Filed Pursuant to Rule 424(b)(4)
Registration No. 333-3807
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. For factors 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.
The Common Stock has been approved for quotation on the Nasdaq National Market
under the symbol "PEGA."
-------------
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.
-------------
<TABLE>
<CAPTION>
Initial Public Underwriting Proceeds to Proceeds to Selling
Offering Price Discount (1) Company (2) Stockholders
<S> <C> <C> <C> <C>
Per Share $12.00 $0.84 $11.16 $11.16
Total (3) $40,800,000 $2,856,000 $30,132,000 $7,812,000
</TABLE>
- -------------
(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 $4,629,000, $3,284,000 and $35,823,600, respectively. See
"Underwriting."
-------------
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 July 24,
1996.
Goldman, Sachs & Co.
Cowen & Company
Montgomery Securities
-------------
The date of this Prospectus is July 18, 1996.
<PAGE>
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.
2
<PAGE>
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).
<PAGE>
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
<PAGE>
The Offering
<TABLE>
<CAPTION>
<S> <C>
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."
Nasdaq National Market symbol PEGA
</TABLE>
- -------------
(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)
<TABLE>
<CAPTION>
Three Months
Ended
Year ended December 31, March 31,
-------------------------- ----------------
1993 1994 1995 1995 1996
------ ------ ------ ----- -------
<S> <C> <C> <C> <C> <C>
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 3 451
License interest income 1,305 1,457 1,486 370 368
Net income 1,233 2,193 2,878 224 481
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
</TABLE>
<TABLE>
<CAPTION>
March 31, 1996
-----------------------
As Adjusted
Actual (1)
------ --------------
<S> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents $ 2,644 $30,807
Working capital 6,952 35,845
Long-term license installments, net 11,444 11,444
Total assets 26,555 54,718
Long-term debt 672 --
Stockholders' equity 15,136 44,701
</TABLE>
- -------------
(1) Gives effect to (i) the sale of the 2,700,000 shares of Common Stock
offered by the Company hereby at the initial public offering price
of $12.00 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 the amendment and restatement of the Company's
Articles of Organization (the "Restated Articles") 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, effective July 10, 1996, and (iv) assumes no
exercise of the Underwriters' over-allotment option. See "Description of
Capital Stock" and "Underwriting."
4
<PAGE>
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
5
<PAGE>
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
<PAGE>
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
7
<PAGE>
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
and training 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 $10.31
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 a majority 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 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 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 $29,532,000 ($35,223,600 if the Underwriters' over-allotment option is
exercised in full), 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 the initial public offering
price of $12.00 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
---------------------
Adjusted
Actual (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 106 29,643
Deferred compensation (86) (86)
Retained earnings 15,003 15,003
Cumulative foreign currency translation adjustment (122) (122)
------- --------
Total stockholders' equity 15,136 44,701
------- --------
Total capitalization $15,808 $44,701
======= ========
</TABLE>
- -------------
(1) Adjusted to give effect to the sale of 2,700,000 shares of Common Stock
offered by the Company hereby at the initial public offering price
of $12.00 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 the initial public offering price of $12.00
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 $44,346,418 or $1.69 per share of Common
Stock. This represents an immediate increase in such pro forma net tangible
book value of $1.06 per share to existing stockholders and an immediate
dilution of $10.31 per share to new investors purchasing shares in this
offering. The following table illustrates this per share dilution:
<TABLE>
<CAPTION>
<S> <C> <C>
Initial public offering price per share $12.00
Net tangible book value per share as of March 31, 1996 $0.63
Increase per share attributable to new investors $1.06
-----
Pro forma net tangible book value per share as of March 31, 1996 after
offering 1.69
------
Net tangible book value dilution per share to new investors $10.31
======
</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:
<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 32,400,000 99.7 $12.00
---------- --- ----------- ----- ------
Total 26,290,800 100% $32,507,728 100.0%
========== === =========== =====
</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 3 451
License interest income 987 1,220 1,305 1,457 1,486 370 368
Net income 1,791 1,867 1,233 2,193 2,878 224 481
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 $354,000 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.
The Company's export revenue has fluctuated considerably in the past due
to the fact that such revenue has been largely attributable to a small number
of product acceptances during a given period. The Company's export revenue
increased from $1.0 million in 1993 to $3.9 million in 1994 due primarily to
product acceptance by a single customer in Ireland in 1994, the year in which
the Company organized its subsidiary in the United Kingdom. Export revenue
declined to $2.3 million in 1995 due to the lack of large product acceptances
during the year.
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>
Three Months
Year Ended 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 31.2 28.4
----- ----- ----- ----- -----
Total cost of revenue 34.0 29.9 30.6 36.0 30.8
----- ----- ----- ----- -----
Gross margin 66.0 70.1 69.4 64.0 69.2
----- ----- ----- ----- -----
Operating expenses:
Research and development 36.9 33.5 31.7 35.9 32.5
Sales and marketing 13.2 16.2 16.1 19.9 19.7
General and administrative 8.2 6.7 6.9 8.2 7.8
----- ----- ----- ----- -----
Total operating expenses 58.3 56.4 54.7 64.0 60.0
----- ----- ----- ----- -----
Income from operations 7.7 13.7 14.7 0.0 9.2
License interest income 12.8 9.0 6.7 9.2 7.4
Other interest income 0.3 0.1 0.1 0.2 0.2
Interest expense (0.3) (0.3) (0.5) (0.4) (0.8)
----- ----- ----- ----- -----
Income before provision for
income taxes 20.5 22.5 21.0 9.0 16.0
Provision for income taxes 8.4 9.0 7.9 3.4 6.3
----- ----- ----- ---- -----
Net income 12.1% 13.5% 13.1% 5.6% 9.7%
===== ===== ===== ==== =====
</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
17
<PAGE>
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.
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 12.5% 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 31.2% for the 1995 Period to 28.4% for the 1996
Period, and declined as a percentage of services revenue from 69.5% 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 11.4% 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
35.9% for the 1995 Period to 32.5% for the 1996 Period due to the growth in
the Company's total revenue.
Sales and marketing expenses for the 1996 Period increased 22.2% to
$974,000 from $797,000 for the 1995 Period. As a percentage of total revenue,
sales and marketing expenses decreased slightly from 19.9% 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 19.0% to $389,000 from $327,000 for the 1995 Period due to staff
growth. Such expenses declined slightly as a percentage of total revenue from
8.2% for the 1995 Period to 7.8% for the 1996 Period due to the growth in the
Company's total revenue.
18
<PAGE>
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.
Provision for Income Taxes
The provisions for federal, state and foreign taxes were $137,000 and
$311,000 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 40.9% 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 11.6% 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 $ 5,114 $2,520
Services 1,796 2,113 2,032 2,778 2,421
------- ------- ------- ------- ------
Total revenue 4,005 4,694 5,656 7,892 4,941
------- ------- ------- ------- ------
Cost of revenue:
Cost of software license 191 190 127 127 118
Cost of services 1,249 1,404 1,605 1,903 1,405
------- ------- ------- ------- ------
Total cost of revenue 1,440 1,594 1,732 2,030 1,523
------- ------- ------- ------- ------
Gross profit 2,565 3,100 3,924 5,862 3,418
------- ------- ------- ------- ------
Operating expenses:
Research and development $ 1,438 $1,640 $1,871 $2,112 $1,604
Sales and marketing 797 867 878 1,050 974
General and administrative 327 380 381 453 389
------- ------- ------- ------- ------
Total operating expenses 2,562 2,887 3,130 3,615 2,967
------- ------- ------- ------- ------
Income from operations 3 213 794 2,247 451
------- ------- ------- ------- ------
License interest income 370 368 384 364 368
Other interest income 6 4 6 0 12
Interest expense (18) (17) (33) (50) (39)
------- ------- ------- ------- ------
Income before provision for income
taxes 361 568 1,151 2,561 792
Provision for income taxes 137 216 437 973 311
------- ------- ------- ------- ------
Net income $ 224 $ 352 $ 714 $1,588 $ 481
======= ======= ======= ======= ======
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 31.2 29.9 28.4 24.1 28.4
------- ------- ------- ------- ------
Total cost of revenue 36.0 34.0 30.6 25.7 30.8
------- ------- ------- ------- ------
Gross margin 64.0 66.0 69.4 74.3 69.2
------- ------- ------- ------- ------
Operating expenses:
Research and development 35.9 34.9 33.1 26.8 32.5
Sales and marketing 19.9 18.5 15.5 13.3 19.7
General and administrative 8.2 8.1 6.7 5.7 7.8
------- ------- ------- ------- ------
Total operating expenses 64.0 61.5 55.3 45.8 60.0
------- ------- ------- ------- ------
Income from operations 0.0 4.5 14.1 28.5 9.2
License interest income 9.2 7.8 6.8 4.6 7.4
Other interest income 0.2 0.1 0.1 0.0 0.2
Interest expense (0.4) (0.3) (0.6) (0.7) (0.8)
------- ------- ------- ------- ------
Income before provision for income
taxes 9.0 12.1 20.4 32.4 16.0
Provision for income taxes 3.4 4.6 7.8 12.3 6.3
------- ------- ------- ------- ------
Net income 5.6% 7.5% 12.6% 20.1% 9.7%
======= ======= ======= ======= ======
</TABLE>
22
<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 which developed in such
quarter.
Three Months Ended June 30, 1996
The Company expects that its total revenue for the three months ended June
30, 1996 (the "1996 Second Quarter") will be approximately $6.4 million, an
increase of 37% from the Company's total revenue for the three months ended June
30, 1995 (the "1995 Second Quarter") of $4.7 million. Software license revenue
is expected to increase 50% to approximately $3.9 million in the 1996 Second
Quarter from $2.6 million for the 1995 Second Quarter, while services revenue is
expected to increase 21% to approximately $2.6 million for the 1996 Second
Quarter from $2.1 million for the 1995 Second Quarter. The Company anticipates
that its net income will increase 157% to approximately $900,000 for the 1996
Second Quarter from $352,000 for the 1995 Second Quarter.
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.
In 1993, the Company recorded bad debt expense in the amount of $326,000 as a
result of certain specifically identified accounts receivable relating primarily
to services rendered by the Company. The Company recorded no bad debt expense in
1994. In 1995, the Company recorded bad debt expense in the amount of $793,000
as a result of indications in the fourth quarter of the year that certain
receivables relating primarily to services rendered by the Company would not be
collected in full. The receivables with respect to which bad debt expense was
recorded in 1993 and 1995 related primarily to maintenance and installation
services provided by the Company. At the time such services were rendered (and
the resulting revenue was recognized) there was no significant uncertainty
regarding the acceptance thereof and the collectibility of the related
receivables was probable.
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
23
<PAGE>
any such required additional capital will be available on reasonable terms,
if at all, at such time as required by the Company.
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.
26
<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.
27
<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.
28
<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
29
<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
34
<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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<PAGE>
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. 43 Director
Schlesinger(2)
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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<PAGE>
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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<PAGE>
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.
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<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) $2,101,200 $2,521,440
Michael R. Pyle 151,200 172,800 (3) 1,765,008 2,017,152
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 equal to the initial public offering price of $12.00
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.
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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.
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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.
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<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 to be
Shares Beneficially Beneficially Owned
Owned Prior to After Offering (1)
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.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists 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
The Board of Directors is 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)
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<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 of Organization (the "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 a majority 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 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.
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<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 July 10, 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 15 106 106
Deferred compensation -- (91) (86)
Retained earnings 11,644 14,522 15,003
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 1,249 1,405
---------- ---------- ---------- --------- -----------
Total cost of revenue 3,469 4,866 6,796 1,440 1,523
---------- ---------- ---------- --------- -----------
Gross profit 6,743 11,397 15,451 2,565 3,418
Operating expenses
Research and development 3,766 5,440 7,061 1,438 1,604
Sales and marketing 1,350 2,629 3,592 797 974
General and administrative 834 1,092 1,541 327 389
---------- ---------- ---------- --------- -----------
Total operating expenses 5,950 9,161 12,194 2,562 2,967
---------- ---------- ---------- --------- -----------
Income from operations 793 2,236 3,257 3 451
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 4,641 361 792
Provision for income taxes 860 1,465 1,763 137 311
---------- ---------- ---------- --------- -----------
Net income $1,233 $2,193 $2,878 $224 $481
========== ========== ========== ========= ===========
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 Deferred Retained Translation Stockholders'
Shares Amount Capital Compensation Earnings Adjustment Equity
--------- ------ -------- ------------ -------- ---------- -------------
(in thousands except for share-related data)
<S> <C> <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)
Issuance of stock options -- -- 91 $(91) -- -- --
Net income -- -- -- -- 2,878 -- 2,878
---------- ---- --- --- ------- ----- -------
Balance at December 31, 1995 23,490,000 235 106 (91) 14,522 (98) 14,674
Foreign currency translation
adjustment -- -- -- -- -- (24) (24)
Amortization of deferred
compensation -- -- -- 5 -- -- 5
Net income (unaudited) -- -- -- -- 481 -- 481
---------- ---- --- --- ------- ----- -------
Balance at March 31, 1996
(unaudited) 23,490,000 $235 $106 $(86) $15,003 $(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 $ 224 $ 481
Adjustments to reconcile net income to net
cash provided (used) by operating
activities:
Provision for deferred income taxes 629 961 1,836 103 501
Depreciation and amortization 1,536 1,511 1,455 309 374
Provision for doubtful accounts 326 -- 793 -- --
Change in operating assets and liabilities:
Decrease (increase) in trade and
installment accounts receivable (2,149) (3,988) (5,638) 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) (623) (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>
In December 1995, the Company granted options to purchase 335,250 shares of
Common Stock at an exercise price of $.39 per share. The Company recorded an
increase to additional paid-in-capital and a corresponding charge to deferred
compensation in the amount of $90,518 to recognize the aggregate difference
between the deemed fair value for accounting purposes of the stock options at
the date of grant and the exercise price. The deferred compensation will be
amortized over the option vesting period of five years.
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>
Year ended December 31, (in thousands)
<S> <C>
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.
On July 10, 1996, the Company increased the number of shares of common stock
authorized from 9 million to 45 million shares. The Company's Board of Directors
approved a three-for-one stock split in the form of a stock dividend effective
on July 10, 1996.
The financial statements give effect to both stock splits for all periods
presented.
The Board of Directors is 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. 733,334
Cowen & Company 733,333
Montgomery Securities 733,333
Adams, Harkness & Hill, Inc. 200,000
Alex. Brown & Sons Incorporated 200,000
Hambrecht & Quist LLC 200,000
Edward D. Jones & Co. 200,000
Morgan Stanley & Co. Incorporated 200,000
Robertson, Stephens & Company LLC. 200,000
---------
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 $0.45 per share. The Underwriters may allow,
and such dealers may reallow, a concession not in excess of $0.10 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 was negotiated among the Company
and the representatives. Among the factors considered in determining the initial
public offering price of the Common Stock, in addition to prevailing market
conditions, were 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
<TABLE>
<CAPTION>
Page
--------
<S> <C>
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 Fi-
nancial 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
</TABLE>
Through and including August 12, 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
================================================================================
