending such uses, the Company intends to invest the
net proceeds from this offering in short-term, investment-grade,
interest-bearing securities.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its Common Stock
and does not anticipate paying any cash dividends in the foreseeable future. The
Company currently intends to retain future earnings to fund the development and
growth of its business. The Company's current loan agreement with a bank
prohibits the payment of dividends without the bank's consent.
12
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of March
31, 1996 and as adjusted to give effect to the sale of 2,700,000 shares of
Common Stock offered by the Company hereby at an assumed initial public offering
price of $13.00 per share and the receipt and application of the proceeds
therefrom, after deducting the estimated underwriting discount and offering
expenses payable by the Company. See "Use of Proceeds." This information should
be read in conjunction with the Company's Consolidated Financial Statements and
the Notes thereto appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
March 31, 1996
---------------------
Actual Adjusted (1)
------ -----------
(in thousands except
share-related data)
<S> <C> <C>
Long-term debt, less current maturities $ 672 --
Stockholders' equity
Common Stock, $.01 par value, 45,000,000 shares
authorized, 23,490,000 shares
issued and outstanding (actual);
and 26,290,800 shares issued
and outstanding (as adjusted) (2) (3) 235 $ 263
Additional paid-in capital 15 32,063
Retained earnings 15,008 15,008
Cumulative foreign currency translation adjustment (122) (122)
------- ---------
Total stockholders' equity 15,136 47,212
------- ---------
Total capitalization $15,808 $47,212
======= =========
</TABLE>
- -------------
(1) Adjusted to give effect to the sale of 2,700,000 shares of Common Stock
offered by the Company hereby at an assumed initial public offering price of
$13.00 per share, after deducting the estimated underwriting discount and
offering expenses payable by the Company, and the anticipated application of
the net proceeds therefrom.
(2) Includes 100,800 shares of Common Stock issuable upon exercise of stock
options to be exercised immediately prior to the closing of this offering.
(3) Excludes 2,308,200 shares of Common Stock issuable pursuant to the
exercise of options outstanding at May 13, 1996, of which options to
purchase 487,950 shares were then exercisable. See "Management--Stock
Plans."
13
<PAGE>
DILUTION
The net tangible book value of the Company at March 31, 1996 was $14,814,418
or $0.63 per share of Common Stock, after giving effect to the anticipated
exercise of options to purchase 100,800 shares of Common Stock immediately prior
to the closing of this offering. Net tangible book value per share is equal to
the Company's total tangible assets less total liabilities, divided by the total
number of shares of Common Stock outstanding. Net tangible book value dilution
per share represents the difference between the amount per share paid by
purchasers of shares of Common Stock in the offering made hereby and the net
tangible book value per share of Common Stock immediately after completion of
this offering. After giving effect to the sale by the Company of the 2,700,000
shares of Common Stock offered hereby at an assumed initial public offering
price of $13.00 per share, and after deducting the estimated underwriting
discount and offering expenses, the pro forma net tangible book value of the
Company as of March 31, 1996 would have been $46,857,418 or $1.78 per share of
Common Stock. This represents an immediate increase in such pro forma net
tangible book value of $1.15 per share to existing stockholders and an immediate
dilution of $11.22 per share to new investors purchasing shares in this
offering. If the initial public offering price is higher or lower, the dilution
to the new investors will be, respectively, greater or less. The following table
illustrates this per share dilution:
<TABLE>
<CAPTION>
<S> <C> <C>
Assumed initial public offering price per share $13.00
Net tangible book value per share as of March 31, 1996 $0.63
Increase per share attributable to new investors $1.15
-----
Pro forma net tangible book value per share as of March 31, 1996 after
offering 1.78
------
Net tangible book value dilution per share to new investors $11.22
======
</TABLE>
The following table summarizes on a pro forma basis as of March 31, 1996, the
number of shares of Common Stock purchased from the Company, the total
consideration paid to the Company and the average price paid per share by
existing stockholders and by new investors (assuming an initial public offering
price of $13.00 per share):
<TABLE>
<CAPTION>
Shares Purchased Total Consideration
------------------- --------------------
Average Price
Number Percent Amount Percent Per Share
--------- ------ ---------- ------ -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders (1)
(2) 23,590,800 90% $ 107,728 0.3% $0.005
New investors (1) 2,700,000 10 35,100,000 99.7 $13.00
------- ---- ------------ ----- ------
Total 26,290,800 100% $35,207,728 100.0%
======= ==== =========== =====
</TABLE>
- -------------
(1) Sales by Selling Stockholders in this offering will reduce the number of
shares of Common Stock held by existing stockholders to 22,890,800 shares,
or 87% of the total number of shares of Common Stock to be outstanding after
this offering (85% if the Underwriters' over-allotment option is exercised
in full), and will increase the number of shares of Common Stock held by new
investors to 3,400,000, or 13% of the total number of shares to be
outstanding (3,910,000 shares or 15% if the Underwriters' over-allotment
option is exercised in full). See "Principal and Selling Stockholders."
(2) Includes 100,800 shares of Common Stock issuable upon exercise of stock
options to be exercised immediately prior to the closing of this offering at
an exercise price of approximately $0.33 per share.
As of May 13, 1996, there were options outstanding to purchase 2,409,000
shares of Common Stock under the Company's 1994 Long-Term Incentive Plan at a
weighted average exercise price of $2.51 per share, of which options to purchase
588,750 shares were then exercisable. To the extent any such options are
exercised (other than those referred to in note (2) to the above table), there
will be further dilution to the new investors. In addition, on May 13, 1996, the
Company's Board of Directors adopted the 1996 Non- Employee Director Stock
Option Plan (the "Director Plan") and the 1996 Employee Stock Purchase Plan (the
"Stock Purchase Plan"); and 250,000 shares and 500,000 shares have been reserved
for issuance under the Director Plan and the Stock Purchase Plan, respectively.
The issuance of shares under these plans is not reflected in the preceding
tables. See "Management--Stock Plans."
14
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data at December 31, 1994 and 1995 and
for the three years ended December 31, 1995, are derived from consolidated
financial statements of Pegasystems Inc., which have been audited by Ernst &
Young LLP, independent auditors. The selected consolidated financial data at
December 31, 1991 and 1992 and for each of the two years ended December 31,
1992, are derived from consolidated financial statements of the Company audited
by Ernst & Young LLP but not included in this Prospectus. The selected
consolidated financial data presented below at and for the three months ended
March 31, 1995 and 1996 are derived from the Company's unaudited financial
statements also appearing herein and which, in the opinion of management,
include all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the results for the unaudited interim
periods. The results of operations for the three months ended March 31, 1996 are
not necessarily indicative of the results that may be expected for the full year
or for any future period. The data presented below should be read in conjunction
with the consolidated financial statements, related notes and other financial
information included herein. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
Three Months
Ended
Year Ended December 31, March 31,
-------------------------------------------- ----------------
1991 1992 1993 1994 1995 1995 1996
----- ----- ------ ------ ------ ----- -------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Consolidated Statement of
Income Data:
Total revenue $ 7,784 $ 8,963 $10,212 $16,263 $22,247 $ 4,005 $ 4,941
Income from operations 1,858 1,944 793 2,236 3,257 66 456
License interest income 987 1,220 1,305 1,457 1,486 370 368
Net income 1,791 1,867 1,233 2,193 2,878 263 486
Net income per share $ 0.07 $ 0.08 $ 0.05 $ 0.09 $ 0.11 $ 0.01 $ 0.02
Weighted average common
and common equivalent
shares outstanding 24,471 24,471 24,231 24,102 25,551 25,600 25,505
</TABLE>
<TABLE>
<CAPTION>
March
December 31, 31,
----------------------------------------- --------
1991 1992 1993 1994 1995 1996
----- ----- ----- ----- ----- --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents $ 80 $ 336 $ 435 $ 456 $ 511 $ 2,644
Working capital 1,904 3,428 4,231 4,441 4,393 6,952
Long-term license
installments, net 5,512 6,319 6,782 9,135 13,399 11,444
Total assets 11,992 14,387 17,057 20,787 25,876 26,555
Long-term debt 108 118 458 450 816 672
Stockholders' equity 6,576 8,444 9,676 11,872 14,674 15,136
</TABLE>
15
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of operation
of the Company should be read in conjunction with the Company's Consolidated
Financial Statements and Notes thereto, and the other financial information
included elsewhere in this Prospectus.
Overview
The Company was founded in April 1983 to develop, market and support customer
management software solutions for financial services organizations. Product
development began immediately and by the end of the year the Company had secured
its first customer. The Company has been profitable in each fiscal quarter since
the first quarter of 1985.
The Company's revenue is derived from two sources: software license fees and
services revenue. License fees, which have historically represented the majority
of the Company's total revenue, are generally payable on a monthly basis under
license agreements which typically have a five-year term and are subject to
renewal at the customer's option for an additional fixed period. Such license
agreements are generally non-cancellable, although some may be terminated by the
licensee for a fee prior to the expiration of the initial term but after a
minimum specified period. The Company's licenses generally provide for annual
license fee increases (the "inflation adjustments") based on recognized
inflation indexes (sometimes subject to maximums). The Company believes that
both it and its customers derive substantial benefits from the recurring fee
model because it encourages the Company to be responsive to customer needs and
provides the Company with additional revenue opportunities through license
renewals.
License revenue is recognized upon product acceptance. In the case of license
renewals, revenue is recognized upon execution of the renewal agreement or if,
as is generally the case, renewal is automatic unless the customer gives notice
of termination, at the expiration of the period during which the customer has
the right to terminate. The inflation adjustments are recognized ratably over
the months to which they apply. In accordance with Statement of Position No.
91-1 issued by the American Institute of Certified Public Accountants, the
amount of software license revenue recognized upon product acceptance or license
renewal is equal to the present value of the payments due during the minimum
initial or renewal term, as the case may be, plus the present value of any early
termination fee. In 1993, 1994 and 1995 and the three months ended March 31,
1996, the discount rate for purposes of the present value calculation was 7%. In
the future, the Company intends to establish the discount rate quarterly based
on the Company's then current marginal borrowing rate, reduced, with respect to
licenses which provide for inflation adjustments, by 1.5%, reflecting the
Company's estimate of the benefit of future inflation adjustments during the
minimum license term. The imputed interest portion of the license fees, which is
reported as license interest income in the Company's consolidated statements of
income, is recognized over the minimum initial or the renewal term, as the case
may be. To date, a substantial majority of the Company's software licenses have
been renewed upon expiration. License renewals accounted for 32%, 26%, 28% and
25% of total revenue in 1993, 1994, 1995 and the three months ended March 31,
1996, respectively. The fact that a significant portion of the Company's revenue
is derived from the renewal of license agreements with fixed expiration dates
assists the Company in anticipating future revenue.
The Company's services revenue is comprised of fees for implementation,
consulting, maintenance and training services. All software license customers
are required to enter into a maintenance contract requiring the customer to pay
a monthly maintenance fee over the term of the related license agreement equal
to approximately 18% of the license fee. Maintenance fees are recognized ratably
over the term of the maintenance agreement. The Company's software license
agreements typically require the Company to provide a specified level of
implementation services for a fixed fee, typically with additional
implementation services available at an hourly rate. Implementation fees are
payable upon the achievement of specified milestones. The Company generally
recognizes implementation as well as consulting and training fees as the
services are provided.
In accordance with generally accepted accounting principles, the Company has
capitalized certain software development costs which it has typically amortized
over two years. No such costs, however, were
16
<PAGE>
capitalized in 1995 or in the three months ended March 31, 1996. At March 31,
1996, the Company carried $350,000 of capitalized software development costs.
These costs will be fully amortized by the end of 1996. As a result, the Company
expects that its cost of software license revenue will be lower in 1997 than in
1996.
Substantially all of the Company's contracts are denominated in U.S. dollars,
although several are denominated in British pounds sterling. The Company expects
that in the future more of its contracts will be denominated in foreign
currencies. The Company has not experienced any significant foreign exchange
gains or losses, and the Company does not expect that foreign currency
fluctuations will have a significant effect on either its revenue or costs in
the near term.
Results of Operations
The following table sets forth, for the periods indicated, certain items in
the Company's consolidated statement of income reflected as a percentage of
total revenue:
<TABLE>
<CAPTION>
Year Ended Three Months Ended
December 31, March 31,
----------------------- ------------------
1993 1994 1995 1995 1996
----- ----- ----- ------ ------
<S> <C> <C> <C> <C> <C>
Revenue:
Software license 63.1% 59.4% 60.8% 55.2% 51.0%
Services 36.9 40.6 39.2 44.8 49.0
--- --- --- ---- ------
Total revenue 100.0 100.0 100.0 100.0 100.0
--- --- --- ---- ------
Cost of revenue:
Cost of software license 12.2 6.6 2.9 4.8 2.4
Cost of services 21.8 23.3 27.7 30.6 28.4
--- --- --- ---- ------
Total cost of revenue 34.0 29.9 30.6 35.4 30.8
--- --- --- ---- ------
Gross margin 66.0 70.1 69.4 64.6 69.2
--- --- --- ---- ------
Operating expenses:
Research and development 36.9 33.5 31.7 35.3 32.4
Sales and marketing 13.2 16.2 16.1 19.6 19.7
General and administrative 8.2 6.7 6.9 8.0 7.8
--- --- --- ---- ------
Total operating expenses 58.3 56.4 54.7 62.9 59.9
--- --- --- ---- ------
Income from operations 7.7 13.7 14.7 1.7 9.3
License interest income 12.8 9.0 6.7 9.2 7.4
Other interest income 0.3 0.1 0.1 0.1 0.2
Interest expense (0.3) (0.3) (0.5) (0.5) (0.8)
--- --- --- ---- ------
Income before provision for
income taxes 20.5 22.5 21.0 10.5 16.1
Provision for income taxes 8.4 9.0 7.9 4.0 6.3
--- --- --- ---- ------
Net income 12.1% 13.5% 13.1% 6.5% 9.8%
=== === === ==== ======
</TABLE>
Three Months Ended March 31, 1996 Compared to Three Months Ended March 31, 1995
Revenue
Total revenue for the three months ended March 31, 1996 (the "1996 Period")
increased 23.4% to $4.9 million from $4.0 million for the three months ended
March 31, 1995 (the "1995 Period"). The increase was primarily due to an
increase in services revenue, and to a lesser extent, an increase in software
license revenue.
Software license revenue for the 1996 Period increased 14.1% to $2.5 million
from $2.2 million for the 1995 Period. The increase in software license revenue
was primarily attributable to software license agreement renewals, the licensing
of standard product templates, and inflation-based increases in monthly license
fees.
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Services revenue for the 1996 Period increased 34.8% to $2.4 million from $1.8
million for the 1995 Period. The increase in services revenue was primarily
attributable to increased demand for consulting and implementation services, and
to a lesser extent, increased maintenance revenue from a larger installed
product base.
Revenue from customers headquartered outside of the United States for the
1996 Period increased 398% to $1.3 million from $250,000 in the 1995 Period due
largely to the expanded operations of the Company's office in the United
Kingdom.
Cost of Revenue
Cost of software license consists of amortization expense related to
capitalized software development costs, royalty payments to third party software
vendors and costs of product media, duplication and packaging. Cost of software
license for the 1996 Period decreased 38.0% to $118,000 from $191,000 for the
1995 Period, and decreased as a percentage of total revenue from 4.8% for the
1995 Period to 2.4% for the 1996 Period. As a percentage of software license
revenue, cost of software license decreased from 8.6% for the 1995 Period to
4.7% for the 1996 Period. Such decreases were due to decreased amortization
expense related to capitalized software development costs.
Cost of services consists primarily of the costs of providing implementation,
consulting, maintenance and training services. Cost of services for the 1996
Period increased 14.4% to $1.4 million from $1.2 million for the 1995 Period
mainly due to increased staffing in the Company's Reengineering and Client
Services group in the United Kingdom and in the Company's domestic regional
offices. Cost of services as a percentage of total revenue declined from 30.6%
for the 1995 Period to 28.4% for the 1996 Period, and declined as a percentage
of services revenue from 68.4% for the 1995 Period to 58.0% for the 1996 Period,
in both cases due to the growth in the Company's total revenue and increased
utilization of service personnel.
Operating Expenses
Research and development expenses consist primarily of the cost of personnel
and equipment needed to conduct the Company's research and development efforts.
Research and development expenses for the 1996 Period increased 13.4% to $1.6
million from $1.4 million for the 1995 Period. The modest increase in research
and development expenses reflected the substantial completion in December 1995
of the Company's efforts to develop versions of its products based on the C++
programming language. As a percentage of total revenue, research and development
expenses declined from 35.3% for the 1995 Period to 32.4% for the 1996 Period
due to the growth in the Company's total revenue.
Sales and marketing expenses for the 1996 Period increased 23.8% to $972,000
from $785,000 for the 1995 Period. As a percentage of total revenue, sales and
marketing expenses increased slightly from 19.6% for the 1995 Period to 19.7%
for the 1996 Period. Such increases were attributable to the hiring of
additional direct sales personnel, increased sales commission payments
attributable to higher sales, and investments in marketing materials. The
Company's license agreements, by providing for the payment of license fees in
installments over the term of the agreement, have historically limited the
Company's working capital and consequently its ability to invest in sales and
marketing. With the proceeds of this offering, the Company intends to increase
substantially its sales and marketing spending.
General and administrative expenses consist primarily of the salaries of the
Company's executive, administrative and financial personnel, and associated
expenses. General and administrative expenses for the 1996 Period increased
20.4% to $388,000 from $322,000 for the 1995 Period due to staff growth. Such
expenses declined slightly as a percentage of total revenue from 8.0% for the
1995 Period to 7.8% for the 1996 Period due to the growth in the Company's total
revenue.
License Interest Income
License interest income represents the portion of all license fees due under
software license agreements which was not recognized upon product acceptance or
license renewal. License interest income for the 1996 Period and the 1995 Period
remained constant at $370,000.
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Provision for Income Taxes
The provisions for federal, state and foreign taxes were $160,000 and
$310,000 for the 1995 Period and the 1996 Period, respectively. The effective
tax rates were 38% for the 1995 Period and 39% for the 1996 Period. The increase
in the effective tax rate was primarily due to the reduced availability of
research and development tax credit carryforwards. At March 31, 1996, the
Company had $440,000 in research and development tax credit carryforwards
available to offset future federal taxable income.
Year Ended December 31, 1995 Compared to Year Ended December 31, 1994
Revenue
Total revenue for 1995 increased 36.8% to $22.2 million from $16.3 million
for 1994 due primarily to an increase in software license revenue, and to a
lesser extent, an increase in services revenue.
Software license revenue for 1995 increased 40.0% to $13.5 million from $9.7
million in 1994 due to increased product acceptances and license renewals.
Services revenue for 1995 increased 32.1% to $8.7 million from $6.6 million
in 1994 primarily due to an increase in the amount of implementation and
consulting services provided, and to a lesser extent, increases in the billing
rates of the personnel providing these services and an increase in training
revenue.
Cost of Revenue
Cost of software license for 1995 decreased 42.9% to $640,000 from $1.1
million for 1994, and decreased as a percentage of total revenue from 6.6% for
1994 to 2.9% for 1995. As a percentage of software license revenue, cost of
software license decreased from 11.1% for 1994 to 4.7% for 1995. Such decreases
were due to reduced amortization of capitalized software development costs.
Cost of services for 1995 increased 62.5% to $6.2 million from $3.8 million
for 1994 and increased as a percentage of total revenue from 23.3% for 1994 to
27.7% for 1995. Cost of services as a percentage of total services revenue
increased from 57.4% for 1994 to 70.7% for 1995. Such increases were due to the
hiring of additional personnel to provide implementation and consulting services
to support the Company's growing customer base.
Operating Expenses
Research and development expenses for 1995 increased 29.8% to $7.1 million
from $5.4 million for 1994 as a result of increased efforts by the Company to
develop versions of its products capable of running on multiple UNIX platforms
in a client/server environment. As a percentage of total revenue, research and
development expenses declined from 33.5% for 1994 to 31.7% for 1995 due to the
growth in the Company's total revenue.
Sales and marketing expenses for 1995 increased 36.6% to $3.6 million from
$2.6 million for 1994 due to the hiring of additional sales and marketing
personnel, increased sales commission payments and increased investment in trade
shows and other sales and marketing efforts. As a percentage of total revenue,
sales and marketing expenses decreased slightly from 16.2% for 1994 to 16.1% for
1995 due to growth in the Company's total revenue.
General and administrative expenses for 1995 increased 41.2% to $1.5 million
from $1.1 million for 1994 due to increased management recruiting costs, the
establishment of two new regional offices in Chicago and Dallas/Fort Worth and
the relocation of the Company's United Kingdom office. General and
administrative expenses were 6.9% of total revenue in 1995 and 6.7% in 1994.
License Interest Income
License interest income for 1995 and 1994 remained constant at $1.5 million.
19
<PAGE>
Provision for Income Taxes
The provisions for federal, state and foreign taxes were $1.5 million and
$1.8 million for 1994 and 1995, respectively. The effective tax rates were 40%
for 1994 and 38% for 1995. The decrease in the effective tax rate was primarily
due to increased availability of research and development tax credits. See Note
7 of Notes to Consolidated Financial Statements.
Year Ended December 31, 1994 Compared to Year Ended December 31, 1993
Revenue
Total revenue for 1994 increased 59.2% to $16.3 million from $10.2 million
for 1993. In January 1994, the Company organized Pegasystems Limited, a
wholly-owned subsidiary based in the United Kingdom. In its first year of
operation, Pegasystems Limited introduced the Company's products into Ireland,
France and Luxembourg. Financial results for 1994 and subsequent years reflect
the consolidated earnings of Pegasystems Inc. and Pegasystems Limited.
Software license revenue represented 59.4% and 63.1% of total revenue for
1994 and 1993, respectively. Software license revenue for 1994 increased 49.8%
to $9.7 million from $6.4 million for 1993. The increase in software license
revenue in 1994 was primarily attributable to increased product acceptances by
customers headquartered outside of the United States. The Company's software
license revenue from customers headquartered outside of the United States was
$3.1 million, or 32.5% of software license revenue, and $0.7 million, or 10.8%
of software license revenue, in 1994 and 1993, respectively.
Services revenue for 1994 increased 75.3% to $6.6 million from $3.8 million
for 1993 primarily due to the increased amount of implementation and consulting
services provided to a widening customer base. Following a focused internal
reengineering effort which began in 1993 and continued into 1994, the Company
redeveloped its strategy for new customer implementations leading to greater
services revenue from more effective and timely implementations and the creation
of standard training courses.
Cost of Revenue
Cost of software license decreased 13.5% to $1.1 million for 1994 from $1.2
million for 1993 and decreased as a percentage of total revenue from 12.2% for
1993 to 6.6% for 1994. As a percentage of software license revenue, cost of
software license decreased from 19.3% for 1993 to 11.1% for 1994. Such decreases
were due to reduced amortization of capitalized software development costs.
Cost of services for 1994 increased 70.3% to $3.8 million from $2.2 million
for 1993 and increased as a percentage of total revenue from 21.8% for 1993 to
23.3% for 1994. Such increases were due to the costs associated with
establishing the Company's United Kingdom office in January 1994 and with
developing new training facilities in Cambridge, Massachusetts and San
Francisco, California. Cost of services as a percentage of total services
revenue decreased from 59.2% for 1993 to 57.4% for 1994 due to increased
utilization of service personnel.
Operating Expenses
Research and development expenses for 1994 increased 44.4% to $5.4 million
from $3.8 million for 1993 primarily as a result of efforts by the Company to
develop versions of its products capable of running on multiple UNIX platforms
in a client/server environment. As a percentage of total revenue, research and
development expenses declined to 33.5% for 1994 from 36.9% for 1993 due to
growth in the Company's total revenue.
Sales and marketing expenses for 1994 increased 94.7% to $2.6 million from
$1.4 million for 1993, representing 16.2% and 13.2% of total revenue in the
respective years. Such increases reflected the establishment of a sales
operation in the United Kingdom and increased sales commission payments.
General and administrative expenses for 1994 increased 30.8% to $1.1 million
from $830,000 for 1993 due to overhead associated with the expansion of the
Company's headquarters in Cambridge, Massachusetts, relocation of the regional
office in San Francisco, California, and the establishment of
20
<PAGE>
operations in the United Kingdom. General and administrative expenses as a
percentage of total revenue declined slightly to 6.7% for 1994 from 8.2% for
1993 due to the growth in the Company's total revenue.
License Interest Income
License interest income for 1994 increased 10.9% to $1.5 million from $1.3
million in 1993 primarily due to the prepayment by one customer in 1994 of
certain monthly software license fees.
Provision for Income Taxes
The provisions for federal, state and foreign taxes were $860,000 and $1.5
million for 1993 and 1994, respectively. The effective tax rates were 41% for
1993 and 40% for 1994. The decrease in the effective tax rate was primarily
due to the use of certain tax credits. See Note 7 of Notes to Consolidated
Financial Statements.
Quarterly Operating Results
The following tables set forth certain unaudited consolidated financial
information for each of the four quarters in 1995 and for the first quarter of
1996. In management's opinion, this unaudited quarterly information has been
prepared on the same basis as the audited consolidated financial statements and
includes all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of the information for the quarters presented,
when read in conjunction with the audited consolidated financial statements and
notes thereto included elsewhere in this Prospectus. The Company believes that
quarter-to-quarter comparisons of its financial results are not necessarily
meaningful and should not be relied upon as an indication of future performance.
21
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------------------------------------
March June September December
31, 30, 30, 31, March 31,
1995 1995 1995 1995 1996
------- ------ ----------- ---------- ---------
(in thousands except percentage data)
<S> <C> <C> <C> <C> <C>
Consolidated Statement of Income Data:
Revenue:
Software license $ 2,209 $2,581 $3,624 $5,115 $2,520
Services 1,796 2,113 2,032 2,777 2,421
----- ---- --------- -------- -------
Total revenue 4,005 4,694 5,656 7,892 4,941
----- ---- --------- -------- -------
Cost of revenue:
Cost of software license 191 191 127 127 118
Cost of services 1,228 1,383 1,584 1,966 1,405
----- ---- --------- -------- -------
Total cost of revenue 1,419 1,574 1,711 2,093 1,523
----- ---- --------- -------- -------
Gross profit 2,586 3,120 3,945 5,799 3,418
----- ---- --------- -------- -------
Operating expenses:
Research and development $ 1,413 $1,615 $1,846 $2,187 $1,602
Sales and marketing 785 854 865 1,088 972
General and administrative 322 375 376 468 388
----- ---- --------- -------- -------
Total operating expenses 2,520 2,844 3,087 3,743 2,962
----- ---- --------- -------- -------
Income from operations 66 276 858 2,056 456
----- ---- --------- -------- -------
License interest income 370 368 383 364 368
Other interest income 6 4 7 0 12
Interest expense (18) (17) (33) (50) (39)
----- ---- --------- -------- -------
Income before provision for
income taxes 424 631 1,215 2,370 797
Provision for income taxes 161 240 462 901 311
----- ---- --------- -------- -------
Net income $ 263 $ 391 $ 753 $1,469 $ 486
===== ==== ========= ======== =======
Percent of Total Revenue:
Revenue:
Cost of software license 55.2% 55.0% 64.1% 64.8% 51.0%
Cost of services 44.8 45.0 35.9 35.2 49.0
----- ---- --------- -------- -------
Total revenue 100.0 100.0 100.0 100.0 100.0
Cost of revenue:
Software license 4.8 4.1 2.2 1.6 2.4
Services 30.6 29.5 28.0 24.9 28.4
----- ---- --------- -------- -------
Total cost of revenue 35.4 33.6 30.2 26.5 30.8
----- ---- --------- -------- -------
Gross margin 64.6 66.4 69.8 73.5 69.2
----- ---- --------- -------- -------
Operating expenses:
Research and development 35.3 34.4 32.6 27.7 32.4
Sales and marketing 19.6 18.2 15.3 13.8 19.7
General and administrative 8.0 8.0 6.7 5.9 7.8
----- ---- --------- -------- -------
Total operating expenses 62.9 60.6 54.6 47.4 59.9
----- ---- --------- -------- -------
Income from operations 1.7 5.8 15.2 26.1 9.3
License interest income 9.2 7.8 6.8 4.6 7.4
Other interest income 0.1 0.1 0.1 0.0 0.2
Interest expense (0.5) (0.4) (0.6) (0.6) (0.8)
----- ---- --------- -------- -------
Income before provision for
income taxes 10.5 13.3 21.5 30.1 16.1
Provision for income taxes 4.0 5.1 8.2 11.4 6.3
----- ---- --------- -------- -------
Net income 6.5% 8.2% 13.3% 18.7% 9.8%
===== ==== ========= ======== =======
</TABLE>
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<PAGE>
The Company's business has experienced and is expected to continue to
experience significant seasonality. In recent years the Company has recognized a
greater percentage of its revenue in its third and fourth quarters than in its
first and second quarters due to the Company's sales commission structure and
the impact of that structure on the timing of product acceptances and license
renewals by customers. This pattern is reinforced by the Company's maintenance
contracts, which entitle customers to, among other things, a fixed number of
hours of service per calendar year. Once the annual allotment of service hours
is exhausted, customers pay for additional services on an hourly basis,
typically resulting in higher services revenue in the Company's second, third
and fourth quarters.
Cost of software license declined in each of the quarters shown above due to
decreasing amortization expense relating to capitalized software development
costs. No software development costs were capitalized in 1995 or the first
quarter of 1996.
The increase in total operating expenses in the fourth quarter of 1995
reflected primarily an adjustment for bad debt exposure identified in such
quarter and, to a lesser extent, an accrual for earned vacation for the full
year.
Liquidity and Capital Resources
The Company historically has satisfied its cash requirements through cash
generated from operations and borrowings. The Company's approach of charging
license fees payable in installments over the term of its licenses has
historically deferred the receipt of cash and limited the availability of
working capital.
Net cash provided by operating activities for the years ended December 31,
1993, 1994, 1995, and the three months ended March 31, 1996 was $1.6 million,
$1.5 million, $830,000 and $2.6 million, respectively. During each of these
periods, these sources of cash were used to support the Company's working
capital requirements.
The Company used $890,000, $1.1 million, $1.4 million and $220,000 of net
cash during 1993, 1994, 1995, and the three months ended March 31, 1996,
respectively, to purchase property and equipment, primarily computer hardware
and software, to support the Company's growing employee base and new regional
office and training facilities. The Company's capital commitments consist
primarily of operating leases for office space and equipment. At December 31,
1995, the Company's commitments under noncancellable operating leases for office
space and equipment with terms in excess of one year totalled $1.0 million, $1.1
million and $1.1 million for 1996, 1997 and 1998, respectively. The Company's
total payments under such leases was $800,000, $860,000 and $1.1 million for
1993, 1994 and 1995, respectively. See Note 6 of Notes to Consolidated Financial
Statements.
The Company has a $5.0 million revolving credit line, which expires June 30,
1997, and four term loans from the same bank in the aggregate principal amount
of $1.4 million at March 31, 1996, which are due December 1996 ($155,000),
November 1997 ($211,000), June 1998 ($885,000) and December 1998 ($151,000). The
term loans are secured by certain fixed assets of the Company; the revolving
credit line is unsecured. At March 31, 1996, the Company had no borrowings under
its revolving credit line. The Company intends to use a portion of the proceeds
from this offering to repay the four term loans in full. The Company's credit
agreement prohibits the payment of dividends, has profitability requirements and
requires maintenance of specified levels of tangible net worth and certain
financial ratios. See Note 4 of Notes to Consolidated Financial Statements.
The Company believes that the net proceeds from this offering together with
cash generated by operations and availability under its bank credit facility
will be sufficient to fund the Company's operations for at least one year
following the completion of this offering. However, there can be no assurance
that additional capital beyond the amounts currently forecasted by the Company
will not be required or that any such required additional capital will be
available on reasonable terms, if at all, at such time as required by the
Company.
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<PAGE>
Inflation
Inflation has not had a significant impact on the Company's operating results
to date, nor does the Company expect it to have a significant impact in the
future due to the fact that the Company's license and maintenance fees are
typically subject to annual increases based on recognized inflation indexes.
Significant Customers
In 1993, First Interstate Bank and Fidelity Investments accounted for
approximately 12.9% and 12.3%, respectively, of the Company's total revenue. In
1994, Chemical Bank accounted for approximately 16.8% of the Company's total
revenue. In 1995, Citibank, Household Credit Services and Chemical Bank
accounted for approximately 16.2%, 14.9% and 12.6%, respectively, of the
Company's total revenue. During the three months ended March 31, 1996, Fidelity
Investments, Bank of America and Cedel accounted for approximately 25.3%, 11.7%
and 10.5%, respectively, of the Company's total revenue.
24
<PAGE>
BUSINESS
Pegasystems develops customer service management software to automate
customer interactions across transaction-intensive enterprises. Many of the
world's largest banks, mutual funds and credit card organizations use the
Company's solutions to integrate, automate, standardize and manage a broad array
of mission-critical customer service activities, including account set-up,
record retrieval, correspondence, disputes, investigations and adjustments. The
Company's systems can be used by thousands of concurrent users to manage
customer interactions and to generate billions of dollars a day in resulting
transactions. Work processes initiated by the Company's systems are driven by a
highly adaptable "rule base" defined by the user-organization for its specific
needs. The rule base facilitates a high level of consistency in customer
interactions, yet drives different processes depending on the customer profile
or the nature of the request. The Company's open, multi-tier, client/server
systems operate on a broad variety of platforms, including UNIX, Windows/NT and
IBM/MVS. The Company offers consulting, training and support services to
facilitate the use of its solutions.
Industry Background
Intensifying competition is forcing businesses to reduce costs while focusing
on customer service management as an important means of differentiation. Many
types of businesses are increasingly recognizing customer interactions as a
critical opportunity to solidify and expand customer relationships. Due to the
volume and precise nature of their transactions, it is especially critical for
financial services organizations to implement cost-effective systems to manage
customer interactions accurately and efficiently.
Providing high quality, cost-effective customer service management is
complex. Organizations with global operations must be able to manage customer
interactions in different languages, time zones, currencies and regulatory
environments. The challenge is magnified as the product offerings of an
organization increase and organizations are combined. Work processes occasioned
by a single customer interaction often involve multiple departments within an
organization, which may have different priorities and service standards, and may
involve a variety of different computer systems. Customers may contact an
organization through various means, including telephone, facsimile, the Internet
or in person. The organization must be able to respond in a timely, accurate and
consistent fashion or risk customer defection.
Historically, in attempting to meet demand for new customer management
software systems, organizations have faced a choice between building custom
systems or purchasing third party systems. Building custom systems or modifying
third party systems can be slow and costly and has often led to isolated,
departmentalized solutions. Traditional third party systems are often
inflexible, requiring organizations to conform their work processes to the
system, rather than vice-versa. Neither custom nor third party solutions have
generally accommodated an organization's need to evolve or expand operations
without significant programming effort. Moreover, neither has had the high
volume transaction processing or integration capabilities necessary to support
the comprehensive customer interaction requirements of large organizations.
Today, organizations need flexible, scalable customer service management
solutions that can be implemented on an enterprise-wide basis to facilitate
consistent, cost-effective customer service management.
A 1995 report of the Aberdeen Group, Inc., a market research firm, estimates
the size of the customer interaction software market at $1.7 billion in 1996,
and projects that it will grow to $2.7 billion by 1998. Of this market, the
share held by independent software vendors is estimated at $540 million in 1996,
growing to $925 million in 1998. The total market, as defined by the Aberdeen
Group, includes software supporting customer service, internal help desks, field
and telesales automation, order entry, sales or product configuration, service
dispatching and quality assurance.
25
<PAGE>
The Pegasystems Solution
The Company's solutions integrate, automate, standardize and manage on an
enterprise-wide basis a broad array of mission-critical customer interactions
for financial services organizations, including account set- up, record
retrieval, correspondence, disputes, investigations and adjustments.
Pegasystems' solutions provide a service backbone that drives intelligent
processing and seamlessly integrates an organization's geographically dispersed
and product specific service operations and isolated computer systems. By
bridging these "islands of automation" within large organizations, the Company's
solutions increase the efficiency of service representatives and enable
organizations to address multiple customer needs during a single contact.
The Company's customer service management solutions offer the following
advantages:
Flexibility and Consistency. The Company's solutions are based on rules
defined by the user- organization which drive various types of processing
depending on such factors as the content of the customer request, the profile of
the customer, the organization's policies and procedures and the authority or
qualifications of the customer service representative. By modifying its rule
base, an organization can evolve its processing to address the competitive
requirements of its business without costly and time consuming reprogramming.
Significantly, the rule base feature of the Company's systems permits an
organization to establish consistent standards yet interact differently with
different segments of its customer base and thereby "mass customize" its
services.
Scalability and Robust Functionality. The scalability of the Company's
multi-tier client/server architecture allows an organization to add branches or
departments easily to new or existing servers without performance degradation.
Organizations currently entrust the Company's systems with the storage and
management of data relating to hundreds of millions of financial transactions.
The Company's systems can be used by more than 4,000 concurrent users to manage
customer interactions and to process accurately and securely transactions
involving billions of dollars a day that result from those interactions.
Ease-of-Use. The Company's client software application, PegaVIEW-ACE,
increases the effectiveness and productivity of customer service representatives
by providing them with a flexible graphical user interface and processing
capabilities that leverage the power of client/server desktop computers. The
Company's solutions allow customer service representatives to focus on
delivering superior customer service, rather than on mastering the protocols and
procedures of multiple applications.
Integration Capabilities. The Company's open architecture permits its
solutions to be integrated with a wide variety of other applications and
technologies, including industry standard relational database management
systems, advanced telephony equipment and diverse storage media (including
magnetic, optical, tape and microfilm). The Company's solutions also support the
message formats of major financial transaction networks such as the SWIFT
international funds network, the Federal Reserve's Fedwire system and the VISA
and MasterCard networks.
Multi-Platform Server Support. The Company's solutions feature a common
software code base which, in addition to facilitating maintenance and
enhancement development efforts, simplifies the support of multiple platforms.
The Company's solutions are designed to run on a broad range of computer
operating systems including IBM's MVS/CICS and AIX/UNIX systems, Digital
Equipment Corporation's VMS and UNIX systems, Microsoft's Windows/NT system and
Sun Microsystems' Solaris UNIX system.
Improved Efficiency of Customer Service Representatives. Pegasystems'
solutions actually perform work, rather than simply track a customer service
representative's tasks. Variable data elements (for example, date, amount,
customer, account) automatically route service requests and invoke system
processes, depending on an organization's rule base. This feature allows
customer service representatives to focus on revenue enhancing opportunities,
such as cross-selling, and other matters requiring personal attention. When
service representative involvement is required during a customer interaction,
the Company's solutions provide pertinent, consolidated information to guide the
service representative. Savings are realized through reduced talk time, fewer
manual processes and less rework.
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<PAGE>
Business Strategy
Pegasystems' objective is to become the leading provider of mission-critical
client/server customer service management software to organizations performing a
high volume of complex interactions with demanding customers. To achieve this
objective, the Company is pursuing the following strategies:
Leverage Strength in Financial Services Market. Pegasystems provides customer
service management solutions to many of the largest financial services
organizations in the world. The Company is seeking to expand its business with
these organizations through a sales group focused on marketing the Company's
products and services to other business operations of these organizations. The
Company is also leveraging its relationships and expertise with large financial
services organizations to penetrate the medium-sized financial services market.
Target Other Markets. Pegasystems believes that the insurance, medical,
utilities, retail and other markets have similar customer service management
needs and that the Company's core technology is readily adaptable to these
additional markets. The Company is exploring these additional markets, and if
appropriate, expects to develop the necessary industry specific extensions of
its core technology and hire or otherwise gain access to personnel with
expertise in such markets.
Increase Sales and Support Efforts. Pegasystems intends to establish
additional sales and support offices and to increase significantly its domestic
and international direct sales forces. In addition, the Company plans to explore
relationships with financial transaction processors and consulting firms through
which the Company's products can be distributed and implemented.
Develop Standard Product Templates. The Company recently commenced licensing
standard product templates that give organizations an advanced starting point
for configuring their work processes. The Company intends to continue to develop
and market standard product templates for financial services organizations,
including templates for outbound telemarketing, collections and account set-up.
The Company believes that these templates will facilitate more rapid
implementation of the Company's solutions and will be a cost-effective way to
address the needs of smaller organizations.
Reduce Implementation Time. The Company is continuing to refine its PegaSTAR
consulting methodology, an approach to the reengineering of an organization's
work processes that facilitates more rapid implementation of the Company's
customer management systems and continued evolution of such systems by an
organization's personnel after initial implementation. This methodology
complements the Company's standard product templates in reducing the time
required to implement the Company's systems.
Maintain Technological Leadership Position. Pegasystems is continuing to
develop and invest in its technology. Current development efforts include
integration of additional databases and support of emerging technical and
workflow standards.
Technology
The Company's technology is designed to optimize the performance of
mission-critical, customer service management processes over a variety of
computer platforms, networks and databases. Pegasystems' solutions have the
following key technological attributes:
"Any-Call, Any-Time, Anywhere" Information Management. Effective customer
response requires up-to-date information about the customer relationship,
regardless of how, why, when or where the customer contacts the organization.
Pegasystems' customer service management systems centralize core customer
information to facilitate global access.
Multi-tier, Dynamic Distributed Processing. Although the Company's systems
are currently used primarily in a two-tier client/server environment, they are
also designed to run in an advanced, highly scalable three-tier environment. In
traditional three-tier client/server environments, the user interface, the
application code, and the data are segregated onto separate tiers. In the
Pegasystems three-tier client/server environment, the application code, the rule
base and selected data are replicated on both the central and satellite tiers so
that processing may occur on either the central server or the distributed
satellite servers to minimize network traffic and enhance performance. The rule
base determines the optimal location for processing to occur based on the nature
of the work required and the data involved. Rule base changes are replicated
across the organization's central and satellite servers to facilitate consistent
processing by all parts of the organization.
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<PAGE>
Distributed Processing Environment
[Graphic Representation of Pegasystems Worldwide
Platform Processing Environment]
Satellite Server
Code
Rules
Central Server
Code
Rules
Work Item Data
Satellite Server
Code
Rules
Satellite Server
Code
Rules
Inherited Workflow. Pegasystems solutions maintain organizational consistency
while providing the flexibility needed for mass customization. The rule base of
the Company's systems may be defined so that certain processes are standardized
across an organization while others may be superseded or supplemented by "local"
rules tailored to the specific requirements of groups within the organization.
Resiliency. Fallback options are provided to deal with hardware or network
failure. For example, in a three-tier environment, the PC client can bypass a
failed satellite server and connect directly to the central server. The Company
is presently working to enhance its systems so that should a failure occur at
the central server, each satellite server's replicated code and rule base could
support continued processing, with "store and forward" capabilities to
automatically re-synchronize the central server when it resumes operation.
Platform Independence. Recognizing that organizations often use a variety of
computer platforms, Pegasystems provides technology alternatives by supporting a
range of mainframes, minicomputers, PC networks and interface devices. While the
Company offers its advanced Windows-based PegaVIEW-ACE application for the
desktop, the Company's server applications can also drive "dumb terminals",
allowing organizations to preserve their investments in legacy networks.
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<PAGE>
Pegasystems Platform Options
[Graphic of Pegasystems Platform Options]
<TABLE>
<CAPTION>
Desktop Local Distributed Global Central
Networks Satellite Servers Networks Servers
<S> <C> <C> <C> <C> <C>
Windows TCP/IP IBM AIX TCP/IP IBM MVS
UNIX CICS
Windows 95 LU6.2 DEC Open LU6.2 IBM AIX
VMS UNIX
Windows NT Pathworks Microsoft Pathworks DEC Open Data
Windows NT VMS
OS/2 Novell SUN Solaris(1) Novell SUN Solaris(1) Data
IPX UNIX IPX UNIX
IBM 3270 IBM DEC UNIX IBM DEC UNIX Data
"Dumb Terminal" VTAM LU2 VTAM LU2
Character-Based Async IBM MVS Async Windows NT
"Dumb Terminal" CICS
Netscape(1) Microsoft HP/UX(2) SNA HP/UX(2)
Motif DDE UNIX UNIX
Netscape(1) Procedure (1) Shipping in Q3, 1996
Windows Call (2) Availability planned in Q4, 1996
</TABLE>
Internet and Intranet Access. Pegasystems' solutions use the Internet-based
HTML (Hypertext Markup Language) to define display attributes for its
PegaVIEW-ACE graphical user interface, leveraging logic and presentation rules
between PegaVIEW-ACE and Internet/Intranet workflows. Pegasystems' rules
dynamically create HTML forms, menus and displays, thereby facilitating
interaction with the Internet. Pegasystems is a Netscape Development partner and
supports the Netscape Commerce Server interface.
Interfacing With Other Systems. Pegasystems' open architecture permits
integration with a wide variety of other applications and networks, including
relational databases, legacy systems accessed through IBM 3270 emulation, and
messaging protocols. The Company offers a Universal Application Programming
Interface (API) that allows an organization's custom software to be integrated
with the Company's applications without the need to modify the Company's core
application code. Pegasystems' solutions also integrate with other applications,
accounting systems and imaging products. The Company's systems support the
message formats of major financial transaction networks, such as the SWIFT
international funds network, the Federal Reserve's Fedwire system and the VISA
and MasterCard networks.
Storage Options. Data storage flexibility is important to the Company's
customers, and the Company's software uses an innovative object-oriented
approach that dynamically maps data according to the type of workflow. Versions
of the Company's systems designed to run on Windows/NT can store customer
service request data in Microsoft's SQL Server relational database, and the
Company has developed similar compatibility in the Windows/NT and RS 6000/AIX
environments for databases from Oracle Corporation.
Products
The Company's products employ a consistent architecture and support the
following customer service management functions:
Receiving. Organizations receive service requests by telephone, mail,
facsimile, or personal contact. Customer service representatives enter
details of incoming requests into PegaVIEW-ACE, the
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<PAGE>
Company's easy-to-use, graphical user interface. Alternatively, electronic
service requests received from various networks and systems, such as the SWIFT
network, Fedwire system, and the VISA and MasterCard networks are entered
directly into the Company's system. The Company's systems also support direct
electronic access by customers through PCs, Internet browsers and voice response
units. In all cases, the service request automatically initiates appropriate
processing.
Routing. As processing steps are completed, the Company's systems categorize
and queue the request either for automatic or manual processing.
Productivity-based load leveling and dynamic prioritization ensure high
performance and responsiveness. As work is processed, each service
representative's "work-list" is automatically updated in real time. The systems
monitor each service request for conformance to the organization's timeliness
standards, automatically increasing priority and generating warnings based on
the service standards of the organization.
Researching. The Company's systems determine when more information is needed,
where to locate it, and how to retrieve it from databases or other repositories.
Pegasystems' rule-driven processing automatically extracts relevant data,
directs it to the customer service representative or customer, links it to the
work, and keeps it readily accessible. The Company's systems can access
information from multiple data sources, whether maintained by the Company's
systems or third party systems.
Responding. The Company's systems facilitate communications by an
organization with its customers by combining user-defined templates and specific
customer information to create personalized correspondence. When appropriate,
service representatives may further refine message content before forwarding by
mail, facsimile or electronic transmission, and may attach images of statements,
checks and other data. Follow-up communications are automatically composed,
customized and sent. Sensitive correspondence can be queued for online review
before release, and the systems create a permanent audit trail of all customer
communications.
Resolving. Concluding a piece of work involves application of the
organization's rules for resolving a request or stepping the customer service
representative through the process when human judgment is required. Resolution
also includes the creation of transactions, transmission to production systems,
management of financial adjustments, posting of service charges, updating of
general ledger accounts and synchronization of multiple item requests.
Reporting. Data automatically collected by the Company's systems enables an
organization to analyze service representative efficiency and determine needs
for service representative training or changes to work processes. The Company's
systems produce reports, graphical output and feeds to spreadsheets illustrating
the volume and status of customer requests, the productivity of customer service
representatives and service levels with specific customers.
The Company offers a number of different products, each with components and
features designed to address particular business areas, but all sharing core
technology and adaptable rule-driven processing:
PegaCARD manages credit and debit card customer service operations by
supporting a wide variety of interactions with cardholders and merchants,
including simple inquiries (for example, balances or credit limits), customer
requests (address changes, additional cards, credit line increases) and problem
management (disputes, chargebacks, fraud, financial adjustments, penalties).
Automated features include processing of electronic chargeback messages and
images from the MasterCard and VISA networks. PegaCARD allows service
representatives to move seamlessly among multiple back-end accounting systems
without having to be familiar with the different protocols of each system.
PegaCLAIMS manages corporate and wholesale banking customer service by
supporting a broad spectrum of customer interactions, including inquiries
(product terms, rates), customer requests (account data changes, duplicate
copies), and problem management (research, financial adjustments). PegaCLAIMS
processes customer service interactions relating to money transfers, securities
movement and control, global custody, trade services, foreign exchange and cash
management, and features electronic message routing, SWIFT processing and
interbank financial compensation management.
PegaSHARES manages customer service for transfer agents, brokers, dealers,
shareholder servicers and mutual fund managers by supporting inquiries (share
balances, net asset values, transactions), customer
30
<PAGE>
requests (account changes, copies of statements) and problem resolution
(incorrect purchases, monetary adjustments). Automated features include share
transfer accounting, literature fulfillment and securities processing
compliance.
PegaTRACE facilitates retail banking and check clearing customer service by
processing inquiries (account balances, fees), customer requests (copies of
statements, account transfers) and problem management (research, financial
adjustments). PegaTRACE securely manages the suspense accounts that major
organizations use to control the flow of accounting entries. Additional features
include integration with check clearing systems, suspense ledger management,
multi-debit/credit adjustments, and electronic check presentment (ECP)
interfaces.
PegaSEARCH and PegaINDEX manage high volumes of archived data, such as check
information, contained on multiple types of storage media including magnetic
disk, optical disk and magnetic tape silos. These systems are designed for
organizations that process tens of millions of checks per day and require seven
years of archived check data.
PegaPRISM and PegaREELAY are used by customer service representatives to
retrieve images, view them on a PC and correlate them with specific customer
service requests. PegaREELAY is a specialized image retrieval product that
automates request processing of reel microfilm.
PegaVIEW-ACE (the Advanced Client Environment) is a graphical client
application designed for use with the Company's server applications to increase
the effectiveness and productivity of customer service representatives.
PegaVIEW-ACE organizes customer data to facilitate service representative
effectiveness and supports graphical methods to view and enter information.
Product Pricing
The Company's systems are licensed to organizations under agreements
requiring the payment of fees, typically in monthly installments, over the term
of the agreement. The amount of the license fee is based on various factors,
including the number of concurrent users, the functionality of the system, the
number of servers on which product is installed, and the scope of business
usage. Typical recent individual system licenses have provided for the payment
of monthly installments of between $5,000 and $50,000. Some organizations
receive discounts for licensing multiple systems. The monthly license payments
generally begin once a system is installed and accepted. The term of such
licenses is typically five years, subject to automatic renewal at the
organization's option.
Services
Pegasystems' Reengineering and Client Services Group, which as of April 30,
1996 was comprised of 50 people located in the Company's six offices, provides
consulting, training and customer support.
Consulting Services. The Company works with its customers during and after
system installation to reengineer customer workflows to leverage the
capabilities of the Company's systems. Using an installation approach based on
its PegaSTAR (the Pegasystems Structured Technique for Analysis and
Reengineering) methodology, the Company's consultants assist customers in six
major areas--analysis, data collection, process definition, configuration,
piloting and measurement. The Company encourages team building and transfer of
knowledge from its consultants to an organization's staff through an interactive
co-production methodology. Pegasystems and its customers work together to
design, document and tailor the system's rule base to the customer's
organization. Pegasystems' goal is to empower its customers' staffs with the
knowledge and confidence to operate, refine and evolve their systems.
Training. The Company offers training programs for those persons within the
customer organization responsible for evolving the rules that drive the various
processes related to customer interactions. Pegasystems also organizes periodic
user group meetings enabling customers to exchange ideas, learn about product
directions and influence Pegasystems' development process.
Maintenance and Support. Pegasystems provides comprehensive maintenance and
support services, which may include 24 hours a day, 7 days a week customer
service, periodic preventative maintenance, documentation updates and new
software releases.
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<PAGE>
Each organization which licenses the Company's systems is required to enter into
a maintenance contract providing for the payment to the Company of a monthly
maintenance fee over the term of the related license agreement equal to
approximately 18% of the license fee. The Company's maintenance agreements
typically obligate Pegasystems to provide up to a specified number of hours of
consulting and support. Organizations seeking additional consulting and support
services are generally charged an incremental fee ranging between $90 and $170
per hour.
Customers
Pegasystems provides robust and scalable customer service management
solutions that can support thousands of concurrent users based in multiple
countries, speaking different languages, and working with different currencies.
A representative list of the Company's major customers and the uses to which
they apply the Company's products is shown below:
Advanta Services Corporation -- Credit card operations, including telephony
center, correspondence generation, dispute and chargeback processing.
Banco Popular de Puerto Rico -- Retail service center automation, check
research and consumer loan inquiry and service.
Bank of America -- Retail/check customer service and research, automation of
branch support centers. Institutional funds transfer and foreign exchange
customer service for U.S. and European operations. Credit and debit card
correspondence, dispute and chargeback service processing.
Bank of Ireland -- Retail/check clearings and research, automation of branch
support centers, and exception/credit item review and verification.
Banque Nationale de Paris -- Institutional funds transfer service, research
and archive.
Barclays Bank -- Institutional funds transfer and foreign exchange customer
service for international operations. Credit card (merchant and individual)
service including telephony center, correspondence, dispute and chargeback
processing.
Cedel Bank -- Global custody and securities movement and control customer
service.
Citibank -- Global funds transfer and foreign exchange customer service.
Check-related customer service and research. Domestic MasterCard service
including image integration, correspondence, dispute and chargeback processing.
Colonial Group -- Mutual fund customer service supporting telephony center
and correspondence.
Federal Reserve Banks of Boston and San Francisco -- Check processing
customer service, suspense ledger management, research, adjustment and archive.
Fidelity Investments -- Mutual fund customer service supporting telephony
center and correspondence.
First National Bank of Chicago -- Retail/check customer service and research.
Wholesale banking, funds transfer, check, corporate lockbox and interbank
compensation service for global operations.
Franklin/Templeton -- Mutual fund customer service supporting telephony
center, correspondence and research.
Household Credit Services -- Credit card service including telephony center,
correspondence, dispute and chargeback processing. Private label customer
service for major retailers.
Marine Midland -- Institutional funds transfer customer service.
Mellon Bank -- Retail/check customer service, research and archive.
Wholesale, institutional, cash management, and corporate lockbox customer
service.
Prudential Securities -- "All-in-one" account support and service for
brokerage, credit, and clearing transactions.
Trans Union Corporation -- Credit bureau data-management customer service for
institutional customers and real estate property appraisal processing.
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<PAGE>
Sales and Marketing
The Company markets its software and services primarily through a direct
sales force. As of April 30, 1996, the Company's sales force consisted of four
people located in the Company's Cambridge, Massachusetts headquarters, and two
people based in the Company's United Kingdom office. The Company intends to
increase substantially the size of its sales force, which will be necessary if
the Company is to achieve significant revenue growth in the future. Competition
for qualified sales personnel is intense and there can be no assurance that the
Company will be able to attract such personnel. If the Company is unable to hire
additional qualified sales personnel on a timely basis, the Company's business,
operating results and financial condition could be materially and adversely
affected. See "Risk Factors-- Dependence on Key Personnel."
In the future, the Company may market and sell its products through value
added resellers (VARs) and systems integrators. There can be no assurance,
however, that the Company will be able to attract and retain VARs and system
integrators that will be able to market and sell the Company's products
effectively.
To support its sales force, the Company conducts marketing programs which
include trade shows, public relations and seminars. Sales leads are also
generated by the Company's consulting staff.
In 1993, 1994 and 1995, international sales represented 10%, 24% and 10%,
respectively, of the Company's total revenue. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Results of
Operations."
Product Development
Since its inception, the Company has made substantial investments in product
development. The Company believes that its future performance depends on its
ability to maintain and enhance its current products and develop new products.
The Company's product development priorities include (1) developing the
capability of the Company's systems to operate with additional third party
relational databases such as Oracle; (2) developing standard Application
Programming Interfaces that allow other client workstation and server
applications to interoperate with the Company's systems; and (3) enhancing
existing interfaces between the Company's systems and popular applications such
as e-mail, spreadsheets and Lotus Notes.
In 1993, 1994, 1995 and the three months ended March 31, 1996, the Company's
research and development expenses were approximately $3.8 million, $5.4 million,
$7.1 million and $1.6 million, respectively.
Competition
The customer service management software market is intensely competitive and
subject to rapid change. Competitors vary in size and in the scope and breadth
of the products and services offered. The Company encounters competition
primarily from internal information systems departments of potential or current
customers that develop custom software. The Company also competes with: (1)
software companies that target the customer interaction or workflow markets such
as Remedy Corporation, Scopus Technology, Inc. and The Vantive Corporation; (2)
companies that target specific service areas such as DST Systems Inc. and First
Data Corp.; and (3) professional services organizations such as Andersen
Consulting that develop custom software in conjunction with rendering consulting
services. In addition, the Company expects additional competition from other
established and emerging companies, including Oracle Corporation and SAP AG, as
the market continues to develop and expand. Increased competition may result in
price reductions, less beneficial contract terms, reduced gross margins and loss
of market share, any of which could materially and adversely affect the
Company's business, operating results and financial condition.
The Company believes that the principal competitive factors affecting its
market include product features such as adaptability, scalability, ability to
integrate with other products and technologies, functionality and ease-of-use,
the timely development and introduction of new products and product
enhancements, as well as product reputation, quality, performance, price,
customer service and support, and the vendor's reputation. Although the Company
believes that its products currently compete favorably
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<PAGE>
with regard to such factors, there can be no assurance that the Company can
maintain its competitive position against current and potential competitors.
Many of the Company's competitors have greater resources than the Company,
and may be able to respond more quickly and efficiently to new or emerging
technologies, programming languages or standards, or to changes in customer
requirements or preferences. Many of the Company's competitors can devote
greater managerial or financial resources than the Company can to develop,
promote and distribute customer service management software products and provide
related consulting, training and support services. There can be no assurance
that the Company's current or future competitors will not develop products or
services which may be superior in one or more respects to the Company's or which
may gain greater market acceptance. Some of the Company's competitors have
established or may establish cooperative arrangements or strategic alliances
among themselves or with third parties, thus enhancing their abilities to
compete with the Company. It is likely that new competitors will emerge and
rapidly acquire market share. There can be no assurance that the Company will be
able to compete successfully against current or future competitors or that the
competitive pressures faced by the Company will not materially and adversely
affect its business, operating results and financial condition. See "Risk
Factors--Intense Competition."
Intellectual Property and Licenses
The Company relies primarily on a combination of copyright, trademark and
trade secrets laws, as well as confidentiality agreements to protect its
proprietary rights. The Company also has one patent application pending in the
United States relating to the architecture of the Company's systems. While the
Company believes that its pending patent application relates to a patentable
invention, there can be no assurance that such patent application or any future
patent application will be granted or that any patent relied upon by the Company
in the future will not be challenged, invalidated or circumvented or that rights
granted thereunder will provide competitive advantages to the Company. Moreover,
despite the Company's efforts to protect its proprietary rights, unauthorized
parties may attempt to copy aspects of the Company's products or to obtain the
use of information that the Company regards as proprietary. In addition, the
laws of some foreign countries do not protect the Company's proprietary rights
to as great an extent as do the laws of the United States. There can be no
assurance that the Company's means of protecting its proprietary rights will be
adequate or that the Company's competitors will not independently develop
similar technology.
The Company is not aware that any of its products infringes the proprietary
rights of third parties. There can be no assurance, however, that third parties
will not claim infringement by the Company with respect to current or future
products. The Company expects that software product developers will increasingly
be subject to infringement claims as the number of products and competitors in
the Company's industry segment grows and the functionality of products in
different industry segments overlaps. Any such claims, with or without merit,
could be time-consuming, result in costly litigation, cause product shipment
delays or require the Company to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, may not be available on terms
acceptable to the Company or at all, which could have a material adverse effect
upon the Company's business, operating results and financial condition.
From time to time, the Company licenses software from third parties for use
with its products. The Company believes that no such license agreement to which
it is presently a party is material and that if any such license agreement were
to terminate for any reason, the Company would be able to obtain a license or
otherwise acquire other comparable technology or software on terms and on a
timetable that would not be materially adverse to the Company.
Employees
As of April 30, 1996, the Company had a total of 160 employees, of whom 135
were based in the United States and 25 were based in the United Kingdom. Of the
total, 73 were in research and development, 50 were in consulting and customer
support, 15 were in sales and marketing, six were in market strategy and
delivery and 16 were in administration and finance. The Company's future
performance depends in significant part upon the continued service of its key
technical, sales and marketing and senior management personnel and its
continuing ability to attract and retain highly qualified
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<PAGE>
technical, sales and marketing and managerial personnel. Competition for such
personnel is intense and there can be no assurance that the Company will be
successful in attracting or retaining such personnel in the future. None of
the Company's employees is represented by a labor union or is subject to a
collective bargaining agreement. The Company has not experienced any work
stoppages and considers its relations with its employees to be good. See
"Risk Factors--Dependence on Key Personnel."
Facilities
Pegasystems' principal administrative, sales, marketing, support, and
research and development operations are located in a 35,000 square foot leased
facility in Cambridge, Massachusetts. The lease for this facility expires in
March 1997, subject to the Company's option to extend the term for up to eight
additional years. The Company also leases offices in New York, New York,
Chicago, Illinois, Dallas, Texas, San Francisco, California and Reading, United
Kingdom pursuant to leases expiring between March 1997 and July 2006. The
Company believes that additional or alternative space will be available in the
future on commercially reasonable terms as needed.
Legal Proceedings
The Company is not a party to any material pending litigation or other
legal proceedings.
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MANAGEMENT
Executive Officers and Directors
The executive officers and directors of the Company and their ages are as
follows:
<TABLE>
<CAPTION>
Name Age Position
- ------------------------- - --------------------------------------------
<S> <C> <C>
Alan Trefler 40 President, Clerk and Director
Clifford R. Balzer 45 Vice President of Reengineering and Client
Services
Eugene A. Bonte 45 Vice President of Market Strategy and
Delivery
Joseph J. Friscia 41 Vice President of Sales and Marketing
Kenneth W. Olson 46 Vice President of Technical Development
Michael R. Pyle 41 Vice President of Applications Development
Ira Vishner 42 Vice President of Corporate Services,
Treasurer, Chief Financial Officer and
Director
Edward A. Maybury(1)(2) 56 Director
Edward B. Roberts(1) 60 Director
Leonard A. Schlesinger(2) 43 Director
Thomas E. Swithenbank 51 Director
</TABLE>
- -------------
(1) Member of Audit Committee
(2) Member of Compensation Committee
Alan Trefler, a founder of the Company, has served as President and Clerk and
has been a director since the Company's organization in 1983. Prior thereto, he
managed an electronic funds transfer product for TMI Systems Corporation, a
software and services company. Mr. Trefler holds a degree in economics and
computer science from Dartmouth College.
Clifford R. Balzer joined the Company in December 1995 as Vice President
of Reengineering and Client Services. From January through November 1995, he
was a Senior Consultant for Arthur D. Little, a research and consulting firm.
From July 1990 through January 1995, Mr. Balzer was employed as a Director of
U.S. Consulting by DMR Group, Inc., an international consulting firm. Mr.
Balzer holds a B.A. from Kansas Wesleyan University and an M.B.A. from
Fordham University.
Eugene A. Bonte joined the Company in April 1996 as Vice President of
Market Strategy and Development. He was a founder of Object Design, Inc., a
developer of object database management systems and tools, where he served as
Vice President from August 1988 through September 1995 and was responsible,
at different times, for marketing, corporate development and product
management. Mr. Bonte holds a B.A. from The Johns Hopkins University and an
M.B.A. from the Harvard Business School.
Joseph J. Friscia joined the Company in 1984 to establish its New York
office and has served as Vice President of Sales and Marketing since 1987.
Prior to joining the Company, he worked as a money transfer operations
manager with Bankers Trust Company and J. Henry Schroder Bank and Trust
Company. Mr. Friscia holds a B.A. from Long Island University and an M.B.A.
from Adelphi University.
Kenneth W. Olson, a founder of the Company, has served as Vice President
of Technical Development since 1983. Prior thereto, he managed the
development of specialized computer systems for large-volume transaction
processing for TMI Systems Corporation. Mr. Olson holds an S.B. in Humanities
and Sciences from the Massachusetts Institute of Technology.
Michael R. Pyle joined the Company in 1985 as an application development
manager and has been Vice President of Applications Development since 1990.
Mr. Pyle holds a B.C.S. from the CS College in
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London. Prior to joining the Company, Mr. Pyle worked in Europe and the
United States developing and deploying large-scale communications systems for
the financial and commercial sectors.
Ira Vishner, a founder of the Company, has served as Vice President of
Corporate Services, Treasurer and Chief Financial Officer of the Company since
1983 and has been a director since 1994. Prior to 1983, he worked in the
executive offices of TMI Systems Corporation where he was responsible for
corporate planning, financial analysis and product marketing. Mr. Vishner holds
an S.B. in Mathematics from the Massachusetts Institute of Technology.
Edward A. Maybury has been a director of the Company since its organization
in 1983. Since July 1991, he has served as a director, and from July 1991
through May 1993 was the President and Chief Executive Officer, of Creative
Systems, Inc., a software and services company. Prior thereto, Mr. Maybury was
the Chief Executive Officer of Data Architect Systems, Inc., a software and
services company.
Edward B. Roberts has been a director of the Company since June 1996. Since
1961, he has been a Professor of Management of Technologies at the Massachusetts
Institute of Technology. He was co-founder and chairman, from 1963 until June
1995, of Pugh-Roberts Associates, Inc., an international management consulting
firm specializing in strategic planning and technology management. In addition,
Dr. Roberts co-founded and is a director of Medical Information Technology,
Inc., a provider of hospital information systems. Dr. Roberts is also a director
of Advanced Magnetics, Inc., a medical imaging company, and Selfcare, Inc., a
manufacturer of home medical diagnostic products, and is a general partner of
Zero Stage Capital, a venture capital firm.
Leonard A. Schlesinger has been a director of the Company since June 1996. He
has been a Professor of Business Administration at the Harvard Business School
since 1988, where he is chairman of the Service Management Group, an
interdisciplinary faculty group that focuses on customer service. Professor
Schlesinger is also a director of Limited, Inc., a clothing retailer, and
Borders Group, Inc., a book and movie store chain.
Thomas E. Swithenbank has been a director of the Company since June 1996.
Since 1990, he has been President and Chief Executive Officer of Harte-Hanks
Data Technologies, a computer software and servicing company specializing in
database marketing systems. Prior thereto, Mr. Swithenbank was President of
International Data Corporation, a world-wide computer marketing consulting
firm. Mr. Swithenbank has an A. B. from Harvard University and an M.B.A. from
the Harvard Business School.
Classes of Directors
Following this offering, the Board of Directors will be divided into three
classes, each of whose members will serve for a staggered three-year term.
Messrs. Swithenbank and Trefler will serve in the class whose term expires in
1997; Messrs. Maybury and Schlesinger will serve in the class whose term expires
in 1998; and Messrs. Roberts and Vishner will serve in the class whose term
expires in 1999. Upon the expiration of the term of a class of directors,
directors within such class will be elected for a three-year term at the annual
meeting of stockholders in the year in which such term expires.
Executive Officers
Executive officers of the Company are elected by the Board of Directors on an
annual basis and serve until the next annual meeting of the Board of Directors
and until their successors have been duly elected and qualified. There are no
family relationships among any of the executive officers or directors of the
Company.
Board Committees
The Company's Board of Directors has established an Audit Committee and a
Compensation Committee. The Audit Committee is responsible for nominating the
Company's independent accountants for approval by the Board of Directors,
reviewing the scope, results and costs of the audit with the Company's
independent accountants and reviewing the financial statements of the
Company. Messrs. Maybury and Roberts are currently the members of the Audit
Committee. The Compensation Committee is responsible for recommending
compensation and benefits for the executive officers of the Company to the
Board of Directors and for administering the Company's stock plans. Messrs.
Maybury and Schlesinger are currently the members of the Compensation
Committee.
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Director Compensation
Each non-employee director of the Company receives $1,000 for every Board or
committee meeting attended. The Company also reimburses non-employee directors
for expenses incurred in attending Board meetings. In addition, non-employee
directors of the Company will receive stock options under the 1996 Non-Employee
Director Stock Option Plan. See "Management--Stock Plans." No other compensation
is paid to directors for attending Board or committee meetings. Messrs. Maybury,
Roberts, Schlesinger and Swithenbank are currently the non-employee directors of
the Company.
Executive Compensation
The following table sets forth all compensation awarded to, earned by or paid
for services rendered to the Company in all capacities during the year ended
December 31, 1995 by (i) the Company's Chief Executive Officer and (ii) the four
most highly compensated other executive officers who received annual
compensation in excess of $100,000 (collectively, the "Named Executive
Officers"):
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation
(1)
--------------------
All Other
Name and Principal Position Salary Bonus Compensation
- ---------------------------------------------- ------- --------- -------------
<S> <C> <C> <C>
Alan Trefler, President $171,250 $23,545(2) --
Joseph J. Friscia, Vice President of Sales and
Marketing 124,583 24,154(3) --
Michael R. Pyle, Vice President of
Applications Development 102,083 23,044(2) --
Ira Vishner, Vice President of Corporate
Services, Treasurer and Chief Financial
Officer 100,500 16,892(2) $ 8,483 (4)
Kenneth W. Olson, Vice President of Technical
Development 98,083 13,118(2) 30,000 (4)
</TABLE>
- -------------
(1) In accordance with the rules of the Securities and Exchange Commission,
other compensation in the form of perquisites and other personal benefits
has been omitted because the aggregate amount of such perquisites and other
personal benefits constituted less than the lesser of $50,000 or 10% of the
total of annual salary and bonuses for each of the Named Executive Officers
for 1995.
(2) The amounts presented are bonuses earned between July 1994 and June 1995,
and paid in 1995. Bonuses, if any, for the period from July 1995 through
June 1996 have not yet been determined.
(3) The amount presented is bonus earned in 1995 and paid in February 1996.
Mr. Friscia earned a bonus of $66,650 in 1994, which was paid in February
1995.
(4) Represents payments in lieu of paid days off.
Option Grants
No stock options or stock appreciation rights ("SARs") were granted to any of
the Named Executive Officers during 1995.
38
<PAGE>
Year-End Option Table
The following table sets forth certain information concerning the number and
value of unexercised stock options held by each of the Named Executive Officers
as of December 31, 1995. No SARs or stock options were exercised during 1995.
Year-End Option Values
<TABLE>
<CAPTION>
Number of Shares
Underlying Value of Unexercised
Unexercised Options In-the-Money Options at
at Year-End (1) Year-End (2)
-------------------------- ----------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Alan Trefler -- -- -- --
Joseph J.
Friscia 180,000 216,000(3) $2,281,212 $2,737,454
Michael R. Pyle 151,200 172,800(3) 1,916,218 2,189,963
Ira Vishner -- -- -- --
Kenneth W. Olson -- -- -- --
</TABLE>
- -------------
(1) The exercise price for each of the unexercised options included in the above
table is approximately $0.33 per share.
(2) There was no public trading market for the Common Stock as of December 31,
1995. Accordingly, as permitted by the rules of the Securities and Exchange
Commission, these values have been calculated on the basis of an assumed
market value of $13.00 per share, which is the mid-point of the estimated
initial public offering price range of $12.00 to $14.00 per share.
(3) These options vest in equal installments on December 29, 1996, 1997, 1998
and 1999.
Merit Payment Program
The Company frequently awards merit payments to its employees as part of a
performance assessment process, under which employees may be awarded cash
payments based upon individual performance. All employees are eligible to
receive merit payments. Historically, the Company's supervisors have been
responsible for recommending the amount of merit payment for each of the
employees under their direct review. These recommendations are then reviewed by
the Board of Directors to promote consistency among departments. Awards of merit
payments are made at the discretion of supervisors and the Board of Directors,
based upon their opinions of employees' respective contributions to the Company.
Awards have generally been made in connection with annual employee reviews.
Sales Compensation
In addition to base salary, the Company pays commissions to its sales
personnel based on the attainment of annual sales quotas, monthly fees generated
during the period from July 1 through June 30 of each year, and cash received by
the Company from new accounts within one year after the initial signing of a
contract with a customer.
Stock Plans
1994 Long-Term Incentive Plan
The Company's 1994 Long-Term Incentive Plan (the "1994 Plan") was adopted by
the Board of Directors on November 23, 1994, and approved by the stockholders on
April 21, 1995. The 1994 Plan provides for the issuance of a maximum of
5,000,000 shares of Common Stock pursuant to the grant of incentive stock
options ("ISOs") to employees and nonqualified stock options ("NSOs"), stock
appreciation rights ("SARs"), restricted stock or long-term performance awards
to employees, consultants, directors and officers of the Company. Long-term
performance awards may be made in cash or in stock, must be awarded in
connection with a performance period of at least two years, and are based on
performance objectives determined by the Compensation Committee. At April 30,
1996, the Company had 161 employees eligible to participate in the 1994 Plan and
options to purchase 2,409,000 were outstanding. To date, no restricted stock,
SARs or long-term performance awards have been granted under the 1994 Plan.
39
<PAGE>
The 1994 Plan is administered by the Compensation Committee of the Board of
Directors (the "Compensation Committee"). Subject to the provisions of the 1994
Plan, the Compensation Committee has the authority to select the optionees or
SAR, long-term performance award or restricted stock recipients and determine
the terms of the options, SARs, long-term performance awards or restricted stock
granted, including: (i) the number of shares or SARs; (ii) the option exercise
terms; (iii) the amount of awards; (iv) the exercise or purchase price (which in
the case of an incentive stock option cannot be less than the market price of
the Common Stock as of the date of grant); (v) the type and duration of transfer
or other restrictions; and (vi) the time and form of payment for restricted
stock and upon exercise of options. Generally, an option is not transferable by
the optionholder except by will or by the laws of descent and distribution. No
option may be exercised following termination for cause or voluntary
termination, or more than three months following involuntary termination. Upon
termination due to death, an option is exercisable for a maximum of one year
after such termination, and upon termination due to disability, the option is
exercisable for a maximum of two years after such termination.
Federal Income Tax Consequences. The following is a brief description of
the federal income tax consequences related to options awarded under the 1994
Plan.
ISOs. A participant who receives an ISO will recognize no taxable income for
regular federal income tax purposes upon either the grant or the exercise of
such ISO. However, when a participant exercises an ISO, the difference between
the fair market value of the shares purchased and the option price of those
shares will be includible in determining the participant's alternative minimum
taxable income.
If the shares are retained by the participant for at least one year from date
of exercise and two years from date of grant of the option, gain will be taxable
to the participant, upon sale of the shares acquired upon exercise of the ISO,
as a long-term capital gain. In general, the adjusted basis for the shares
acquired upon exercise will be the option price paid with respect to such
exercise. The Company will not be entitled to a tax deduction upon the exercise
of an ISO.
If the shares are sold within a period of one year from the date of exercise
or two years from the date of grant of the ISO, the participant will be required
to recognize ordinary income equal to the difference between the option price
and the lesser of the fair market value of the shares on the date of exercise or
the amount realized on the sale or exchange of the shares and the Company will
be entitled to a tax deduction of an equal amount. Any additional gain will be
treated as long-term capital gain if the shares are held for more than one year
prior to the sale and as short-term capital gain if the shares are held for a
shorter period. If the participant sells the stock for less than the option
price, the participant will recognize a capital loss equal to the difference
between the sale price and the option price. The loss will be a long- term
capital loss if the shares are held for more than one year prior to the sale and
short-term if the shares are held for a shorter period.
NSOs. A participant will not recognize taxable income for federal income tax
purposes at the time an NSO is granted. However, the participant will recognize
compensation taxable as ordinary income at the time of exercise for all shares
which are not subject to a substantial risk of forfeiture. The amount of such
compensation will be the difference between the option price and the fair market
value of the shares on the date of exercise of the option. The Company will be
entitled to a deduction for federal income tax purposes at the same time and in
the same amount as the participant is deemed to have recognized compensation
income with respect to shares received upon exercise of the NSO. The
participant's basis in the shares will be adjusted by adding the amount so
recognized as compensation to the purchase price paid by the participant for the
shares.
The participant will recognize gain or loss when he or she disposes of shares
obtained upon exercise of an NSO in an amount equal to the difference between
the selling price and the participant's tax basis in such shares. Such gain or
loss will be treated as long-term or short-term capital gain or loss, depending
upon the holding period.
40
<PAGE>
1996 Non-Employee Director Stock Option Plan
The 1996 Non-Employee Director Stock Option Plan (the "Director Plan") was
adopted by the Board of Directors on May 13, 1996 and approved by the
stockholders on June 26, 1996. The Director Plan provides for the grant of
options for the purchase of up to 250,000 shares of Common Stock of the Company.
To date, no options have been granted under the Director Plan.
The Director Plan is administered by the Compensation Committee and provides
that each person who becomes a director of the Company after May 13, 1996, and
who is not also an employee of the Company will receive upon initial election to
the Board of Directors an option to purchase 30,000 shares of Common Stock
vesting in equal annual installments over five years. The exercise price for all
options granted under the Director Plan will be equal to the market price of the
Common Stock as of the date of grant. Options may not be assigned or transferred
except by will or by the laws of descent and distribution and are exercisable,
only to the extent vested, within 90 days after the optionee ceases to serve as
a director of the Company (except that if a director dies or becomes disabled
while he or she is serving as a director of the Company, the option is
exercisable until the earlier of the scheduled expiration date of the option or
one year from the date of death or disability).
Federal Income Tax Consequences. All options granted under the Director Plan
are NSOs. See the discussion concerning the 1994 Plan above for a description of
the federal income tax consequences of NSOs.
1996 Employee Stock Purchase Plan
The 1996 Employee Stock Purchase Plan (the "Stock Purchase Plan") was adopted
by the Board of Directors on May 13, 1996 and approved by the stockholders on
June 26, 1996. An aggregate of 500,000 shares of Common Stock are reserved for
issuance pursuant to this plan.
The Stock Purchase Plan is administered by the Compensation Committee. All
employees of the Company whose customary employment is in excess of 20 hours per
week and more than five months per year, other than those employees who own 5%
or more of the stock of the Company, are eligible to participate in the Stock
Purchase Plan. As of April 30, 1996, approximately 135 of the Company's
employees would have been eligible to participate in the Stock Purchase Plan.
The Stock Purchase Plan will be implemented by one or more offerings of such
duration as the Compensation Committee may determine, provided that no offering
period may be longer than 27 months. An eligible employee participating in an
offering will be able to purchase Common Stock at a price equal to the lesser
of: (i) 85% of its fair market value on the date the right was granted, or (ii)
85% of its fair market value on the date the right was exercised. Payment for
Common Stock purchased under the Stock Purchase Plan will be through regular
payroll deduction or lump sum cash payment, or both, as determined by the
Compensation Committee. The maximum value of Common Stock an employee may
purchase during an offering period is 10% of the employee's base salary during
such period, calculated on the basis of the employee's compensation rate on the
date the employee elects to participate in that offering.
To date, there have been no offerings under the Stock Purchase Plan and no
shares of Common Stock have been issued thereunder.
Federal Income Tax Consequences. The Stock Purchase Plan is intended to
qualify as an "employee stock purchase plan" as defined in Section 423 of the
Internal Revenue Code of 1986, as amended (the "Code") which provides that an
employee will not realize any federal tax consequences when such employee joins
the Stock Purchase Plan, or when an offering ends and such employee receives
shares of the Company's Common Stock. An employee must, however, recognize
income or loss on the difference, if any, between the price at which he or she
sells the shares and the price he or she paid for them. If any employee has
owned shares purchased under the plan for more than one year, disposes of them
at least two years after the date the offering commenced, and the market price
of the shares on the date of sale is equal to or less than the purchase price
under the Stock Purchase Plan, he or she will recognize a long-term capital loss
in the amount equal to the price paid over the sale price. If an employee has
owned shares for more than one year, more than two years has elapsed from the
date the offering commenced, and the market price of the shares on the date of
sale is higher than the purchase price under the Stock Purchase Plan, the
employee must recognize ordinary income in an amount equal to the lesser of (i)
the fair market value of the shares on the day the offering
41
<PAGE>
commenced over the price paid, or (ii) the excess of the amount actually
received for the shares over the purchase price. Any further gain would be
treated as long-term capital gain.
If an employee sells shares purchased under the Stock Purchase Plan prior to
holding them for more than one year or prior to two years from the date the
offering commenced, he or she must recognize ordinary income in the amount of
the difference between the price he or she paid and the market price of the
shares on the date of purchase and the Company will receive an expense deduction
for the same amount. The employee will recognize a capital gain or loss on the
difference between the sale price and the market price on the date of purchase.
The Company will not be entitled to a tax deduction upon either the purchase or
sale of shares under the Stock Purchase Plan if the holding period requirements
set forth above are met. The Stock Purchase Plan is not qualified under Section
401(a) of the Code.
401(k) Plan
In December 1989, the Company adopted a tax-qualified employee savings and
retirement plan (the "401(k) Plan") covering all of the Company's domestic
employees upon commencement of employment and attainment of the age of 18.
Participants may elect to contribute to the 401(k) Plan up to the lesser of the
statutorily prescribed annual limit ($9,500 in 1996) or 20% of their total
pre-tax compensation. The 401(k) Plan permits, but does not require, the Company
to make additional matching contributions on behalf of participants. The 401(k)
Plan is intended to qualify under Section 401 of the Code so that contributions
by employees or by the Company to the 401(k) Plan, and income earned on plan
contributions, are not taxable to employees until withdrawn from the 401(k)
Plan, and so that contributions by the Company, if any, will be deductible by
the Company when made. Participants are fully vested in their deferred salary
contributions, and Company contributions, if any, vest 20% after three years and
an additional 20% on each anniversary thereof. The administrator of the 401(k)
Plan, at the direction of each participant, invests the plan assets of such
participant among various investment options. Participants have the option of
obtaining loans from the 401(k) Plan secured by their account balances.
Vacation Policy
The Company generally provides its employees with a flexible vacation and
paid time off policy. This policy provides that employees are given one block of
paid days off for all uses, including vacation, sick days, personal days and
holidays. The number of paid days off given to each employee per year varies
according to each employee's length of service with the Company. Unused paid
days off are carried over from year to year. Employees are generally entitled to
payment in cash for the value of unused paid days off. The Company retains the
right to repurchase paid days off in excess of thirty at the end of any quarter
from employees who have accumulated more than thirty paid days off.
Compensation Committee Interlocks and Insider Participation
In 1995, decisions concerning compensation of executive officers were made by
the Board of Directors which included Mr. Trefler, the President of the Company,
and Mr. Vishner, a Vice President and the Chief Financial Officer of the
Company. The Company recently established a Compensation Committee of its Board
of Directors, which currently consists of Messrs. Maybury and Schlesinger. No
executive officer of the Company has served as a director or member of the
compensation committee (or other committee serving an equivalent function) of
any other entity, whose executive officers served as a director of the Company.
CERTAIN TRANSACTIONS
The Company has adopted a policy whereby all future transactions between the
Company and its officers, directors, principal stockholders and their affiliates
will be on terms no less favorable to the Company than could be obtained from
unrelated third parties and will be approved by a majority of the disinterested
members of the Company's Board of Directors. No such transactions are currently
being considered.
The Company borrowed $230,000 from its President, Alan Trefler, in order to
increase the Company's working capital and to fund operations. This loan, which
was evidenced by a note renewed in January 1993 and bore interest at a rate of
8.5% per annum, was repaid in full by the Company in 1995.
42
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of May 13, 1996, and as adjusted for
the sale of the shares of Common Stock offered hereby, by: (i) each person who
is known by the Company to own beneficially more than 5% of the Common Stock,
(ii) each director and Named Executive Officer of the Company, (iii) all
directors and executive officers of the Company as a group, and (iv) each
Selling Stockholder. Unless otherwise indicated below, to the knowledge of the
Company, all persons listed below have sole voting and investment power with
respect to their shares of Common Stock, except to the extent authority is
shared by spouses under applicable law.
<TABLE>
<CAPTION>
Shares Beneficially Shares to be
Owned Prior to Beneficially Owned
Offering (1) After Offering (1) (2)
------------------- ----------------------
Number
of
Number of Shares Number of
Name Shares Percent Offered Shares Percent
- -------------------------- --------- ------ ------- --------- ---------
<S> <C> <C> <C> <C> <C>
Alan Trefler 22,488,000 95.7% 385,900 22,102,100 84.1%
Joseph J. Friscia (3) 234,000 * 90,000 144,000 *
Michael R. Pyle (4) 151,200 * 64,800 86,400 *
Ira Vishner 346,500 1.5 69,300 277,200 1.1
Kenneth W. Olson 450,000 1.9 90,000 360,000 1.4
Edward A. Maybury -- -- -- -- --
Edward B. Roberts -- -- -- -- --
Leonard A. Schlesinger -- -- -- -- --
Thomas E. Swithenbank -- -- -- -- --
All directors and
executive officers as a
group (11 persons) (5) 23,669,700 99.4 700,000 22,969,700 86.6
</TABLE>
- -------------
* Less than 1% of the outstanding Common Stock.
(1) The number of shares of Common Stock deemed outstanding prior to the
offering includes (i) 23,490,000 shares of Common Stock outstanding as of
May 13, 1996 and (ii) shares issuable pursuant to outstanding options held
by the respective person or group which are currently exercisable or which
will be exercisable within 60 days of May 13, 1996, as set forth below. The
number of shares of Common Stock deemed outstanding after this offering
includes (i) 2,700,000 shares which are being offered for sale by the
Company in this offering and (ii) 100,800 shares issuable upon exercise of
stock options to be exercised immediately prior to the closing of this
offering.
(2) Assumes no exercise of the Underwriters' over-allotment option.
(3) Shares beneficially owned prior to offering includes 180,000 shares of
Common Stock subject to stock options exercisable within 60 days of May 13,
1996, 36,000 of which shares will be issued upon the exercise of options
immediately prior to the closing of this offering; shares to be beneficially
owned after offering consists solely of shares of Common Stock subject to
stock options exercisable within 60 days of May 13, 1996.
(4) Consists solely of shares of Common Stock subject to stock options
exercisable within 60 days of May 13, 1996, 64,800 of which shares will be
issued upon the exercise of options immediately prior to the closing of this
offering.
(5) Shares beneficially owned prior to offering includes 331,200 shares of
Common Stock subject to stock options exercisable within 60 days of May 13,
1996, 100,800 of which shares will be issued upon the exercise of options
immediately prior to the closing of this offering; shares to be beneficially
owned after offering includes 230,400 shares of Common Stock subject to
stock options exercisable within 60 days of May 13, 1996.
43
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Effective upon the filing of the Restated Articles of Organization (the
"Restated Articles") prior to this offering, the authorized capital stock of the
Company will consist of 45,000,000 shares of Common Stock, $.01 par value per
share, and 1,000,000 shares of preferred stock, $.01 par value per share (the
"Preferred Stock"), which may be issued in one or more series.
Common Stock
As of May 13, 1996, there were 23,490,000 shares of Common Stock outstanding
and held of record by twelve stockholders. Based upon the number of shares
outstanding as of that date and giving effect to (i) the issuance of the
2,700,000 shares of Common Stock offered by the Company hereby, and (ii) the
exercise of options to purchase 100,800 shares of Common Stock anticipated to
occur immediately prior to the closing of this offering, there will be
26,290,800 shares of Common Stock outstanding upon the closing of this offering.
Holders of Common Stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders and do not have cumulative voting
rights. Accordingly, holders of a majority of the shares of Common Stock
entitled to vote in any election of directors may elect all of the directors
standing for election. Holders of Common Stock are entitled to receive ratably
such dividends, if any, as may be declared by the Board of Directors out of
funds legally available therefor, subject to any preferential dividend rights of
outstanding Preferred Stock. Upon the liquidation, dissolution or winding up of
the Company, the holders of Common Stock are entitled to receive ratably the net
assets of the Company available after the payment of all debts and other
liabilities and subject to the prior rights of any outstanding Preferred Stock.
Holders of the Common Stock have no preemptive, subscription, redemption or
conversion rights. The outstanding shares of Common Stock are, and the shares
offered by the Company in this offering will be, when issued and paid for, fully
paid and nonassessable. The rights, preferences and privileges of holders of
Common Stock are subject to, and may be adversely affected by, the rights of the
holders of shares of any series of Preferred Stock which the Company may
designate and issue in the future. Upon the closing of this offering, there will
be no shares of Preferred Stock outstanding.
Preferred Stock
Upon filing of the Restated Articles, the Board of Directors will be
authorized, subject to certain limitations prescribed by law, without further
stockholder approval, to issue from time to time up to an aggregate of 1,000,000
shares of Preferred Stock in one or more series and to fix or alter the
designations, preferences, rights and any qualifications, limitations or
restrictions of the shares of each such series thereof, including the dividend
rights, dividend rates, conversion rights, voting rights, terms of redemption
(including sinking fund provisions), redemption price or prices, liquidation
preferences and the number of shares constituting any series or designations of
such series. The issuance of Preferred Stock may have the effect of delaying,
deferring or preventing a change of control of the Company. The Company has no
present plans to issue any shares of Preferred Stock. See "Risk
Factors--Potential Adverse Effects of Anti-Takeover Provisions; Possible
Issuance of Preferred Stock."
Massachusetts Law and Certain Provisions of the Company's Restated Articles
of Organization and Restated By-Laws
Following this offering, the Company expects that it will have more than 200
stockholders, thus making it subject to Chapter 110F of the Massachusetts
General Laws, an anti-takeover law. In general, this statute prohibits a
publicly held Massachusetts corporation from engaging in a "business
combination" with an "interested stockholder" for a period of three years after
the date of the transaction in which the person becomes an interested
stockholder, unless (i) the interested stockholder obtains the approval of the
Board of Directors prior to becoming an interested stockholder, (ii) the
interested stockholder acquires 90% of the outstanding voting stock of the
corporation (excluding shares held by certain affiliates of the corporation) at
the time it becomes an interested stockholder, or (iii) the business combination
is approved by both the Board of Directors and the holders of two-thirds of the
outstanding voting stock of the corporation (excluding shares held by the
interested stockholder). An "interested stockholder" is a person who, together
with affiliates and associates, owns (or at any time within the prior three
years did own)
44
<PAGE>
5% or more of the outstanding voting stock of the corporation. A "business
combination" includes a merger, a stock or asset sale, and certain other
transactions resulting in a financial benefit to the interested stockholder.
The Company's Restated Articles and the Restated By-Laws (the "Restated
By-Laws") provide for a classified board of directors consisting of three
classes as nearly equal in size as possible. See "Management--Executive Officers
and Directors." In addition, the Restated Articles and Restated By-Laws provide
that directors may be removed only for cause by the affirmative vote of the
holders of at least 80% of the shares issued outstanding and entitled to vote.
Under the Restated Articles and Restated By-Laws, any vacancy, however
occurring, including a vacancy resulting from an enlargement of the Board, may
only be filled by a vote of a majority of the directors then in office. The
classification of the Board of Directors and the limitations on the removal of
directors and filling of vacancies could have the effect of making it more
difficult for a third party to acquire, or of discouraging a third party from
acquiring, control of the Company.
The Restated By-Laws include a provision excluding the Company from the
applicability of Massachusetts General Laws Chapter 110D, entitled "Regulation
of Control Share Acquisitions". In general, this statute provides that any
stockholder of a corporation subject to this statute who acquires 20% or more of
the outstanding voting stock of a corporation may not vote such stock unless the
stockholders of the corporation so authorize. The Board of Directors may amend
the Company's Restated By-Laws at any time to subject the Company to this
statute prospectively.
The Restated By-Laws also require that a stockholder seeking to have any
business conducted at a meeting of stockholders give notice to the Company not
less than 90 days prior to the scheduled meeting. The notice from the
stockholder must describe the proposed business to be brought before the meeting
and include information about the stockholder making the proposal, any
beneficial owner on whose behalf the proposal is made and any other stockholder
known to be supporting the proposal. The Restated By- Laws further provide that
a special stockholders meeting may be called by the president or the Board of
Directors or upon the request of stockholders holding at least 40% of the voting
power of the Company. These provisions may discourage another person or entity
from making a tender offer for the Company's Common Stock, because such person
or entity, even if it acquired a majority of the outstanding shares, would be
able to take action as a stockholder (such as electing new directors or
approving a merger) only at a duly called stockholders meeting.
The Massachusetts General Laws provide generally that the affirmative vote of
a majority of the shares entitled to vote on any matter is required to amend a
corporation's articles of organization or by- laws, unless a corporation's
articles of organization or by-laws, as the case may be, require a greater
percentage. The Restated Articles and Restated By-Laws require the affirmative
vote of the holders of at least 80% of the shares issued, outstanding and
entitled to vote to amend or repeal any of the provisions described in the
previous three paragraphs.
The Restated By-Laws provide that the directors, officers, employees and
certain other agents of the Company shall be indemnified by the Company to the
fullest extent authorized by Massachusetts law, as it now exists or may in the
future be amended, against all expenses and liabilities reasonably incurred in
connection with service for or on behalf of the Company. In addition, the
Restated Articles provide that the directors of the Company will not be
personally liable for monetary damages to the Company for breaches of their
fiduciary duty as directors, unless they violated their duty of loyalty to the
Company or its stockholders, acted in bad faith, knowingly or intentionally
violated the law, authorized illegal dividends or redemptions or derived an
improper personal benefit from their action as directors.
Transfer Agent and Registrar
The transfer agent and registrar for the Company's Common Stock is Fleet
National Bank.
45
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon the closing of this offering, the Company will have an aggregate of
26,290,800 shares of Common Stock outstanding, assuming no exercise of the
Underwriters' over-allotment option and no exercise of outstanding options to
purchase Common Stock other than the options to purchase 100,800 shares to be
exercised immediately prior to the closing of this offering by certain Selling
Stockholders. Of these shares, the 3,400,000 shares sold in this offering are
freely tradable without restriction or further registration under the Securities
Act of 1933, as amended (the "Securities Act"), except that any shares held by
"affiliates" of the Company, as that term is defined in Rule 144 under the
Securities Act ("Rule 144"), may generally only be sold in compliance with the
limitations of Rule 144 described below.
The remaining 22,890,800 shares of Common Stock are deemed "Restricted
Securities" as defined under Rule 144. Restricted Securities may be sold in the
public market only if registered or if they qualify for an exemption from
registration under Rules 144, 144(k) or 701 promulgated under the Securities
Act, which rules are summarized below. Subject to the executive officers and
directors of the Company entering into lock-up agreements described below and
the provisions of Rules 144, 144(k) and 701, additional shares will be available
for sale in the public market (subject in the case of shares held by affiliates
to compliance with certain volume restrictions) as follows: (i) 12,000 shares
will be available for immediate sale in the public market on the date of this
Prospectus, (ii) 139,500 shares will be eligible for sale 90 days after the date
of this Prospectus and (iii) 22,739,300 shares will be eligible for sale upon
the expiration of lock-up agreements 180 days after the date of this Prospectus.
In general, under Rule 144 as currently in effect, a person (or persons whose
shares are aggregated), including an affiliate, who has beneficially owned
shares for at least two years is entitled to sell, within any three-month period
commencing 90 days after the date of this Prospectus, a number of shares that
does not exceed the greater of (i) 1% of the then outstanding shares of Common
Stock (approximately 262,000 shares immediately after this offering) or (ii) the
average weekly trading volume in the Common Stock during the four calendar weeks
preceding the date on which notice of such sale is filed, subject to certain
restrictions. In addition, a person who is not deemed to have been an affiliate
of the Company at any time during the 90 days preceding a sale and who has
beneficially owned the shares proposed to be sold for at least three years would
be entitled to sell such shares under Rule 144(k) without regard to the
requirements described above. To the extent that shares were acquired from an
affiliate of the Company, such stockholder's holding period for the purpose of
effecting a sale under Rule 144 commences on the date of transfer from the
affiliate. The Securities and Exchange Commission has recently proposed to
reduce the two- and three-year holding periods under Rule 144 to one and two
years, respectively. If enacted, such modifications will have material effect on
the timing of when certain shares of Common Stock become eligible for resale.
Rule 701 promulgated under the Securities Act provides that shares of Common
Stock acquired pursuant to written plans such as the 1994 Plan may be resold by
persons other than affiliates, beginning 90 days after the date of this
Prospectus, subject only to the manner of sale provisions of Rule 144, and by
affiliates, beginning 90 days after the date of this Prospectus, subject to all
provisions of Rule 144 except its two-year minimum holding period.
Shortly after the date of this Prospectus, the Company intends to file a Form
S-8 registration statement under the Securities Act to register all shares of
Common Stock issuable under the 1994 Plan, the Director Plan and the Stock
Purchase Plan (collectively, the "Stock Plans"). See "Management--Stock Plans."
Such registration statement is expected to become effective immediately upon
filing, and shares covered by that registration statement will thereupon be
eligible for sale in the public markets, subject to Rule 144 limitations
applicable to affiliates.
Prior to this offering, there has not been any public market for the Common
Stock of the Company, and no prediction can be made as to the effect, if any,
that market sales of shares of Common Stock or the availability of shares for
sale will have on the market price of the Common Stock prevailing from time to
time. Nevertheless, sales of substantial amounts of Common Stock in the public
market could adversely affect the market price of the Common Stock and could
impair the Company's future ability to raise capital through the sale of its
equity securities.
46
<PAGE>
Except to the extent they have agreed to sell shares in the offering, all
directors and officers, who hold in the aggregate 23,338,500 shares of Common
Stock and options to purchase 906,000 shares of Common Stock, have agreed,
pursuant to agreements with the representatives of the Underwriters, that they
will not, without the prior written consent of the representatives of the
Underwriters, sell or otherwise dispose of any shares of Common Stock or options
to acquire shares of Common Stock during the 180-day period following the date
of this Prospectus.
The Company has agreed not to sell or otherwise dispose of any shares of
Common Stock during the 180-day period following the date of the Prospectus,
except the Company may issue, and grant options to purchase, shares of Common
Stock under the Stock Plans. In addition, the Company may issue shares of Common
Stock in connection with any acquisition of another company if the terms of such
issuance provide that such Common Stock shall not be resold prior to the
expiration of the 180-day period referenced in the preceding sentence.
LEGAL MATTERS
The validity of the shares of Common Stock offered by this Prospectus will be
passed upon for the Company and the Selling Stockholders by Choate, Hall &
Stewart, Boston, Massachusetts. Certain legal matters in connection with the
offering will be passed upon for the Underwriters by Hale and Dorr, Boston,
Massachusetts.
EXPERTS
The consolidated financial statements of Pegasystems Inc., at December 31,
1994 and 1995 and for each of the three years in the period ended December 31,
1995, appearing in this Prospectus and Registration Statement have been audited
by Ernst & Young LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein and are included in reliance upon such report given
upon the authority of such firm as experts in accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form S-1 under the Securities Act with
respect to the shares of Common Stock offered hereby. As permitted by the rules
and regulations of the Commission, this Prospectus omits certain information
contained in the Registration Statement. For further information with respect to
the Company and the Common Stock offered hereby, reference is hereby made to the
Registration Statement and to the exhibits and schedules filed therewith.
Statements contained in this Prospectus as to the contents of any agreement or
other document filed as an exhibit to the Registration Statement are not
necessarily complete, and in each instance reference is made to the copy of such
agreement filed as an exhibit to the Registration Statement, each such statement
being qualified in all respects by such reference. The Registration Statement,
including the exhibits and schedules filed therewith, may be inspected without
charge at the Commission's Public Reference Room, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549, and at the Commission's regional offices
located at Seven World Trade Center, 13th Floor, New York, New York 10048 and at
Northwest Atrium Center, Suite 1400, 500 West Madison Street, Chicago, Illinois
60661. Copies of the Registration Statement may be obtained from the Commission
from its Public Reference Section, 450 Fifth Street, N.W., Washington, D.C.
20549, upon payment of prescribed fees.
The Company intends to distribute to its stockholders annual reports
containing financial statements audited by its independent accountants and will
make available copies of quarterly reports for the first three quarters of each
fiscal year containing unaudited financial statements.
47
<PAGE>
PEGASYSTEMS INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
-------
<S> <C>
Report of Independent Auditors F-2
Consolidated Balance Sheets as of December 31, 1994 and 1995 and
as of March 31, 1996 (unaudited) F-3
Consolidated Statements of Income for the years ended December
31, 1993, 1994 and
1995 and for the three months ended March 31, 1995 and 1996
(unaudited) F-4
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1993, 1994 and 1995 and for the three
months ended March 31, 1996 (unaudited) F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1993, 1994 and 1995 and for the three months
ended March 31, 1995 and 1996 (unaudited) F-6
Notes to Consolidated Financial Statements F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Pegasystems Inc.
We have audited the accompanying consolidated balance sheets of Pegasystems
Inc. as of December 31, 1994 and 1995 and the related consolidated statements of
income, stockholders' equity, and cash flows for each of the three years in the
period ended December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Pegasystems Inc. at December 31, 1994 and 1995, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1995, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Boston, Massachusetts May 6, 1996, except for Notes 10 and 11 as to which the
date is , 1996.
The foregoing report is in the form that will be signed upon completion of
the restatement of the capital accounts described in Note 10 to the consolidated
financial statements.
ERNST & YOUNG LLP
Boston, Massachusetts
May 14, 1996
F-2
<PAGE>
PEGASYSTEMS INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-------------------------
March 31,
1994 1995 1996
----------- ----------- ------------
(unaudited)
(in thousands except share-related data)
<S> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 456 $ 511 $ 2,644
Trade and installment accounts receivable, net of
allowance for doubtful accounts of $0 and $434
at December 31, 1994 and 1995, respectively, and
$434 at March 31, 1996 8,315 8,896 9,628
Prepaid expenses and other assets 204 425 342
--------- --------- -----------
Total current assets 8,975 9,832 12,614
Long-term license installments, net 9,135 13,399 11,444
Equipment and improvements, net 1,564 2,172 2,143
Software development costs, net 1,113 473 354
--------- --------- -----------
Total assets $20,787 $25,876 $26,555
========= ========= ===========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 1,991 $ 1,747 $ 970
Deferred revenue 139 114 803
Current portion of long-term debt 378 782 730
Deferred income taxes 1,976 2,796 3,159
Note payable to stockholder 50 -- --
--------- --------- -----------
Total current liabilities 4,534 5,439 5,662
Deferred income taxes 3,931 4,947 5,085
Long-term debt 450 816 672
Stockholders' equity:
Preferred stock, $.01 par value, 1,000,000 shares
authorized; no shares issued and outstanding -- -- --
Common stock, $.01 par value, 45,000,000 shares
authorized, 23,490,000 shares issued and
outstanding 235 235 235
Additional paid-in-capital 15 15 15
Retained earnings 11,644 14,522 15,008
Cumulative foreign currency translation adjustment (22) (98) (122)
--------- --------- -----------
11,872 14,674 15,136
--------- --------- -----------
Total liabilities and stockholders' equity $20,787 $25,876 $26,555
========= ========= ===========
</TABLE>
See accompanying notes.
F-3
<PAGE>
PEGASYSTEMS INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Three Months Ended
Year Ended December 31, March 31,
-------------------------------------- --------------------------
1993 1994 1995 1995 1996
---------- ---------- ---------- ---------- ------------
(unaudited)
(in thousands except share-related data)
<S> <C> <C> <C> <C> <C>
Revenue
Software license $ 6,448 $ 9,662 $ 13,528 $ 2,209 $ 2,520
Services 3,764 6,601 8,719 1,796 2,421
--------- --------- --------- --------- ----------
Total Revenue 10,212 16,263 22,247 4,005 4,941
Cost of Revenue
Cost of software license 1,242 1,075 635 191 118
Cost of services 2,227 3,791 6,161 1,228 1,405
--------- --------- --------- --------- ----------
Total cost of revenue 3,469 4,866 6,796 1,419 1,523
--------- --------- --------- --------- ----------
Gross profit 6,743 11,397 15,451 2,586 3,418
Operating expenses
Research and development 3,766 5,440 7,061 1,413 1,602
Sales and marketing 1,350 2,629 3,592 785 972
General and administrative 834 1,092 1,541 322 388
--------- --------- --------- --------- ----------
Total operating expenses 5,950 9,161 12,194 2,520 2,962
--------- --------- --------- --------- ----------
Income from operations 793 2,236 3,257 66 456
License interest income 1,305 1,457 1,486 370 368
Other interest income 27 21 16 6 12
Interest expense (32) (56) (118) (18) (39)
--------- --------- --------- --------- ----------
Income before provision for
income taxes 2,093 3,658 4,641 424 797
Provision for income taxes 860 1,465 1,763 161 311
--------- --------- --------- --------- ----------
Net income $ 1,233 $ 2,193 $ 2,878 $ 263 $ 486
========= ========= ========= ========= ==========
Net income per common and
common equivalent share $ .05 $ .09 $ .11 $ .01 $ .02
========= ========= ========= ========= ==========
Weighted average number of
common and common
equivalent shares
outstanding 24,231,000 24,102,000 25,551,000 25,600,000 25,505,000
========= ========= ========= ========= ==========
</TABLE>
See accompanying notes.
F-4
<PAGE>
PEGASYSTEMS INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Common Stock
--------------------
Cumulative
Foreign
Number Additional Currency Total
of Paid-in Retained Translation Stockholders'
Shares Amount Capital Earnings Adjustment Equity
---------- ------ ---------- -------- ---------- --------------
(in thousands except for share-related data)
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1992 22,500,000 $225 -- $ 8,218 -- $ 8,443
Exercise of stock
options 117,000 1 -- -- -- 1
Net income -- -- -- 1,233 -- 1,233
--------- ---- --------- ------ --------- ------------
Balance at December 31,
1993 22,617,000 226 -- 9,451 -- 9,677
Exercise of stock
options 873,000 9 $15 -- -- 24
Foreign currency
translation adjustment -- -- -- -- $ (22) (22)
Net income -- -- -- 2,193 -- 2,193
--------- ---- --------- ------ --------- ------------
Balance at December 31,
1994 23,490,000 235 15 11,644 (22) 11,872
Foreign currency
translation adjustment -- -- -- -- (76) (76)
Net income -- -- -- 2,878 -- 2,878
--------- ---- --------- ------ --------- ------------
Balance at December 31,
1995 23,490,000 235 15 14,522 (98) 14,674
Foreign currency
translation adjustment -- -- -- -- (24) (24)
Net income (unaudited) -- -- -- 486 -- 486
--------- ---- --------- ------ --------- ------------
Balance at March 31,
1996 (unaudited) 23,490,000 $235 $15 $15,008 $(122) $15,136
========= ==== ========= ====== ========= ============
</TABLE>
See accompanying notes.
F-5
<PAGE>
PEGASYSTEMS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Three Months Ended
Year Ended December 31, March 31,
-------------------------------- ------------------
1993 1994 1995 1995 1996
-------- -------- -------- ------ --------
(unaudited)
(in thousands)
<S> <C> <C> <C> <C> <C>
Operating activities
Net income $ 1,233 $ 2,193 $ 2,878 $ 263 $ 486
Adjustments to reconcile net income to net
cash provided (used) by operating
activities:
Provision for deferred income taxes 629 961 1,836 127 501
Depreciation and amortization 1,536 1,511 1,455 309 369
Change in operating assets and liabilities:
Decrease (increase) in trade and
installment accounts receivable (1,823) (3,988) (4,845) 722 1,223
Decrease (increase) in prepaid expenses
and other assets (121) (16) (221) (41) 83
Decrease (increase) in inventory (215) 215 -- -- --
Increase (decrease) in accounts payable
and accrued expenses 8 971 (244) (686) (777)
Increase (decrease) in deferred revenue 333 (336) (25) 416 689
------ ------ ------ ---- ------
Net cash provided by operating
activities 1,580 1,511 834 1,110 2,574
Investing activities
Purchase of equipment and improvements (888) (1,131) (1,423) (370) (221)
Software development costs (1,060) (297) -- -- --
------ ------ ------ ---- ------
Net cash used in investing activities (1,948) (1,428) (1,423) (370) (221)
Financing activities
Repayment of note payable to shareholder -- (180) (50) -- --
Proceeds from issuance of long-term debt 710 380 1,345 -- --
Repayments of long-term debt (243) (263) (575) (95) (196)
Exercise of stock options -- 23 -- -- --
------ ------ ------ ---- ------
Net cash provided (used) by financing
activities 467 (40) 720 (95) (196)
Effect of exchange rate on cash -- (22) (76) (5) (24)
------ ------ ------ ---- ------
Net increase in cash 99 21 55 640 2,133
Cash and equivalents at beginning of year 336 435 456 456 511
------ ------ ------ ---- ------
Cash and equivalents at end of period $ 435 $ 456 $ 511 $1,096 $2,644
====== ====== ====== ==== ======
Supplemental Disclosure of Cash Flow
Information:
Cash paid during period:
Interest $ 32 $ 56 $ 119 $ 18 $ 39
====== ====== ====== ==== ======
Income taxes $ 553 $ 135 $ 315 $ 92 $ 13
====== ====== ====== ==== ======
</TABLE>
See accompanying notes.
F-6
<PAGE>
PEGASYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1995
1. SIGNIFICANT ACCOUNTING POLICIES
Business
Pegasystems Inc. (the Company) was incorporated on April 21, 1983, and
develops customer service management software used by large,
transaction-intensive organizations to automate and manage their customer
interactions. Customers of the Company include large banks and credit card
processors and mutual fund companies. The Company also offers consulting,
training and maintenance and support services to facilitate the installation and
use of its solutions.
The environment of rapid technological change and intense competition which
is characteristic of the software development industry results in frequent new
products and evolving industry standards. The Company's continued success
depends upon its ability to enhance current products and develop new products on
a timely basis which keep pace with the changes in technology and competitors'
innovations.
International revenue is subject to various risks including imposition of
government controls, export license requirements, political and economic
conditions and instability, trade restrictions, currency fluctuations, changes
in taxes, difficulties in staffing and managing international operations, and
high local wage scales and other operating costs and expenses.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, Pegasystems Limited. All intercompany accounts and
transactions have been eliminated in consolidation.
Foreign Currency Translation
The translation of assets and liabilities of the Company's foreign subsidiary
is made at year-end rates of exchange, while revenue and expense accounts are
recorded at the average rates of exchange. The resulting translation adjustments
are excluded from net income and are charged or credited to "Cumulative foreign
currency translation adjustment" included as part of stockholder's equity.
Realized and unrealized exchange gains or losses from transaction adjustments
are reflected in operations and are not material.
Revenue Recognition
The Company recognizes revenue in accordance with Statement of Position 91-1,
Software Revenue Recognition, issued by the American Institute of Certified
Public Accountants. Specifically, revenue from software licenses is recognized
upon product acceptance pursuant to noncancelable license agreements, and is
based on management's assessment that the collectibility risk on the long-term
license installments is low. Upon acceptance, the Company has no significant
vendor obligations. The Company accrues the estimated cost of warranty and
product returns in the period in which product revenue is recognized;
historically these amounts have not been material. In the case of license
renewals, revenue is recognized upon execution of the renewal license agreement
or if, as is generally the case, renewal is automatic unless the customer gives
notice of termination, at the expiration of the period during which the customer
has the right to terminate. Maintenance fees are recognized ratably over the
term of the maintenance agreement. The Company recognizes implementation as well
as consulting and training fees as the services are provided.
Software license revenue represents the present value of future payments
under noncancelable license agreements which provide for payment in installments
typically over a five-year period. A portion of the revenue from each agreement
is recognized as interest income over the term of the agreement.
F-7
<PAGE>
PEGASYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1995
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
The discount rate in effect for 1993, 1994, 1995 and for the three months ended
March 31, 1996 was 7%. The trade and installment accounts receivable recorded on
the balance sheet are net of $3,477,000, $3,937,000 and $3,887,000 as of
December 31, 1994 and 1995, and March 31, 1996, respectively, which represents
the imputed interest portion of future payments due under the Company's license
agreements. Deferred revenue represents payments from customers, primarily for
maintenance services, which are recognized as revenue as the related services
are performed.
Cash and Cash Equivalents
Cash and cash equivalents are stated at cost, which approximates market, and
consist of short-term, highly liquid investments with original maturities of
less than three months.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of trade accounts receivable and long-term
license installments. The Company records long-term license installments in
accordance with its revenue recognition policy which results in receivables from
customers, primarily large financial service organizations with strong credit
ratings.
Interim Financial Statements
The consolidated balance sheet at March 31, 1996, the consolidated statements
of income and consolidated statements of cash flows for the three months ended
March 31, 1995 and 1996 and the consolidated statement of stockholders' equity
for the three months ended March 31, 1996 are unaudited, but, in the opinion of
management, include all adjustments (consisting of normal recurring adjustments)
necessary for a fair presentation of results for these interim periods. The
results of operations for the three months ended March 31, 1996 are not
necessarily indicative of results to be expected for the entire year.
Equipment and Improvements
Equipment and improvements are recorded at cost. Depreciation is computed
using the straight-line method over the estimated useful lives of the assets
which are three years for equipment and five years for furniture and fixtures.
Leasehold improvements are amortized over the life of the lease.
Software Development Costs
In compliance with Statement of Financial Accounting Standards (SFAS) No. 86,
Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise
Marketed, certain software development costs are capitalized in the accompanying
consolidated balance sheets. Capitalization of software development costs begins
upon the establishment of technological feasibility, defined by the Company as a
working model or an operative version of the computer software product that is
completed in the same language and is capable of running on all of the platforms
as the product to be ultimately marketed. During 1994, the Company capitalized
$297,000 of software costs. No costs were capitalized during 1995 or the three
months ended March 31, 1996.
Amortization of capitalized software development cost is included in costs of
software license revenue and is provided on a straight-line basis of two years,
which approximates the estimated useful life of the software as it relates to
the Company's sales. The straight line amortization is not materially different
from the amortization computed using the current period revenues as a percent of
total expected product revenues. Total amortization expense charged to
operations was $1,242,000, $1,075,000, $635,000 and $118,000 during 1993, 1994
and 1995 and the three months ended March 31, 1996, respectively.
F-8
<PAGE>
PEGASYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1995
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
Net Income Per Share
Net income per common and common equivalent share is computed using the
weighted average number of common and dilutive common equivalent shares
outstanding during each period, assuming the exercise of stock options into
common stock under the treasury stock method. Stock issued after May 14, 1995
and common stock issuable pursuant to stock options granted after May 14, 1995
have been reflected as outstanding for all of 1993, 1994 and 1995, using the
treasury stock method. Fully diluted earnings per common share are not presented
as they are not materially different from primary earnings per common share.
Dilutive common equivalent shares consist of stock options (using the treasury
stock method and using the assumed initial public offering price). Net income
per share also reflects a fifteen- for-one stock split effective December 9,
1994, and a three-for-one stock split effective on the effective date of the
Form S-1 registration statement.
Stock Options
The Company grants stock options for a fixed number of shares to employees
with an exercise price equal to the estimated fair market value of the shares at
the date of the grant. The Company accounts for stock option grants in
accordance with APB Opinion No. 25 "Accounting for Stock Issued to Employees,"
and intends to continue to do so. Accordingly, the Company recognizes no
compensation expense for stock option grants.
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Some of the areas where estimates are
utilized included allowance for bad debts, capitalized software, income taxes,
revenue and various accrued expenses. Actual results could differ from those
estimates.
2. EQUIPMENT AND IMPROVEMENTS
The cost and accumulated depreciation of equipment and improvements consist
of the following:
<TABLE>
<CAPTION>
December 31,
----------------------
(in thousands)
1994 1995
--------- ----------
<S> <C> <C>
Equipment $1,435 $ 2,186
Furniture and fixtures 630 863
Leasehold improvements 202 434
------- --------
2,267 3,483
Less accumulated depreciation (703) (1,311)
------- --------
Equipment and improvements, net $1,564 $ 2,172
======= ========
</TABLE>
F-9
<PAGE>
PEGASYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1995
3. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of the following:
<TABLE>
<CAPTION>
December 31,
--------------------
(in thousands)
1994 1995
--------- --------
<S> <C> <C>
Trade accounts payable $ 744 $ 557
Employee compensation and
benefits 508 568
Accrued income taxes 253 --
Other 486 622
------- ------
$1,991 $1,747
======= ======
</TABLE>
4. DEBT AND OTHER FINANCIAL INSTRUMENTS
Long-term debt consists of the following:
<TABLE>
<CAPTION>
December 31,
----------------
(in thousands)
1994 1995
----- -------
<S> <C> <C>
Note payable to bank, with monthly payments of $3,750
plus interest through December 15, 1995 $ 45 --
Note payable to bank, with monthly payments of
$17,222 plus interest through December 1, 1996 413 $ 207
Note payable to bank, with monthly payments of
$10,556 plus interest through December 1, 1997 370 243
Note payable to bank, with monthly payments of
$32,778 plus interest through June 28, 1998 -- 983
Note payable to bank, with monthly payments of $4,583
plus interest through December 28, 1998 -- 165
--- -----
828 1,598
Less current portion 378 782
--- -----
$450 $ 816
=== =====
</TABLE>
The notes bear interest at the bank's prime rate (6% at December 31, 1993 and
8.5% at December 31, 1994 and 1995) plus 1/2%. The notes are secured by all
computer equipment and furniture and fixtures of the Company. Maturities of
these notes are $782,000 in 1996, $564,000 in 1997 and $252,000 in 1998.
The Company has a line of credit with a bank allowing for borrowings up to
$2,500,000 at the prime rate. The line expires June 1, 1996. The Company had no
drawings against the line of credit at December 31, 1995 and 1994. Borrowings
are subject to various covenants which call for a specified level of working
capital and net worth, maintenance of certain financial ratios and restrictions
on the payments of dividends.
The Company had a note payable of $50,000 to the president at December 31,
1994, which was repaid in full during 1995. The interest rate on the note was
8.5% in 1994 and 1995.
F-10
<PAGE>
PEGASYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1995
4. DEBT AND OTHER FINANCIAL INSTRUMENTS (Continued)
Financial instruments outstanding at December 31, 1995 are as follows:
<TABLE>
<CAPTION>
Carrying Fair
Amount Value
--------- ----------
(in thousands)
<S> <C> <C>
Assets
Cash and cash equivalents $ 511 $ 511
Liabilities
Notes payable to bank ($1,598) ($1,598)
</TABLE>
The fair value of the long-term debt approximates the carrying amount due to
the variable interest rate of the debt.
5. EMPLOYEE BENEFIT PLANS
Stock Option Plan
The Company adopted an incentive stock option plan effective July 29, 1983
(the 1983 Plan). Key employees, as selected by the Board of Directors of the
Company, were granted options to purchase the Company's common stock at a price,
which in the Board of Directors' opinion, reflected fair value on the date of
the grant. The 1983 plan expired in 1993. At December 31, 1995, no options
issued under this plan were outstanding.
Long-Term Incentive Plan
During the year ended December 31, 1994, the Company adopted a Long-Term
Incentive Plan (the 1994 Plan) to provide incentives to employees, directors and
consultants through opportunities to purchase stock through incentive stock
options and through options which do not qualify as incentive stock options.
In addition to options, eligible participants under the 1994 Plan may be
granted stock appreciation rights, restricted stock and long-term performance
awards. A maximum of 2,400,000 shares are reserved for issuance under the plan.
Shares equal to 2% of the outstanding shares at the start of each fiscal year
shall be reserved for granting of replacement options; however, this may not
cause the maximum shareholder dilution caused by the Plan to exceed the
2,400,000 shares of stock reserved for issuance under the plan.
The option price per share is to be determined at the date of grant. For
incentive stock options, the option price may not be less than 100% of the fair
market value of the Company's common stock at the grant date. Incentive stock
options granted to a person having greater than 10% of the voting power of all
classes of stock must have an exercise price of at least 110% of fair market
value of the Company's common stock.
F-11
<PAGE>
PEGASYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1995
5. EMPLOYEE BENEFIT PLANS (Continued)
Stock option activity is summarized as follows:
<TABLE>
<CAPTION>
March 31,
December 31, 1996
1993 1994 1995 (unaudited)
------------ ------------ ------------ --------------
<S> <C> <C> <C> <C>
Outstanding options at beginning of
period 1,494,000 1,269,000 1,671,750 1,924,500
Granted -- 1,635,750 335,250 24,000
Exercised (117,000) (873,000) -- --
Canceled (108,000) (360,000) (82,500) (25,500)
---------- ---------- ---------- ------------
Outstanding at end of period 1,269,000 1,671,750 1,924,500 1,923,000
========== ========== ========== ============
Price range of outstanding options $.01-$.69 $.33-$.69 $.33-$.39 $.33-$6.00
========== ========== ========== ============
Exercisable at end of period 1,216,125 396,000 605,850 600,750
========== ========== ========== ============
Available for grant at end of period -- 764,250 475,500 477,000
========== ========== ========== ============
</TABLE>
6. LEASES
The Company leases certain equipment and office space under noncancelable
operating leases. Future minimum rental payments required under the operating
leases with noncancelable terms in excess of one year at December 31, 1995 are
as follows:
<TABLE>
<CAPTION>
<S> <C>
Year ended December 31, (in thousands)
1996 $1,016
1997 1,090
1998 1,090
1999 579
-----------------
Total $3,775
=================
</TABLE>
Total rent expense under operating leases was approximately $800,000,
$863,000, and $1,100,000 for the years ended December 31, 1993, 1994 and 1995,
respectively.
7. INCOME TAXES
Income before income taxes consists of the following:
<TABLE>
<CAPTION>
1993 1994 1995
------ ------ --------
(in thousands)
<S> <C> <C> <C>
Domestic $2,093 $3,512 $4,318
Foreign 0 146 323
----- ----- ------
Total $2,093 $3,658 $4,641
===== ===== ======
</TABLE>
F-12
<PAGE>
PEGASYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1995
7. INCOME TAXES (Continued)
The provision (benefit) for income taxes for the years ended December 31,
1993, 1994 and 1995 consisted of the following:
<TABLE>
<CAPTION>
1993 1994 1995
----- ------ --------
(in thousands)
<S> <C> <C> <C>
Current:
Federal $180 $ 297 $ (107)
State 51 176 (39)
Foreign -- 31 73
--- ---- ------
Total current 231 504 (73)
Deferred:
Federal 449 691 1,563
State 180 270 273
--- ---- ------
Total deferred 629 961 1,836
--- ---- ------
$860 $1,465 $1,763
=== ==== ======
</TABLE>
The effective income tax rate differed from the statutory federal income tax
rate due to:
<TABLE>
<CAPTION>
1993 1994 1995
------ ------ --------
<S> <C> <C> <C>
Statutory federal income tax rate 34.0% 34.0% 34.0%
State income taxes, net of federal benefit 7.3 7.3 5.8
Permanent differences 1.5 2.0 0.7
Tax credits (1.7) (3.3) (2.5)
---- ---- ------
Effective income tax rate 41.1% 40.0% 38.0%
==== ==== ======
</TABLE>
At December 31, 1993, 1994 and 1995, the Company had research and development
credit carryforwards of approximately $495,000, $421,000 and $440,000,
respectively, available to offset future federal taxable income. These
carryforward amounts generally expire from 2004 to 2008. In addition, as of
December 31, 1993, 1994 and 1995, the Company had available alternative minimum
tax (AMT) credit carryforwards of approximately $194,000. The carryforward
period for the AMT credit is unlimited.
Deferred income taxes at December 31, 1994 and 1995 reflect the net tax
effects of temporary differences between the carrying amounts of assets and
liabilities for financial statement purposes and the amounts used for tax
purposes. Significant components of the Company's deferred tax liabilities and
assets as of December 31, 1994 and 1995 are as follows:
F-13
<PAGE>
PEGASYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1995
7. INCOME TAXES (Continued)
<TABLE>
<CAPTION>
December 31,
1994 1995
-------- ----------
(in thousands)
<S> <C> <C>
Deferred tax liabilities:
Software revenue $(6,924) $(9,303)
Capitalized software (501) (213)
Depreciation -- (142)
Other -- (41)
------ --------
Total deferred tax
liabilities (7,425) (9,699)
Deferred tax assets:
Deferred state taxes 590 729
License fees 119 119
Vacation accrual 64 109
Other 133 274
Tax credits 612 725
------ --------
Total deferred tax assets 1,518 1,956
------ --------
Net deferred tax liabilities (5,907) (7,743)
Less current portion (1,976) (2,796)
------ --------
$(3,931) $(4,947)
====== ========
</TABLE>
8. SIGNIFICANT CUSTOMERS
During 1993 the Company had two customers that accounted for 12.9% and 12.3%,
respectively, of the Company's consolidated revenue. In 1994 one customer
accounted for 16.8% of the Company's consolidated revenue. This customer also
accounted for 12.6% of the Company's 1995 consolidated revenue. Additionally, in
1995 two other customers accounted for 16.2% and 14.9%, respectively, of the
Company's consolidated revenue.
9. INTERNATIONAL OPERATIONS
The Company's export sales from the United States are as follows:
<TABLE>
<CAPTION>
1993 1994 1995
------- ------- ---------
(in thousands)
<S> <C> <C> <C>
United Kingdom $ 488 $1,515 $1,343
Ireland 0 1,288 355
Canada 58 1,008 114
Switzerland 469 49 125
France 0 25 297
Other 0 47 100
----- ----- -------
Total $1,015 $3,932 $ 2,334
===== ===== =======
</TABLE>
10. RECAPITALIZATION AND STOCK SPLIT
During the year ended December 31, 1994, the Company increased the number of
shares authorized from 600,000 shares of $.01 par value common stock to 9
million shares of $.01 par value common stock.
On December 9, 1994, the Company's Board of Directors declared a
fifteen-for-one split of shares of $.01 par value common stock effected in the
form of a dividend. This dividend resulted in 7,830,000
F-14
<PAGE>
PEGASYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1995
10. RECAPITALIZATION AND STOCK SPLIT (Continued)
shares of common stock being issued and outstanding after the split. The par
value of the additional shares of common stock issued in connection with the
stock split was credited to common stock and a like amount was charged to
additional paid-in capital to the extent available, and the remainder to
retained earnings.
The Company's Board of Directors has approved an increase in the number of
shares of common stock authorized from 9 million to 45 million shares and a
three-for-one stock split in the form of a stock dividend on the effective date
of the Form S-1 registration statement.
The financial statements give effect to both stock splits for all periods
presented.
Upon filing of the Restated Articles, the Board of Directors will be
authorized, subject to certain limitations prescribed by law, without further
stockholder approval, to issue from time to time up to an aggregate 1,000,000
shares of Preferred Stock in one or more series and to fix or alter the
designations, preferences, rights and any qualifying limitations or restrictions
of the shares of each such series thereof, including the dividend rights,
dividend rates, conversion rights, voting rights, terms of redemptions
(including sinking fund provisions), redemption price or prices, liquidation
preferences and the number of shares constituting any shares or designations of
such series.
11. SUBSEQUENT EVENTS
1996 Non-Employee Director Stock Option Plan The 1996 Non-Employee Director
Stock Option Plan (the "Director Plan") was adopted by the Board of Directors on
May 13, 1996. The Director Plan provides for the grant of options for the
purchase of up to 250,000 shares of common stock of the Company. To date, no
options have been granted under the Director Plan.
The Director Plan is administered by the Compensation Committee and provides
that each person who becomes a director of the Company after May 13, 1996 and
who is not also an employee of the Company will receive upon his initial
election to the Board of Directors, an option to purchase 30,000 shares of
common stock vesting in equal annual installments over five years. The exercise
price per share for all options granted under the Director Plan will be equal to
the market price of the common stock as of the date of grant. Options may not be
assigned or transferred except by will or by the laws of descent and
distribution and are exercisable, only to the extent vested, within 90 days
after the optionee ceases to serve as a director of the Company (except that if
a director dies or becomes disabled while he or she is serving as a director of
the Company, the option is exercisable until the earlier of the scheduled
expiration date of the option or one year from the date of death or disability).
1996 Employee Stock Purchase Plan The 1996 Employee Stock Purchase Plan (the
"Stock Purchase Plan") was adopted by the Board of Directors on May 13, 1996. An
aggregate of 500,000 shares of common stock are reserved for issuance pursuant
to this plan.
The Stock Purchase Plan is administered by the Compensation Committee. All
employees of the Company whose customary employment is in excess of 20 hours per
week and more than five months per year, other than those employees who own 5%
or more of the stock of the Company, are eligible to participate in the Stock
Purchase Plan. The Stock Purchase Plan will be implemented by one or more
offerings of such duration as the Compensation Committee may determine, provided
that no offering period may be longer than 27 months. An eligible employee
participating in an offering will be able to purchase common stock at a price
equal to the lesser of: (i) 85% of its fair market value on the date the right
was granted, or (ii) 85% of its fair market value on the date the right was
exercised. Payment for common stock purchased under the Stock Purchase Plan will
be through regular payroll deduction or lump sum cash payment, or both, as
determined by the Compensation Committee. The maximum value of common stock an
employee may purchase during an offering period is 10% of the employee's base
salary
F-15
<PAGE>
PEGASYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1995
11. SUBSEQUENT EVENTS (Continued)
during such period, calculated on the basis of the employee's compensation rate
on the date the employee elects to participate in that offering.
To date, there have been no offerings under the Stock Purchase Plan and no
shares of common stock have been issued thereunder.
Line of Credit The Company's bank line of credit was increased to $5 million
and extended until June 30, 1997.
1994 Long Term Incentive Plan On May 13, 1996, the Company approved an
increase in the number of shares issuable under the 1994 Long-Term Incentive
Plan from 2,400,000 to 5,000,000.
F-16
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Company and the Selling Stockholders have agreed to sell to each of the
Underwriters named below, and each of such Underwriters, for whom Goldman, Sachs
& Co., Cowen & Company and Montgomery Securities are acting as representatives,
has severally agreed to purchase from the Company and the Selling Stockholders,
the respective number of shares of Common Stock set forth opposite its name
below:
<TABLE>
<CAPTION>
Number of
Shares of
Common
Underwriter Stock
------------------------ ----------
<S> <C>
Goldman, Sachs & Co.
Cowen & Company
Montgomery Securities
--------
Total 3,400,000
========
</TABLE>
Under the terms and conditions of the Underwriting Agreement, the
Underwriters are committed to take and pay for all of the shares offered hereby,
if any are taken.
The Underwriters propose to offer the shares of Common Stock in part directly
to the public at the initial public offering price set forth on the cover page
of this Prospectus and in part to certain securities dealers at such price less
a concession of $ per share. The Underwriters may allow, and such dealers may
reallow, a concession not in excess of $ per share to certain brokers and
dealers. After the shares of Common Stock are released for sale to the public,
the offering price and other selling terms may from time to time be varied by
the representatives.
The Company has granted the Underwriters an option exercisable for 30 days
after the date of this Prospectus to purchase up to an aggregate of 510,000
additional shares of Common Stock to cover over- allotments, if any. If the
Underwriters exercise their over-allotment option, the Underwriters have
severally agreed, subject to certain conditions, to purchase approximately the
same percentage thereof that the number of shares to be purchased by each of
them, as shown in the foregoing table, bears to the 3,400,000 shares of Common
Stock offered.
The Company and the Selling Stockholders have agreed that, subject to certain
exceptions, during the period beginning from the date of this Prospectus and
continuing to and including the date 180 days after the date of the Prospectus,
they will not offer, sell, contract to sell or otherwise dispose of any shares
of Common Stock or of any other securities of the Company (other than pursuant
to stock plans existing on the date of this Prospectus) which are substantially
similar to the shares of Common Stock or which are convertible or exchangeable
into securities which are substantially similar to the shares of Common Stock
without the prior written consent of the representatives, except for the shares
of Common Stock offered in connection with the offering.
The representatives of the Underwriters have informed the Company that they
do not expect sales to accounts over which the Underwriters exercise
discretionary authority to exceed five percent of the total number of shares of
Common Stock offered hereby.
U-1
<PAGE>
Prior to the offering, there has been no public market for the shares of Common
Stock. The initial public offering price will be negotiated among the Company
and the representatives. Among the factors to be considered in determining the
initial public offering price of the Common Stock, in addition to prevailing
market conditions, will be the Company's historical performance, estimates of
business potential and earnings prospects for the Company, an assessment of the
Company's management and the consideration of the above factors in relation to
market valuation of companies in related businesses.
The Company and the Selling Stockholders have agreed to indemnify the several
Underwriters against certain liabilities, including liabilities under the
Securities Act.
U-2
<PAGE>
Picture of Pegasus, the winged horse of mythology, flying out of a computer
terminal screen, against a background of stars.
Service Excellence
Through Automation
<PAGE>
=========================================================
No person has been authorized to give any information or to make any
representations other than those contained in this Prospectus, and, if given or
made, such information or representations must not be relied upon as having been
authorized. This Prospectus does not constitute an offer to sell or the
solicitation of an offer to buy any securities other than the securities to
which it relates or an offer to sell or the solicitation of an offer to buy such
securities in any circumstances in which such offer or solicitation is unlawful.
Neither the delivery of this Prospectus nor any sale made hereunder shall, under
any circumstances, create any implication that there has been no change in the
affairs of the Company since the date hereof or that the information contained
herein is correct as of any time subsequent to its date.
-------------
TABLE OF CONTENTS
Page
-------
Prospectus Summary 3
Risk Factors 5
Use of Proceeds 12
Dividend Policy 12
Capitalization 13
Dilution 14
Selected Consolidated Financial Data 15
Management's Discussion and Analysis of
Financial Condition and Results of
Operations 16
Business 25
Management 36
Certain Transactions 42
Principal and Selling Stockholders 43
Description of Capital Stock 44
Shares Eligible for Future Sale 46
Legal Matters 47
Experts 47
Additional Information 47
Index to Consolidated Financial Statements F-1
Underwriting U-1
Through and including , 1996 (the 25th day after the date of this Prospectus),
all dealers effecting transactions in the Common Stock, whether or not
participating in this distribution, may be required to deliver a Prospectus.
This is in addition to the obligation of dealers to deliver a Prospectus when
acting as Underwriters and with respect to their unsold allotments or
subscriptions.
3,400,000 Shares
PEGASYSTEMS INC.
Common Stock
(par value $.01 per share)
-------------
[Pegasystems Inc. Logo]
-------------
Goldman, Sachs & Co.
Cowen & Company
Montgomery Securities
Representatives of the Underwriters
=========================================================
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
Estimated expenses (other than underwriting discounts and commissions)
payable in connection with the sale of the Common Stock offer hereby are as
follows:
SEC registration fee $ 18,876
NASD filing fee 5,974
Nasdaq National Market listing fee 50,000
Printing and engraving expenses 100,000
Legal fees and expenses 200,000
Accounting fees and expenses 150,000
Blue Sky fees and expenses (including legal fees) 18,000
Transfer agent and registrar fees and expenses 10,000
Miscellaneous 47,150
------
Total $600,000
======
The Registrant will bear all expenses shown above.
Item 14. Indemnification of Directors and Officers.
Section 67 of Chapter 156B of the Massachusetts General Laws provides that a
corporation may indemnify its directors and officers to the extent specified in
or authorized by (i) the articles of organization, (ii) a by-law adopted by the
stockholders, or (iii) a vote adopted by the holders of a majority of the shares
of stock entitled to vote on the election of directors. In all instances, the
extent to which a corporation provides indemnification to its directors and
officers under Section 67 is optional. In its Restated Articles of Organization,
the Registrant has elected to commit to provide indemnification to its directors
and officers in specified circumstances. Generally, the Restated Articles of
Organization provide that the Registrant shall indemnify directors and officers
of the Registrant against liabilities and expenses arising out of legal
proceedings brought against them by reason of their status as directors or
officers or by reason of their agreeing to serve, at the request of the
Registrant, as a director or officer with another organization. Under this
provision, a director or officer of the Registrant shall be indemnified by the
Registrant for all costs and expenses (including attorneys' fees), judgments,
liabilities and amounts paid in settlement of such proceedings, even if he is
not successful on the merits, if he acted in good faith in the reasonable belief
that his action was in the best interests of the Registrant. The Board of
Directors may authorize advancing litigation expenses to a director or officer
at his request upon receipt of an undertaking by any such director or officer to
repay such expenses if it is ultimately determined that he is not entitled to
indemnification for such expenses.
Article VI of the Registrant's Restated Articles of Organization eliminates
the personal liability of the Registrant's directors to the Registrant or its
stockholders for monetary damages for breach of a director's fiduciary duty,
except for liability (i) for any breach of a director's duty of loyalty to the
Registrant or its stockholders, (ii) for acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of laws, (iii) for
authorization of illegal dividends or redemptions, or (iv) for any transaction
in which a director derived an improper personal benefit.
Section 8 of the Underwriting Agreement provides that the Underwriters are
obligated, under certain circumstances, to indemnify the Company, directors,
officers and controlling persons of the Company against certain liabilities,
including liabilities under the Securities Act. Reference is made to the form of
Underwriting Agreement filed as Exhibit 1.1 hereto.
The Company maintains directors and officers liability insurance for the
benefit of its directors and certain of its officers.
II-1
<PAGE>
Item 15. Recent Sales of Unregistered Securities.
In the three years preceding the filing of this registration statement, the
Company has issued the below-listed securities that were not registered under
the Securities Act. The numbers below have been adjusted to give effect to (i)
the 15-for-1 split of the Registrant's Common Stock, in the form of a dividend,
which became effective on December 9, 1994 and (ii) the 3-for-1 split of the
Registrant's Common Stock, in the form of a dividend, to be effective
immediately prior to this offering.
Between December 1993 and May 13, 1996, the Registrant issued an aggregate of
990,000 shares of Common Stock upon the exercise of options, at a weighted
average exercise price of approximately $0.03 per share, to certain officers and
employees of the Registrant for total consideration of $24,800.
In addition, the Registrant will issue an aggregate of 100,800 shares of
Common Stock upon the exercise of options at an exercise price of approximately
$0.33 per share, immediately prior to the closing of this offering, to certain
officers of the Registrant for total consideration of $32,928.
Since December 1994, the Registrant has issued options to certain officers,
directors and employees of the Registrant to purchase an aggregate of 2,409,000
shares of Common Stock under the Registrant's 1994 Long-Term Incentive Plan at a
weighted average exercise price of approximately $2.60 per share.
No underwriters were involved in the foregoing sales of securities. Such
sales were made in reliance upon an exemption from the registration provisions
of the Securities Act set forth in Section 4(2) thereof relative to sales by an
issuer not involving any public offering or the rules and regulations
thereunder, or, in the case of options, Rule 701 of the Securities Act. All of
the foregoing securities are deemed restricted securities for the purposes of
the Securities Act.
Item 16. Exhibits and Financial Statement Schedules.
(a) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ---------- --------------------------------------------------------------
<S> <C>
1.1.+ Form of Underwriting Agreement.
3.1.* Articles of Organization of the Registrant, as amended.
3.2.* By-Laws of the Registrant.
3.3.* Form of Restated Articles of Organization of the Registrant,
to be effective immediately prior to the effectiveness of the
offering.
3.4.* Form of Restated By-Laws of the Registrant, to be effective
immediately prior to the effectiveness of the offering.
4.1. Specimen certificate representing the Common Stock.
5.1.+ Opinion of Choate, Hall & Stewart with respect to the legality
of the securities of the Registrant being registered.
10.1.* Amended and Restated 1994 Long-Term Incentive Plan.
10.2.* 1996 Non-Employee Director Stock Option Plan.
10.3.* 1996 Employee Stock Purchase Plan.
10.4.* Loan Agreement dated as of December 16, 1993 between the
Registrant and Fleet Bank of Massachusetts, N.A.
10.5.* Loan Modification Agreement dated as of May 5, 1995 between
the Registrant and Fleet Bank of Massachusetts, N.A.
10.6. Second Loan Modification Agreement between the Registrant and
Fleet National Bank (successor by merger to Fleet Bank of
Massachusetts, N.A.).
10.7.* Promissory Note in the amount of $620,000.00 dated December 16,
1993 made by the Registrant to the order of Fleet Bank of
Massachusetts, N.A.
10.8.* Promissory Note in the amount of $380,000.00 dated November 17,
1994 made by the Registrant to the order of Fleet Bank of
Massachusetts, N.A.
10.9.* Promissory Note in the amount of $1,180,000.00 dated June 28,
1995 made by the Registrant to the order of Fleet Bank of
Massachusetts, N.A.
II-2
<PAGE>
EXHIBIT
NO. DESCRIPTION
- ---------- --------------------------------------------------------------
10.10.* Promissory Note in the amount of $165,000.00 dated December 28,
1995 made by the Registrant to the order of Fleet Bank of
Massachusetts, N.A.
10.11. Promissory Note in the amount of $5,000,000 made by the
Registrant to the order of Fleet National Bank.
10.12.* Security Agreement dated as of December 16, 1993 between the
Registrant and Fleet Bank of Massachusetts, N.A.
10.13.* Lease Agreement dated February 26, 1993 between the Registrant
and Riverside Office Park Joint Venture.
10.14.* Amendment Number 1 to Lease Agreement dated August 7, 1994
between the Registrant and Riverside Office Park Joint
Venture.
21.1.* Subsidiaries of the Registrant.
23.1. Consent of Ernst & Young LLP.
23.2.+ Consent of Choate, Hall & Stewart (included in Exhibit 5.1).
23.3 Consent of Edward B. Roberts.
23.4 Consent of Leonard A. Schlesinger.
23.5 Consent of Thomas E. Swithenbank.
24.1.* Powers of Attorney.
27.1.* Financial Data Schedule.
99.1 Valuation and Qualifying Accounts of the Registrant.
</TABLE>
- -------------
*Previously filed.
+To be filed by amendment.
(b) Financial Statement Schedules:
Schedule II--Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable, not required
under the instructions, or all of the information required is set forth in the
financial statements or notes thereto.
Item 17. Undertakings.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to provisions described in Item 14 above, or otherwise, the
Registrant has been advised that in the opinion of the Securities and Exchange
Commission, such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
The Registrant hereby undertakes (1) to provide to the Underwriters at the
closing specified in the Underwriting Agreement certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser; (2) that for purposes of determining
any liability under the Securities Act, the information omitted from the form of
prospectus filed as part of this Registration Statement in reliance upon Rule
430A and contained in a form of prospectus filed by the Registrant pursuant to
Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be
part of this Registration Statement as of the time it was declared effective;
and (3) that for the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Amendment No. 1 to be signed on its behalf by the
undersigned, thereunto duly authorized, in Cambridge, Massachusetts on June
19, 1996.
PEGASYSTEMS INC.
By /s/ Alan Trefler
Alan Trefler
President
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 1 has been signed below by the following persons in the capacities and on
the dates indicated.
<TABLE>
<CAPTION>
Signature Title(s) Date
- ----------------------- ----------------------------- ---------------
<S> <C> <C>
/s/ Alan Trefler President, Clerk and Director
Alan Trefler (Principal Executive Officer) June 19, 1996
Vice President of Corporate
Services, Treasurer and
Ira Vishner* Director (Principal Financial
Ira Vishner and Accounting Officer) June 19, 1996
Edward A. Maybury*
Edward A. Maybury Director June 19, 1996
*By: /s/ Alan Trefler
Alan Trefler,
Attorney-in-Fact
</TABLE>
II-4
<PAGE>
=========================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------
EXHIBITS
TO
FORM S-1
REGISTRATION STATEMENT
Under
The Securities Act of 1933
-------------
PEGASYSTEMS, INC.
(Exact Name of Registrant As Specified In its Charter)
-------------
101 Main Street
Cambridge, Massachusetts 02142
(Address of Principal Executive Offices)
=========================================================
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the captions "Experts" and
"Selected Consolidated Financial Data" and to the use of our report dated May
6, 1996 (except for Notes 10 and 11, as to which the date is , 1996), in
the Registration Statement (Form S-1 No. 333-03807) and the related Prospectus
of Pegasystems Inc. for the registration of 3,910,000 shares of its common
stock.
Our audits also included the financial statement schedule of Pegasystems Inc.
located at Exhibit 99.1. This schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits. In
our opinion, the financial statement schedule referred to above, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
ERNST & YOUNG LLP
Boston, Massachusetts
The foregoing consent is in the form that will be signed upon the completion
of the restatement of capital accounts described in Note 10 to the financial
statements.
ERNST & YOUNG LLP
Boston, Massachusetts
June 18, 1996
<PAGE>
COMMON STOCK COMMON STOCK
NUMBER SHARES
PS-
[Pegasystems Logo]
Pegasystems Inc.
THIS CERTIFICATE IS TRANSFERABLE SEE REVERSE FOR
IN HARTFORD, CT AND NEW YORK, NY CERTAIN DEFINITIONS
CUSIP 705573 10 3
INCORPORATED UNDER THE LAWS OF THE COMMONWEALTH OF MASSACHUSETTS
THIS CERTIFIES THAT
is the owner of
FULLY PAID AND NON-ASSESSABLE SHARES OF THE
COMMON CAPITAL STOCK, $.01 PAR VALUE, OF
Pegasystems Inc.
transferable only on the books of the Corporation by the holder hereof
in person or by duly authorized attorney upon surrender of this Certificate
properly endorsed. This Certificate and the shares represented hereby are
issued under and subject to the laws of the Commonwealth of Massachusetts and to
the Restated Articles of Organization and Restated Bylaws of the Corporation,
all as in effect from time to time. This certificate is not valid until
countersigned and registered by the Transfer Agent and Registrar.
WITNESS the facsimile seal of the Corporation and the facsimile signatures
of its duly authorized officers.
Dated:
[Signature of Alan Trefler] [Signature of Ira Vishner]
PRESIDENT TREASURER
Pegasystems Inc.
Corporate
SEAL
1983
MASSACHUSETTS
*
COUNTERSIGNED AND REGISTERED:
FLEET NATIONAL BANK
TRANSFER AGENT AND REGISTRAR
BY
AUTHORIZED SIGNATURE
<PAGE>
PEGASYSTEMS INC.
The Corporation is authorized to issue more than one class of stock. Upon
written request, made by the holder of this Certificate, the Corporation will
furnish to such holder without charge a copy of the full text of the
preferences, voting powers, qualifications and special and relative rights of
the shares of each class authorized to be issued, as set forth in the Restated
Articles of Organization and the votes of the Board of Directors.
The following abbreviations, when used in the inscription on the face of
this certificate, shall be construed as though they were written out in full
according to applicable laws or regulations:
TEN COM--as tenants in common
TEN ENT--as tenants by the entireties
JT TEN --as joint tenants with right of
survivorship and not as tenants
in common
UNIF GIFT MIN ACT--________ Custodian ________
(Cust) (Minor)
under Uniform Gifts to Minors
Act _______________________
(State)
UNIF TRF MIN ACT--_________ Custodian (until age ______)
(Cust)
_________ under Uniform Transfers
(Minor)
to Minors Act ______________________
(State)
Additional abbreviations may also be used though not in the above list.
FOR VALUE RECEIVED, _________________________________________ hereby sell,
assign and transfer unto
PLEASE INSERT SOCIAL SECURITY OR OTHER
IDENTIFYING NUMBER OF ASSIGNEE
______________________________________
______________________________________
_______________________________________________________________________________
(PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE, OF ASSIGNEE)
_______________________________________________________________________________
_______________________________________________________________________________
________________________________________________________________________ Shares
of the capital stock represented by the within Certificate, and do hereby
irrevocably constitute and appoint
______________________________________________________________________ Attorney
to transfer the said stock on the books of the within named Corporation with
full power of substitution in the premises.
Dated __________________________________
X ______________________________________
X ______________________________________
NOTICE:
THE SIGNATURE(S) TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME(S) AS WRITTEN
UPON THE FACE OF THE CERTIFICATE IN EVERY PARTICULAR, WITHOUT ALTERATION OR
ENLARGEMENT OR ANY CHANGE WHATEVER.
Signature(s) Guaranteed:
By ________________________________________________________
THE SIGNATURE(S) SHOULD BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION
(BANKS, STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS AND CREDIT UNIONS WITH
MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM), PURSUANT TO
S.E.C. RULE 17Ad-15.
SECOND LOAN MODIFICATION AGREEMENT
This Second Loan Modification Agreement ("this Agreement") is made as
of May 15, 1996 between Pegasystems Inc., a Massachusetts corporation (the
"Borrower") and Fleet National Bank (successor by merger to Fleet Bank of
Massachusetts, N.A.) (the "Bank"). For good and valuable consideration, receipt
and sufficiency of which are hereby acknowledged, the Borrower and the Bank act
and agree as follows:
1. Reference is made to (i) that certain letter agreement dated
December 16, 1993 between the Borrower and Fleet Bank of Massachusetts, N.A., as
amended by Loan Modification Agreement dated as of May 5, 1995 (as so amended,
the "Letter Agreement"), the Bank having succeeded to the rights of Fleet Bank
of Massachusetts, N.A. thereunder; (ii) that certain $2,500,000 face principal
amount promissory note dated May 5, 1995 (the "1995 Revolving Note") made by the
Borrower and payable to the order of Fleet Bank of Massachusetts, N.A.; (iii)
that certain Security Agreement dated as of December 16, 1993 given by the
Borrower to Fleet Bank of Massachusetts, N.A., as amended by said May 5, 1995
Loan Modification Agreement (as so amended, the "Security Agreement"), the Bank
having succeeded to the rights of Fleet Bank of Massachusetts, N.A. thereunder;
(iv) certain term notes of the Borrower (the "Term Notes") heretofore issued by
the Borrower to Fleet Bank of Massachusetts, N.A., the Bank having succeeded to
the rights of Fleet Bank of Massachusetts, N.A. thereunder; and (v) that certain
$5,000,000 face principal amount promissory note of even date herewith (the
"1996 Revolving Note") made by the Borrower and payable to the order of the
Bank. The Letter Agreement, the Security Agreement, the Term Notes and the 1996
Revolving Note are hereinafter collectively referred to as the "Financing
Documents". The aforesaid May 5, 1995 Loan Modification Agreement is hereinafter
referred to as the "1995 Modification".
2. The Letter Agreement is hereby amended, effective as of the
date hereof:
a. By providing that all references therein to the "Bank" will
be deemed to refer to Fleet National Bank.
b. By deleting in its entirety clause (i) of Section 1.1 of the
Letter Agreement and by substituting in its stead the following:
"(i) that certain $5,000,000 face principal amount promissory
note (the `Revolving Note') dated May 15, 1996 made by the
Borrower and payable to the order of the Bank,"
As a result, all references in the Letter Agreement to a "Revolving Note" or to
the "1995 Revolving Note" will be deemed to refer to the 1996 Revolving Note.
c. By deleting from the third sentence of the third paragraph of
Section 1.8 of the Letter Agreement (as renumbered by the 1995 Modification) the
words "at its Principal Office, in immediately available funds" and by
substituting in their stead the following:
", in immediately available funds, at its Principal Office or
to such other address as the Bank may from time to time
direct"
d. By deleting from the first sentence of Section 1.9 of the Letter
Agreement (as renumbered by the 1995 Modification) the amount "$2,500,000" and
by substituting in its stead the following:
"$5,000,000"
<PAGE>
e. By deleting the period at the end of the fourth sentence of
Section 6.3 of the Letter Agreement (as replaced by the 1995 Modification) and
by substituting in its stead the following:
"; provided that commencing with the quarterly facility fee
payment due July 1, 1996 the quarterly facility fee shall be
$3,125 per quarter and the Borrower shall also pay on May 15,
1996 the sum of $407.99, representing the increased facility
fee for the period May 15, 1996 - June 30, 1996."
f. By deleting from Section 6.6 of the Letter Agreement the
words "Fleet Bank of Massachusetts, N.A." and by substituting in their stead
the following:
"Fleet National Bank"
g. By deleting from the definition of "Expiration Date" appearing in
Section 7.1 of the Letter Agreement the date "June 1, 1996" (such date having
been inserted by the 1995 Modification) and by substituting in its stead the
following:
"June 30, 1997"
As a result, from and after the date hereof, for the purposes of the Letter
Agreement and the other Financing Documents, the "Expiration Date" will be
deemed to be June 30, 1997.
h. By deleting from the definition of "Maximum Revolving Amount"
appearing in Section 7.1 of the Letter Agreement the amount "$2,500,000" and by
substituting in its stead the following:
"$5,000,000"
i. By inserting into the definition of "Principal Office" appearing in
Section 7.1 of the Letter Agreement, immediately after the words "of the Bank",
the following:
"in Boston, MA"
3. Each of the Term Notes is hereby modified by providing that all
references therein to the "Bank" will be deemed to refer to Fleet National Bank.
4. The Security Agreement is hereby modified by providing that all
references therein to the "Bank" will be deemed to refer to Fleet National Bank.
5. Wherever in any Financing Document, or in any certificate or opinion
to be delivered in connection therewith, reference is made to a "letter
agreement" or to the "Letter Agreement", from and after the date hereof same
will be deemed to refer to the Letter Agreement, as hereby amended.
6. Simultaneously with the execution and delivery of this Agreement,
the Borrower is executing and delivering to the Bank the 1996 Revolving Note, in
substitution for the 1995 Revolving Note. The 1996 Revolving Note is a
$5,000,000 promissory note of the Borrower, substantially in the form attached
hereto as Exhibit 1. Wherever in any of the Financing Documents or in any
certificate or opinion to be delivered in connection therewith, reference is
made to a "Revolving Note", from and after the date hereof same will be deemed
to refer to the 1996 Revolving Note. The Bank agrees that, within 10 business
days after it has received the executed originals of the 1996 Revolving Note and
this Agreement (together with the related Clerk's Certificate and opinion of
counsel) and has received payment of all interest accrued under the 1995
Revolving Note to May 15, 1996, the Bank will mark the 1995 Revolving Note
"paid" and will return it to the Borrower.
<PAGE>
7. In order to induce the Bank to enter into this Agreement, the
Borrower further represents and warrants as follows:
a. The execution, delivery and performance of this Agreement and the
1996 Revolving Note have been duly authorized by the Borrower by all necessary
corporate and other action, will not require the consent of any third party and
will not conflict with, violate the provisions of, or cause a default or
constitute an event which, with the passage of time or the giving of notice or
both, could cause a default on the part of the Borrower under its charter
documents or by-laws or under any contract, agreement, law, rule, order,
ordinance, franchise, instrument or other document, or result in the imposition
of any lien or encumbrance (except in favor of the Bank) on any property or
assets of the Borrower.
b. The Borrower has duly executed and delivered each of this
Agreement and the 1996 Revolving Note.
c. Each of this Agreement and the 1996 Revolving Note is the legal,
valid and binding obligation of the Borrower, enforceable against the Borrower
in accordance with its respective terms.
d. The statements, representations and warranties made in the Letter
Agreement continue to be correct as of the date hereof; except as amended,
updated and/or supplemented by the attached Supplemental Disclosure Schedule.
e. The covenants and agreements of the Borrower contained in the
Letter Agreement have been complied with on and as of the date hereof.
f. No event which constitutes or which, with notice or lapse of time,
or both, could constitute, an Event of Default (as defined in the Letter
Agreement) has occurred and is continuing.
g. No material adverse change has occurred in the financial condition
of the Borrower from that disclosed in the annual financial statements of the
Borrower dated December 31, 1994, heretofore furnished to the Bank.
8. Except as expressly affected hereby, the Letter Agreement and
each of the other Financing Documents remains in full force and effect as
heretofore.
9. Nothing contained herein will be deemed to constitute a waiver or a
release of any provision of any of the Financing Documents. Nothing contained
herein will in any event be deemed to constitute an agreement to give a waiver
or release or to agree to any amendment or modification of any provision of any
of the Financing Documents on any other or future occasion.
Executed, as an instrument under seal, as of the day and year first
above written.
PEGASYSTEMS INC.
By:____________________________
Name:
Title:
Accepted and agreed:
FLEET NATIONAL BANK
By:_____________________________
Name:
Title:
<PAGE>
SUPPLEMENTAL DISCLOSURE SCHEDULE
1. Messrs. Trefler and Vishner have transferred certain shares
of their stock in the Borrower to family members and/or trusts for the benefit
of same.
2. The Borrower's English office is located at Apex Plaza,
Reading, Berkshire RG1 1AX, England. The landlord is The Prudential Assurance
Company Limited.
PROMISSORY NOTE
$5,000,000.00 Boston, Massachusetts
May 15, 1996
FOR VALUE RECEIVED, the undersigned Pegasystems Inc., a Massachusetts
corporation (the "Borrower") hereby promises to pay to the order of FLEET
NATIONAL BANK (the "Bank") the principal amount of Five Million and 00/100
($5,000,000.00) Dollars or such portion thereof as has been advanced or
hereafter may be advanced by the Bank and/or its corporate predecessor pursuant
to ss.1.2 of that certain letter agreement between the Borrower and Fleet Bank
of Massachusetts, N.A. dated December 16, 1993, as amended (as so amended, the
"Letter Agreement") (the Bank having succeeded to the rights of Fleet Bank of
Massachusetts, N.A. thereunder) and remains outstanding from time to time
hereunder ("Principal"), with interest, at the rate hereinafter set forth, on
the daily balance of all unpaid Principal, from the date hereof until payment in
full of all Principal and interest hereunder.
Interest on all unpaid Principal shall be due and payable monthly in
arrears, on the first day of each month, commencing on the first such date after
the advance of any Principal and continuing on the first day of each month
thereafter and on the date of payment of this note in full, at a fluctuating
rate per annum (computed on the basis of a year of three hundred sixty (360)
days for the actual number of days elapsed) which shall at all times be equal to
the Prime Rate, as in effect from time to time (but in no event in excess of the
maximum rate permitted by then applicable law). A change in the aforesaid rate
of interest shall become effective on the same day on which any change in the
Prime Rate is effective. Overdue Principal and, to the extent permitted by law,
overdue interest shall bear interest at a fluctuating rate per annum which at
all times shall be equal to the sum of (i) two (2%) percent per annum plus (ii)
the per annum rate otherwise payable under this note (but in no event in excess
of the maximum rate permitted by then applicable law), compounded monthly and
payable on demand. As used herein, "Prime Rate" means that rate of interest per
annum announced by the Bank from time to time as its prime rate, it being
understood that such rate is merely a reference rate, not necessarily the
lowest, which serves as the basis upon which effective rates of interest are
calculated for obligations making reference thereto. If the entire amount of any
required Principal and/or interest is not paid within ten (10) days after the
same is due, the Borrower shall pay to the Bank a late fee equal to five percent
(5%) of the required payment, provided that such late fee shall be reduced to
three percent (3%) of any required Principal and interest that is not paid
within fifteen (15) days of the date it is due if this note is secured by a
mortgage on an owner-occupied residence of 1-4 units.
All outstanding Principal and all interest accrued thereon shall be due
and payable in full on the first to occur of: (i) an acceleration under ss.5.2
of the Letter Agreement or (ii) June 30, 1997. The Borrower may at any time and
from time to time prepay all or any portion of said Principal, without premium
or penalty. Under certain circumstances set forth in the Letter Agreement,
prepayments of Principal may be required.
<PAGE>
Payments of both Principal and interest shall be made, in immediately
available funds, at the office of the Bank located at 75 State Street, Boston,
Massachusetts 02109, or at such other address as the Bank may from time to time
designate.
The undersigned Borrower irrevocably authorizes the Bank to make or
cause to be made, on a schedule attached to this note or on the books of the
Bank, at or following the time of making any Revolving Loan (as defined in the
Letter Agreement) and of receiving any payment of Principal, an appropriate
notation reflecting such transaction and the then aggregate unpaid balance of
Principal. Failure of the Bank to make any such notation shall not, however,
affect any obligation of the Borrower hereunder or under the Letter Agreement.
The unpaid Principal balance of this note, as recorded by the Bank from time to
time on such schedule or on such books, shall constitute prima facie evidence of
the aggregate unpaid principal amount of the Revolving Loans.
The Borrower hereby (a) waives notice of and consents to any and all
advances, settlements, compromises, favors and indulgences (including, without
limitation, any extension or postponement of the time for payment), any and all
receipts, substitutions, additions, exchanges and releases of collateral, and
any and all additions, substitutions and releases of any person primarily or
secondarily liable, (b) waives presentment, demand, notice, protest and all
other demands and notices generally in connection with the delivery, acceptance,
performance, default or enforcement of or under this note, and (c) agrees to pay
all costs and expenses, including, without limitation, reasonable attorneys'
fees, incurred or paid by the Bank in enforcing this note and any collateral or
security therefor, all whether or not litigation is commenced.
This note is the Revolving Note referred to in, and is entitled to the
benefits of, the Letter Agreement. This note is subject to prepayment as set
forth in the Letter Agreement. The maturity of this note may be accelerated upon
the occurrence of an Event of Default, as provided in the Letter Agreement.
Executed, as an instrument under seal, as of the day and year first
above written.
CORPORATE SEAL PEGASYSTEMS INC.
ATTEST:
____________________________ By:__________________________
Clerk Name:
Title:
June 18, 1996
The undersigned, who is a nominee for election to the Board of
Directors of Pegasystems Inc. (the "Company"), hereby consents to be named in
the Company's Registration Statement on Form S-1 and understands that this
consent will be filed as an exhibit thereto.
------------------------------
Edward B. Roberts
June 18, 1996
The undersigned, who is a nominee for election to the Board of
Directors of Pegasystems Inc. (the "Company"), hereby consents to be named in
the Company's Registration Statement on Form S-1 and understands that this
consent will be filed as an exhibit thereto.
------------------------------
Leonard A. Schlesinger
June 18, 1996
The undersigned, who is a nominee for election to the Board of
Directors of Pegasystems Inc. (the "Company"), hereby consents to be named in
the Company's Registration Statement on Form S-1 and understands that this
consent will be filed as an exhibit thereto.
------------------------------
Thomas E. Swithenbank
Exhibit 99.1
PEGASYSTEMS, INC.
Schedule II
Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
Additions
Charged
Balance at to
beginning costs Balance at
of and end of
Description period expenses Deductions period
- ------------------------------- ---------- -------- --------- ----------
<S> <C> <C> <C> <C>
Year ended December 31, 1995
Allowance for doubtful
accounts $ 0 $793,310 $359,423(a) 433,887
Year ended December 31, 1994
Allowance for doubtful
accounts 340,041 0 340,041(a) 0
Year ended December 31, 1993
Allowance for doubtful
accounts 18,087 325,862 3,908(a) 340,041
</TABLE>
(a) Deductions are related to accounts receivable write-offs
