As filed with the Securities and Exchange Commission on January 22, 1997
Registration No. 333-16475
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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POST-EFFECTIVE
AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
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PEGASYSTEMS INC.
(Exact name of Registrant as specified in its charter)
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<CAPTION>
Massachusetts 7389 04-2787865
<S> <C> <C>
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer Identification Number)
incorporation or organization) Classification Code Number)
</TABLE>
101 Main Street, Cambridge, Massachusetts 02142 (617) 374-9600
(Address and Telephone Number of Registrant's Principal Executive Offices)
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ALAN TREFLER
President
PEGASYSTEMS INC.
101 Main Street
Cambridge, Massachusetts 02142
(617) 374-9600
(Name, Address and Telephone Number of Agent for Service)
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Copies to:
ROBERT V. JAHRLING III, ESQ. MARK G. BORDEN, ESQ.
Choate, Hall & Stewart JEFFREY A. STEIN, ESQ.
Exchange Place Hale and Dorr
53 State Street 60 State Street
Boston, Massachusetts 02109-2891 Boston, Massachusetts 02109-1816
(617) 248-5000 (617) 526-6000
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Approximate date of commencement of proposed sale to the public: As soon
as practicable after this Post-Effective Amendment No. 2 becomes effective.
If any of the securities being registered on this form are being offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities
Act of 1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [ ]
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<PAGE>
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement
becomes effective. This prospectus shall not constitute an offer to sell or
the solicitation of an offer to buy nor shall there be any sale of these
securities in any State in which such offer, solicitation or sale would be
unlawful prior to registration or qualification under the securities laws of
any such State.
SUBJECT TO COMPLETION, DATED JANUARY 22, 1997
2,245,000 Shares
[Pegasystems Logo]
Pegasystems Inc.
Common Stock
(par value $.01 per share)
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Of the 2,245,000 shares of Common Stock offered hereby, 1,500,000 are being
sold by Pegasystems Inc. ("Pegasystems" or the "Company") and 745,000 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.
See "Risk Factors" beginning on page 5 for certain considerations relevant
to an investment in the Common Stock.
The last reported sale price of the Common Stock, which is quoted under the
symbol "PEGA" on the Nasdaq National Market, was $30.4375 per share on
January 21, 1997. See "Price Range of Common Stock."
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
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Initial Public Underwriting Proceeds to Proceeds to Selling
Offering Price Discount (1) Company (2) Stockholders
<S> <C> <C> <C> <C>
Per Share $ $ $ $
Total (3) $ $ $ $
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(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933. See "Underwriting."
(2) Before deducting expenses of the offering payable by the Company,
estimated to be $300,000.
(3) The Company has granted to the Underwriters an option for 30 days to
purchase up to an additional 336,750 shares at the initial offering price
per share, less the underwriting discount, solely to cover
over-allotments, if any. If such option is exercised in full, the total
initial public offering price, underwriting discount and proceeds to
Company will be $ , $ and $ , respectively.
See "Underwriting."
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The shares offered hereby are offered severally by the 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
certificates for the shares will be ready for delivery in New York, New York,
on or about , 1997, against payment therefor in immediately available
funds.
Goldman, Sachs & Co.
Cowen & Company
Montgomery Securities
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The date of this Prospectus is , 1997.
<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.
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP
MEMBERS (IF ANY) OR THEIR RESPECTIVE AFFILIATES MAY ENGAGE IN PASSIVE MARKET
MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN
ACCORDANCE WITH RULE 10b-6A UNDER THE SECURITIES EXCHANGE ACT OF 1934. SEE
"UNDERWRITING."
<PAGE>
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 new markets such as insurance,
telecommunications and public utilities 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 15 people as of December 31, 1996. The Company
intends to increase substantially the size and productivity of its sales
force, both of 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
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<S> <C>
Common Stock offered by the Company 1,500,000 shares
Common Stock offered by the Selling 745,000 shares
Stockholders
Common Stock to be outstanding after 28,012,200 shares (1)
the offering
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
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(1) Based on the number of shares of Common Stock outstanding on December 31,
1996, plus 120,000 shares of Common Stock issuable upon exercise of stock
options to be exercised immediately prior to the closing of this
offering. Excludes 2,462,250 shares of Common Stock issuable upon
exercise of stock options outstanding as of December 31, 1996, at a
weighted average exercise price of $5.29 per share, of which options to
purchase 563,570 shares were then exercisable. See "Capitalization" and
"Management--Stock Plans."
Summary Consolidated Financial Data
(in thousands, except per share data)
<TABLE>
<CAPTION>
Nine Months Ended
Year ended December 31, September 30,
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1993 1994 1995 1995 1996
--------- --------- --------- -------------------
<S> <C> <C> <C> <C> <C>
Consolidated Statement of Income Data:
Total revenue $10,212 $16,263 $22,247 $14,355 $20,956
Income from operations 793 2,236 3,257 1,010 4,514
License interest income 1,305 1,457 1,486 1,122 1,127
Net income 1,233 2,193 2,878 1,290 3,567
Net income per common and common
equivalent share $ 0.05 $ 0.09 $ 0.11 $ 0.05 $ 0.14
Weighted average number of common and
common equivalent shares outstanding 24,231 24,102 25,551 25,600 25,952
</TABLE>
<TABLE>
<CAPTION>
September 30, 1996
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Actual As Adjusted (1)
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<S> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents $25,419 $ 68,304
Working capital 34,521 77,406
Long-term license installments, net 18,032 18,032
Total assets 59,728 102,613
Stockholders' equity 48,136 91,021
</TABLE>
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(1) Gives effect to (i) the sale of the 1,500,000 shares of Common Stock
offered by the Company hereby at an assumed public offering price of
$30.4375 per share, after deducting the estimated underwriting discount
and offering expenses payable by the Company, and (ii) the exercise of
stock options to purchase 120,000 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 a 3-for-1 split of the outstanding Common
Stock, in the form of a stock dividend, effective July 10, 1996, and (iii)
assumes no exercise of the Underwriters' over-allotment option. See
"Description of Capital Stock" and "Underwriting."
4
<PAGE>
RISK FACTORS
This Prospectus contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended. Discussion containing
such forward-looking statements may be found in the material set forth under
"Prospectus Summary," "Risk Factors," "Use of Proceeds," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business," as well as within this Prospectus generally. Actual results could
differ materially from those projected in the forward- looking statements as
a result of the risk factors set forth below and the matters set forth in
this Prospectus generally. The Company cautions the reader, however, that
this list of factors may not be exhaustive. The following risk factors should
be considered carefully in addition to the other information contained in
this Prospectus before purchasing the Common Stock offered hereby.
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 possible 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
5
<PAGE>
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 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, Digital OpenVMS, Sun Solaris and Windows/NT platforms, of
which the RS 6000/AIX, Digital OpenVMS and Sun Solaris systems have been
brought 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 shipped Sun Solaris and Windows/NT versions of its
software capable of storing work items in Oracle and Microsoft SQL Server
relational databases. However, the Company's existing and potential customers
may demand that the Company's systems be compatible with other relational
databases and 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."
6
<PAGE>
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'
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, telecommunications,
medical, public 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 77% of the
Company's outstanding Common Stock (76% if the over-allotment option granted
to the Underwriters is exercised in full). As of December 31, 1996, there were
outstanding options to purchase 2,582,250 shares of the Company's Common
Stock, of which options to purchase 683,570 shares were then exercisable.
Assuming the exercise of all such outstanding options, Mr. Trefler would own
approximately 71% of the outstanding Common Stock (70% 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."
7
<PAGE>
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 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
8
<PAGE>
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, Luxembourg, Mexico and Sweden and is in negotiations
with potential customers based in other foreign countries. The Company
recently established an office in Paris, France, and may establish additional
offices 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.
9
<PAGE>
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."
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 has also recently begun
establishing relationships with third parties that will distribute the
Company's products. The Company's strategy in entering into these
relationships is to keep pace with the technological and marketing
developments of major software vendors, to acquire technical assistance for
the Company's product development efforts and to leverage the Company's sales
and marketing capabilities. 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.
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
10
<PAGE>
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 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 5,872,900
shares (including the 2,245,000 offered hereby) freely tradeable without
restriction or further registration under the Securities Act of 1933, as
amended (the "Securities Act"), 36,000 shares of Common Stock will be
eligible for future sale in the public market pursuant to Rule 144 or Rule
701 under the Securities Act. Upon the expiration of lock-up agreements
between certain stockholders of the Company and the representatives of the
Underwriters 120 days after the date of the Prospectus, an additional
22,103,300 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."
As of December 31, 1996, giving effect to the exercise of options for the
purchase of 120,000 shares immediately prior to the closing of this offering,
options to purchase a total of 2,462,250 shares were outstanding (of which
563,570 were then exercisable) and 3,287,750 shares were reserved for future
issuance under the Company's stock plans. Shares issuable upon exercise of
such options and issuable under such stock plans are eligible for sale in the
public market, subject to Rule 144 limitations applicable to affiliates. See
"Shares Eligible for Future Sale."
Potential Volatility of Stock Price
The market price of the Company's Common Stock has been volatile and could be
subject to wide fluctuations in the future 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 "Price Range of
Common Stock" and "Underwriting."
11
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 1,500,000 shares of
Common Stock offered by the Company pursuant to this offering are estimated
to be $42,845,000 ($52,531,000 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 and to increase the
visibility of the Company in the marketplace. The Company intends to use the
net proceeds from this offering for general corporate purposes, including
working capital, product development and capital expenditures.
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.
PRICE RANGE OF COMMON STOCK
The Company's Common Stock has been traded on the Nasdaq National Market
under the symbol "PEGA" since the Company's initial public offering in July
1996. The following table shows the high and low sale prices for one share of
Common Stock on the Nasdaq National Market for the periods indicated.
High Low
------------------
1996
- ----
Third quarter (beginning July 19, 1996) $27.00 $10.00
Fourth quarter $37.00 $26.125
On January 21, 1997, the closing sale price of the Common Stock was
$30.4375. As of January 21, 1997, there were approximately 27 holders of
record of the Company's Common Stock.
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
September 30, 1996 and as adjusted to give effect to the sale of 1,500,000
shares of Common Stock offered by the Company hereby at an assumed public
offering price of $30.4375 per share and the receipt 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>
September 30, 1996
------------------------
Actual Adjusted (1)
--------- -------------
(in thousands except
share-related data)
<S> <C> <C>
Stockholders' equity
Common Stock, $.01 par value, 45,000,000 shares
authorized, 26,372,000 shares issued and outstanding
(actual); and 27,992,000 shares issued and outstanding
(as adjusted) (2) (3) $ 264 $ 280
Additional paid-in capital 29,994 72,863
Deferred compensation (77) (77)
Retained earnings 18,089 18,089
Cumulative foreign currency translation adjustment (134) (134)
--------- ---------
Total stockholders' equity 48,136 91,021
--------- ---------
Total capitalization $48,136 $91,021
========= =========
</TABLE>
- -------------
(1) Adjusted to give effect to (i) the sale of 1,500,000 shares of Common
Stock offered by the Company hereby at an assumed public offering price
of $30.4375 per share, after deducting the estimated underwriting discount
and offering expenses payable by the Company, and (ii) the exercise of
stock options to purchase 120,000 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.
(2) Includes 120,000 shares of Common Stock issuable upon exercise of stock
options to be exercised immediately prior to the closing of this
offering.
(3) Excludes 2,397,950 shares of Common Stock issuable pursuant to the
exercise of options outstanding at September 30, 1996, of which options
to purchase 401,390 shares were then exercisable. See "Management--Stock
Plans."
13
<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, 1992 and 1993 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 nine
months ended September 30, 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 financial
position and the results of operations for the unaudited interim periods. The
results of operations for the nine months ended September 30, 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>
Nine Months Ended
Year Ended December 31, September 30,
-------------------------------------------------- ---------------------
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 $14,355 $20,956
Income from operations 1,858 1,944 793 2,236 3,257 1,010 4,514
License interest income 987 1,220 1,305 1,457 1,486 1,122 1,127
Net income 1,791 1,867 1,233 2,193 2,878 1,290 3,567
Net income per common and
common equivalent share $ 0.07 $ 0.08 $ 0.05 $ 0.09 $ 0.11 $ 0.05 $ 0.14
Weighted average common and
common equivalent shares
outstanding 24,471 24,471 24,231 24,102 25,551 25,600 25,952
</TABLE>
<TABLE>
<CAPTION>
December 31, September 30,
--------------------------------------------------------------
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 $25,419
Working capital 1,904 3,428 4,231 4,441 4,393 34,521
Long-term license installments,
net 5,512 6,319 6,782 9,135 13,399 18,032
Total assets 11,992 14,387 17,057 20,787 25,876 59,728
Long-term debt 108 118 458 450 816 --
Stockholders' equity 6,576 8,444 9,676 11,872 14,674 48,136
</TABLE>
14
<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%; for the three months ended June 30,
1996 and September 30, 1996, such discount rate was 6.75%. Commencing with
the three months ended March 31, 1996, the Company has established and
intends to continue 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% and 28% of total revenue in 1993, 1994 and 1995,
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.
15
<PAGE>
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 capitalized in 1995 or
in the nine months ended September 30, 1996. At September 30, 1996, the
Company carried $123,000 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.
Most of the Company's contracts are denominated in U.S. dollars, although
several are denominated in other currencies, primarily 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>
Nine Months
Year Ended Ended
December 31, September 30,
------------------------- ----------------
1993 1994 1995 1995 1996
------- ------- ------- ------- --------
<S> <C> <C> <C> <C> <C>
Revenue:
Software license 63.1% 59.4% 60.8% 58.6% 61.5%
Services 36.9 40.6 39.2 41.4 38.5
------- ------- ------- ------- --------
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 3.5 1.7
Cost of services 21.8 23.3 27.7 29.7 23.9
------- ------- ------- ------- --------
Total cost of revenue 34.0 29.9 30.6 33.2 25.6
------- ------- ------- ------- --------
Gross profit 66.0 70.1 69.4 66.8 74.4
------- ------- ------- ------- --------
Operating expenses:
Research and development 36.9 33.5 31.7 34.5 28.1
Sales and marketing 13.2 16.2 16.1 17.7 18.5
General and administrative 8.2 6.7 6.9 7.6 6.3
------- ------- ------- ------- --------
Total operating expenses 58.3 56.4 54.7 59.8 52.9
------- ------- ------- ------- --------
Income from operations 7.7 13.7 14.7 7.0 21.5
License interest income 12.8 9.0 6.7 7.8 5.4
Other interest income 0.3 0.1 0.1 0.1 1.4
Interest expense (0.3) (0.3) (0.5) (0.4) (0.4)
------- ------- ------- ------- --------
Income before provision for
income taxes 20.5 22.5 21.0 14.5 27.9
Provision for income taxes 8.4 9.0 7.9 5.5 10.9
------- ------- ------- ------- --------
Net income 12.1% 13.5% 13.1% 9.0% 17.0%
======= ======= ======= ======= ========
</TABLE>
16
<PAGE>
Nine Months Ended September 30, 1996 Compared to Nine Months Ended
September 30, 1995
Revenue
Total revenue for the nine months ended September 30, 1996 (the "1996
Period") increased 46.0% to $21.0 million from $14.4 million for the nine
months ended September 30, 1995 (the "1995 Period"). The increase was
primarily due to an increase in software license revenue.
Software license revenue for the 1996 Period increased 53.3% to $12.9
million from $8.4 million for the 1995 Period. The increase in software
license revenue was primarily attributable to software license acceptances by
new customers, software license agreement renewals, expanded software usage
by existing customers, the licensing of standard product templates and
inflation-based increases in monthly license fees.
Services revenue for the 1996 Period increased 35.7% to $8.1 million from
$5.9 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.
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 30.3% to $354,000 from
$508,000 for the 1995 Period, and decreased as a percentage of total revenue
from 3.5% for the 1995 Period to 1.7% for the 1996 Period. As a percentage of
software license revenue, cost of software license decreased from 6.0% for
the 1995 Period to 2.7% 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 17.6% to $5.0 million from $4.3
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 to meet growing client commitments. Cost
of services as a percentage of total revenue declined from 29.7% for the 1995
Period to 23.9% for the 1996 Period, and declined as a percentage of services
revenue from 71.7% for the 1995 Period to 62.1% 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 18.9% to $5.9 million from $4.9 million for the 1995 Period. The
increase in research and development expenses was due to the hiring of
additional development personnel. As a percentage of total revenue, research
and development expenses declined from 34.5% for the 1995 Period to 28.1% for
the 1996 Period reflecting the Company's strategy of leveraging existing
product functionality by shifting its historical focus on research and
development to sales and marketing.
Sales and marketing expenses for the 1996 Period increased 52.2% to $3.9
million from $2.5 million for the 1995 Period. As a percentage of total
revenue, sales and marketing expenses increased from 17.7% for the 1995
Period to 18.5% for the 1996 Period. Such increases were attributable to the
hiring of additional direct sales and marketing personnel, increased sales
commission payments attributable to higher sales, and increased investment in
marketing support activities and materials.
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 22.2% to $1.3 million from $1.1 million for the 1995 Period due to
increased investment in the infrastructure needed to support the Company's
growth. Such expenses declined as a percentage of total revenue from 7.6% for
the 1995 Period to 6.3% for the 1996 Period due to the growth in the
Company's total revenue.
17
<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 $1.1 million.
Provision for Income Taxes
The provisions for federal, state and foreign taxes were $790,000 and $2.3
million 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
September 30, 1996, the Company had $420,000 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.
18
<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
19
<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 three
quarters 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.
20
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended
---------------------------------------------------------------------------------
March 31, June 30, September 30, December 31, March 31, June 30, September 30,
1995 1995 1995 1995 1996 1996 1996
--------- --------- ------------------------- --------- --------- -------------
(in thousands except percentage data)
<S> <C> <C> <C> <C> <C> <C> <C>
Consolidated Statement of Income Data:
Revenue:
Software license $2,209 $2,581 $3,624 $5,114 $2,520 $3,874 $6,502
Services 1,796 2,113 2,032 2,778 2,421 2,575 3,064
--------- --------- ---------- ---------- --------- --------- ----------
Total revenue 4,005 4,694 5,656 7,892 4,941 6,449 9,566
--------- --------- ---------- ---------- --------- --------- ----------
Cost of revenue:
Cost of software
license 191 190 127 127 118 118 118
Cost of services 1,249 1,404 1,605 1,903 1,405 1,584 2,017
--------- --------- ---------- ---------- --------- --------- ----------
Total cost of
revenue 1,440 1,594 1,732 2,030 1,523 1,702 2,135
--------- --------- ---------- ---------- --------- --------- ----------
Gross profit 2,565 3,100 3,924 5,862 3,418 4,747 7,431
--------- --------- ---------- ---------- --------- --------- ----------
Operating expenses:
Research and
development $1,438 $1,640 $1,871 $2,112 $1,604 $1,918 $2,361
Sales and marketing 797 867 878 1,050 974 1,282 1,614
General and
administrative 327 380 381 453 389 399 541
--------- --------- ---------- ---------- --------- --------- ----------
Total operating
expenses 2,562 2,887 3,130 3,615 2,967 3,599 4,516
--------- --------- ---------- ---------- --------- --------- ----------
Income from
operations 3 213 794 2,247 451 1,148 2,915
--------- --------- ---------- ---------- --------- --------- ----------
License interest
income 370 368 384 364 368 378 381
Other interest
income 6 4 6 0 12 11 273
Interest expense (18) (17) (33) (50) (39) (30) (16)
--------- --------- ---------- ---------- --------- --------- ----------
Income before
provision for
income taxes 361 568 1,151 2,561 792 1,507 3,553
Provision for income
taxes 137 216 437 973 311 588 1,386
--------- --------- ---------- ---------- --------- --------- ----------
Net income $ 224 $ 352 $ 714 $1,588 $ 481 $ 919 $2,167
========= ========= ========== ========== ========= ========= ==========
Percent of Total
Revenue:
Revenue:
Software license 55.2% 55.0% 64.1% 64.8% 51.0% 60.1% 68.0%
Services 44.8 45.0 35.9 35.2 49.0 39.9 32.0
--------- --------- ---------- ---------- --------- --------- ----------
Total revenue 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Cost of revenue:
Cost of software
license 4.8 4.1 2.2 1.6 2.4 1.8 1.2
Cost of services 31.2 29.9 28.4 24.1 28.4 24.6 21.1
--------- --------- ---------- ------------ --------- --------- ----------
Total cost of
revenue 36.0 34.0 30.6 25.7 30.8 26.4 22.3
--------- --------- ---------- ------------ --------- --------- ----------
Gross profit 64.0 66.0 69.4 74.3 69.2 73.6 77.7
--------- --------- ---------- ------------ --------- --------- ----------
Operating expenses:
Research and
development 35.9 34.9 33.1 26.8 32.5 29.7 24.7
Sales and marketing 19.9 18.5 15.5 13.3 19.7 19.9 16.9
General and
administrative 8.2 8.1 6.7 5.7 7.8 6.2 5.6
--------- --------- ---------- ------------ --------- --------- ----------
Total operating
expenses 64.0 61.5 55.3 45.8 60.0 55.8 47.2
--------- --------- ---------- ------------ --------- --------- ----------
Income from
operations 0.0 4.5 14.1 28.5 9.2 17.8 30.5
License interest
income 9.2 7.8 6.8 4.6 7.4 5.9 4.0
Other interest
income 0.2 0.1 0.1 0.0 0.2 0.1 2.9
Interest expense (0.4) (0.3) (0.6) (0.7) (0.8) (0.4) (0.2)
--------- --------- ---------- ------------ --------- --------- ----------
Income before
provision for
income taxes 9.0 12.1 20.4 32.4 16.0 23.4 37.2
Provision for income
taxes 3.4 4.6 7.8 12.3 6.3 9.1 14.5
--------- --------- ---------- ------------ --------- --------- ----------
Net income 5.6% 7.5% 12.6% 20.1% 9.7% 14.3% 22.7%
========= ========= ========== ============ ========= ========= ==========
</TABLE>
21
<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 has been declining due to decreasing amortization
expense relating to capitalized software development costs. No software
development costs were capitalized in 1995 or the first nine months 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 December 31, 1996
The Company expects that its total revenue for the three months ended
December 31, 1996 (the "1996 Fourth Quarter") will be approximately $12.6
million, an increase of 60% from the Company's total revenue for the three
months ended December 31, 1995 (the "1995 Fourth Quarter") of $7.9 million.
Software license revenue is expected to increase 83% to approximately $9.4
million in the 1996 Fourth Quarter from $5.1 million for the 1995 Fourth
Quarter, while services revenue is expected to increase 16% to approximately
$3.2 million for the 1996 Fourth Quarter from $2.8 million for the 1995 Fourth
Quarter. The Company anticipates that its net income will increase 147% to
approximately $3.9 million (or 14 cents per share) for the 1996 Fourth Quarter
from $1.6 million (or 6 cents per share) for the 1995 Fourth Quarter. The
information contained in this paragraph is preliminary only, and is subject to
confirmation pending the completion of Pegasystems' year-end audit.
Liquidity and Capital Resources
Since its inception, the Company has funded its operations primarily
through cash flow from operations and bank borrowings. In July 1996, the
Company issued and sold 2,700,000 shares of Common Stock in connection with
its initial public offering. Net proceeds to the Company from such offering
were approximately $29.4 million. At September 30, 1996, the Company had cash
and cash equivalents of approximately $25.4 million and working capital of
approximately $34.5 million. 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 and 1995 was $1.6 million, $1.5 million and $830,000,
respectively. Such amounts were used to support the Company's working capital
requirements. During the nine months ended September 30, 1996, net cash used
by operating activities was $1.8 million, primarily due to an increase in
accounts receivable.
The Company used $890,000, $1.1 million, $1.4 million and $1.1 million of
net cash during 1993, 1994, 1995, and the nine months ended September 30,
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 is unsecured
and expires on June 30, 1997. At September 30, 1996, the Company had no
borrowings under its revolving credit line. 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.
22
<PAGE>
The Company believes that the net proceeds from this offering and its
initial public offering together with cash generated by operations and
availability under its bank credit facility will be sufficient to fund the
Company's operations for at least one year following the completion of this
offering. However, there can be no assurance that additional capital beyond
the amounts currently forecasted by the Company will not be required or that
any such required additional capital will be available on reasonable terms,
if at all, at such time as required by the Company.
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 nine months ended September 30, 1996,
Chase Manhattan Bank accounted for approximately 14.4% of the Company's total
revenue.
23
<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.
24
<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.
25
<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,
telecommunications, medical, public 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 develop further its 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 the
development of tools to facilitate the configuration by an organization of
its customer service management system, the integration of the Company's
products with additional databases, the Internet and intranet systems 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
26
<PAGE>
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.
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.
27
<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 Novell SUN Solaris 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 Microsoft HP-UX* SNA HP-UX*
Motif DDE UNIX UNIX
Netscape Procedure
Windows Call * Availability planned in Q1, 1997
</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,
RS 6000/AIX and Sun Solaris 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 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
28
<PAGE>
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 requests (account
changes, copies of statements) and problem resolution (incorrect purchases,
monetary
29
<PAGE>
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 December
31, 1996 was comprised of 68 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 December 31, 1996, the Company's sales force consisted of a
total of fifteen salespersons in the Company's domestic and foreign offices. The
Company intends to increase substantially the size of its sales force. In
addition, the Company is seeking to enhance the productivity of its direct sales
force by hiring additional support personnel to assist with the sales, marketing
and technical requirements of the Company's complex and lengthy sales cycle. To
achieve significant revenue growth in the future, it will be necessary for the
Company both to increase the size and to enhance the productivity of its direct
sales force. 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."
The Company has recently begun to develop an indirect distribution channel by
entering into an agreement with First Data Investor Services Group, Inc., under
which the Company's PegaSHARES product will be integrated with a shareholder
servicing product distributed by First Data. In addition, the Company has
established a joint marketing relationship with Sun Microsystems. In the future,
the Company may also 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, system integrators and other
third parties 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, VARs and other third parties.
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) creating
tools to enable organizations to configure more easily their customer service
management systems; (2) integrating the Company's products with the Internet
for customer self-service and with intranet systems for departmental service;
(3) developing standard Application Programming Interfaces that allow other
client workstation and server applications to interoperate with the Company's
systems; and (4) enhancing existing interfaces between the Company's systems
and popular applications such as e-mail and spreadsheets.
In 1993, 1994, 1995 and the nine months ended September 30, 1996, the
Company's research and development expenses were approximately $3.8 million,
$5.4 million, $7.1 million and $5.9 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.
32
<PAGE>
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 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.
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<PAGE>
Employees
As of December 31, 1996, the Company had a total of 220 employees, of whom
178 were based in the United States and 42 were based in Europe. Of the
total, 84 were in research and development, 68 were in consulting and
customer support, 47 were in sales and marketing, and 21 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 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 1999, 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, Reading, United
Kingdom and Paris, France pursuant to leases expiring between June 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.
34
<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 46 Vice President of Reengineering and Client
Services
Eugene A. Bonte 46 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 42 Vice President of Applications Development
Ira Vishner 43 Vice President of Corporate Services, Treasurer,
Chief Financial Officer and Director
Edward A. Maybury(1)(2) 57 Director
Edward B. Roberts(1) 60 Director
Leonard A. Schlesinger(2) 44 Director
Thomas E. Swithenbank 51 Director
</TABLE>
- -------------
(1) Member of Audit Committee
(2) Member of Compensation Committee
Alan Trefler, a founder of the Company, has served as President and Clerk
and has been a director since the Company's organization in 1983. Prior
thereto, he managed an electronic funds transfer product for TMI Systems
Corporation, a software and services company. Mr. Trefler holds a degree in
economics and computer science from Dartmouth College.
Clifford R. Balzer joined the Company in December 1995 as Vice President
of Reengineering and Client Services. From January through November 1995, he
was a Senior Consultant for Arthur D. Little, a research and consulting firm.
From July 1990 through January 1995, Mr. Balzer was employed as a Director of
U.S. Consulting by DMR Group, Inc., an international consulting firm. Mr.
Balzer holds a B.A. from Kansas Wesleyan University and an M.B.A. from
Fordham University.
Eugene A. Bonte joined the Company in April 1996 as Vice President of
Market Strategy and Development. He was a founder of Object Design, Inc., a
developer of object database management systems and tools, where he served as
Vice President from August 1988 through September 1995 and was responsible,
at different times, for marketing, corporate development and product
management. Mr. Bonte holds a B.A. from The Johns Hopkins University and an
M.B.A. from the Harvard Business School.
Joseph J. Friscia joined the Company in 1984 to establish its New York
office and has served as Vice President of Sales and Marketing since 1987.
Prior to joining the Company, he worked as a money transfer operations
manager with Bankers Trust Company and J. Henry Schroder Bank and Trust
Company. Mr. Friscia holds a B.A. from Long Island University and an M.B.A.
from Adelphi University.
Kenneth W. Olson, a founder of the Company, has served as Vice President
of Technical Development since 1983. Prior thereto, he managed the
development of specialized computer systems for large-volume transaction
processing for TMI Systems Corporation. Mr. Olson holds an S.B. in Humanities
and Sciences from the Massachusetts Institute of Technology.
Michael R. Pyle joined the Company in 1985 as an application development
manager and has been Vice President of Applications Development since 1990.
Mr. Pyle holds a B.C.S. from the CS College in
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<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
The Board of Directors is divided into three classes, each of whose
members serve for a staggered three-year term. Messrs. Swithenbank and
Trefler serve in the class whose term expires in 1997; Messrs. Maybury and
Schlesinger serve in the class whose term expires in 1998; and Messrs.
Roberts and Vishner serve in the class whose term expires in 1999. Upon the
expiration of the term of a class of directors, directors within such class
are 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 are eligible to 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 years ended
December 31, 1996 and 1995 by (i) the Company's Chief Executive Officer and (ii)
the five most highly compensated other executive officers during fiscal 1996
(collectively, the "Named Executive Officers"):
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation (1)
------------------------- All Other
Name and Principal Position Year Salary Bonus Compensation
- --------------------------------------------------- ---------------------- ------------- ---------------
<S> <C> <C> <C> <C>
Alan Trefler, President 1996 $180,000 -- (2) $15,000 (3)
1995 171,250 $23,545 (4) --
Joseph J. Friscia, Vice President of Sales and 1996 125,000 -- (5) --
Marketing 1995 124,583 24,154 (6) --
Clifford R. Balzer, Vice President of 1996 122,083 12,816 (8) 4,483 (3)
Reengineering and Client Services (7) 1995 9,195 -- --
Michael R. Pyle, Vice President of Applications 1996 111,250 41,285 (9) --
Development 1995 102,083 23,044 (4) --
Ira Vishner, Vice President of Corporate Services, 1996 110,667 30,169 (9) --
Treasurer and Chief Financial Officer 1995 100,500 16,892 (4) 8,483 (3)
Kenneth W. Olson, Vice President of Technical 1996 105,583 27,365 (9) --
Development 1995 98,083 13,118 (4) 30,000 (3)
</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 1996 and 1995.
(2) Bonus for the period from July 1995 through June 1996 has not yet been
determined. Bonus, if any, for the period from July 1996 through June 1997
has not yet been determined.
(3) Represents payments in lieu of paid days off.
(4) Represents bonus earned between July 1994 and June 1995 and paid in 1995.
(5) Bonus for 1996 has not yet been determined.
(6) Represents bonus earned in 1995 and paid in February 1996. Does not include
a bonus of $66,650 earned in 1994 and paid in February 1995.
(7) Mr. Balzer joined the Company in December 1995.
(8) Represents bonus earned between December 1995 and June 1996 and paid in
1996. Bonus, if any, for the period from July 1996 through June 1997 has
not yet been determined.
(9) Represents bonuses earned between July 1995 and June 1996 and paid in 1996.
Bonuses, if any, for the period from July 1996 through June 1997 have not
yet been determined.
Option Grants
No stock options or stock appreciation rights ("SARs") were granted to any
of the Named Executive Officers during 1996.
37
<PAGE>
Aggregated Option Exercises and Year-End Option Table
The following table sets forth certain information concerning options
exercised during 1996 and the number and value of unexercised stock options
held by each of the Named Executive Officers as of December 31, 1996.
Aggregated Option Exercises in Last Fiscal Year and Year-End Option Values
<TABLE>
<CAPTION>
Number of Shares
Underlying Value of Unexercised
Unexercised Options In-the-Money Options at
Shares at Year-End (1) Year-End (2)
Acquired on Value ------------------------------- -------------------------------
Name Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
-------------------------------- ---------------------------- ---------------- -------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Alan Trefler -- -- -- -- -- --
Joseph J. Friscia 36,000 $420,240 198,000 162,000 (3) $5,900,070 $4,827,330
Clifford R. Balzer -- -- 12,000 48,000 (4) 356,860 1,427,440
Michael R. Pyle 64,800 756,432 129,600 129,600 (3) 3,861,864 3,861,864
Ira Vishner -- -- -- -- -- --
Kenneth W. Olson -- -- -- -- -- --
</TABLE>
- -------------
(1) The exercise price of the unexercised options held by Messrs. Friscia and
Pyle is approximately $0.33 per share and of the unexercised options held
by Mr. Balzer is approximately $0.39 per share.
(2) The closing sale price of the Common Stock on December 31, 1996 was $30.125.
(3) These options vest in equal installments on December 29, 1997, 1998
and 1999.
(4) These options vest in equal installments on December 29, 1997, 1998, 1999
and 2000.
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.
38
<PAGE>
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 December 31, 1996, the Company had approximately 220 employees eligible to
participate in the 1994 Plan and options to purchase 2,492,250 shares were
outstanding. To date, no restricted stock, SARs or long-term performance
awards have been granted under the 1994 Plan.
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.
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.
As of December 31, 1996, options to purchase 90,000 shares were outstanding
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 is 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 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 December 31, 1996, approximately 220 of the
Company's
39
<PAGE>
employees were eligible to participate in the Stock Purchase Plan.
The Stock Purchase Plan is 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 is 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 is 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.
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
Prior to May 1996, 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. In May 1996, the Company 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.
40
<PAGE>
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 bearing interest at
a rate of 8.5% per annum, was repaid in full by the Company in 1995.
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of December 31, 1996, and as adjusted
for the sale of the shares of Common Stock offered hereby, by: (i) each person
who is known by the Company to own beneficially more than 5% of the Common
Stock, (ii) each director and Named Executive Officer of the Company, (iii) all
directors and executive officers of the Company as a group, and (iv) each
Selling Stockholder. Unless otherwise indicated below, to the knowledge of the
Company, all persons listed below have sole voting and investment power with
respect to their shares of Common Stock, except to the extent authority is
shared by spouses under applicable law.
<TABLE>
<CAPTION>
Shares Beneficially Shares to be
Owned Prior to Beneficially Owned
Offering (1) After Offering (1) (2)
----------------------- ------------------------
Number of
Number of Shares Number of
Name Shares Percent Offered Shares Percent
- ---- --------- ------- --------- --------- -------
<S> <C> <C> <C> <C> <C>
Alan Trefler 22,091,100 83.7% 500,000 21,591,100 77.1%
Joseph J. Friscia (3) 198,000 * 70,000 128,000 *
Michael R. Pyle (4) 129,600 * 50,000 79,600 *
Ira Vishner 277,200 1.1 55,000 222,200 *
Kenneth W. Olson 360,000 1.4 70,000 290,000 1.0
Edward A. Maybury (5) 7,200 * -- 7,200 *
Edward B. Roberts 5,000 * -- 5,000 *
Leonard A. Schlesinger -- -- -- -- --
Thomas E. Swithenbank -- -- -- -- --
All directors and executive
officers as a group (11
persons) (6) 23,080,100 86.3 745,000 22,335,100 79.1
</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) 26,392,200 shares of Common Stock outstanding as of
December 31, 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 December 31, 1996, as set
forth below. The number of shares of Common Stock deemed outstanding
after this offering includes (i) 1,500,000 shares which are being offered
for sale by the Company in this offering and (ii) 120,000 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) Consists solely of shares of Common Stock subject to stock options
exercisable within 60 days of December 31, 1996, 70,000 of which shares
will be issued upon the exercise of options immediately prior to the
closing of the offering.
41
<PAGE>
(4) Consists solely of shares of Common Stock subject to stock options
exercisable within 60 days of December 31, 1996, 50,000 of which shares
will be issued upon the exercise of options immediately prior to the
closing of this offering.
(5) Consists solely of shares of Common Stock subject to stock options
exercisable within 60 days of December 31, 1996.
(6) Shares beneficially owned prior to offering includes 346,800 shares of
Common Stock subject to stock options exercisable within 60 days of
December 31, 1996, 120,000 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 includes 226,800 shares of
Common Stock subject to stock options exercisable within 60 days of
December 31, 1996.
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 December 31, 1996, there were 26,392,000 shares of Common Stock
outstanding and held of record by approximately 25 stockholders. Based upon the
number of shares outstanding as of that date and giving effect to (i) the
issuance of the 1,500,000 shares of Common Stock offered by the Company hereby,
and (ii) the exercise of options to purchase 120,000 shares of Common Stock
anticipated to occur immediately prior to the closing of this offering, there
will be 28,012,200 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
The Company is 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
42
<PAGE>
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) 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.
43
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon the closing of this offering, the Company will have an aggregate of
28,012,200 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 120,000 shares to be
exercised immediately prior to the closing of this offering by certain
Selling Stockholders. Of these shares, 5,872,900 shares (including the
2,245,000 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 22,129,300 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 or 701 promulgated
under the Securities Act, which rules are summarized below. Subject to the
executive officers 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 the Rule 144 volume limitations) as
follows: (i) 36,000 shares will be eligible for immediate sale in the public
market on the date of this Prospectus and (ii) 22,103,300 shares will be
eligible for sale upon the expiration of lock-up agreements 120 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, a number of shares that does not exceed the greater of
(i) 1% of the then outstanding shares of Common Stock (approximately 280,000
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.
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, subject only to the manner of sale
provisions of Rule 144, and by affiliates, subject to all provisions of Rule
144 except its two-year minimum holding period.
In addition, as of December 31, 1996, the Company had reserved 5,750,000
shares of Common Stock for issuance under its stock plans. See
"Management--Stock Plan." Shares issuable under the Company's stock plans
have been registered pursuant to a Registration Statement on Form S-8 and are
therefore freely tradeable, subject to Rule 144 limitations applicable to
affiliates.
The Company can make no prediction 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.
Except to the extent they have agreed to sell shares in the offering,
officers, who hold in the aggregate 22,728,300 shares of Common Stock and
options to purchase 619,200 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 120-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 120-day period following the date of the Prospectus,
except the Company may issue, and grant options to purchase, shares of Common
Stock under its stock plans. In addition, the Company may issue shares
44
<PAGE>
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 120-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.
AVAILABLE INFORMATION
The Company is subject to the informational reporting requirements of the
Securities Exchange Act of 1934, as amended, and, in accordance therewith,
files reports, proxy statements and other information with the Securities and
Exchange Commission (the "Commission"). Such reports, proxy statements and
other information filed with the Commission may be inspected and copied 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 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 such materials may be obtained from the Public
Reference Section of the Commission at 450 Fifth Street, N.W., Washington,
D.C. 20549 upon payment of prescribed fees. The Commission maintains a site
on the World Wide Web at http://www.sec.gov that contains reports, proxy and
information statements and other information regarding registrants, such as
the Company, that file electronically with the Commission through the
Commission's Electronic Data Gathering, Analysis and Retrieval (EDGAR)
system.
ADDITIONAL INFORMATION
The Company has filed with 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 in New
York and Chicago, the addresses of which are set forth in "Available
Information." 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 Registration
Statement may also be accessed electronically at the Commission's site on the
World Wide Web at http://www.sec.gov.
The Company distributes to its stockholders annual reports containing
financial statements audited by its independent accountants and makes
available copies of quarterly reports for the first three quarters of each
fiscal year containing unaudited financial statements.
45
<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
September 30, 1996 (unaudited) F-3
Consolidated Statements of Income for the years ended December 31, 1993,
1994 and 1995 and for the nine months ended September 30, 1995 and 1996
(unaudited) F-4
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1993, 1994 and 1995 and for the nine months ended
September 30, 1996 (unaudited) F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1993,
1994 and 1995 and for the nine months ended September 30, 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 Note 10, as to which
the date is July 10, 1996 and Note 11, as to
which the date is November 19, 1996.
F-2
<PAGE>
PEGASYSTEMS INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
---------------------------
September 30,
1994 1995 1996
---- ---- ----
(unaudited)
(in thousands except share-related data)
<S> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 456 $ 511 $25,419
Trade and installment accounts receivable, net of
allowance for doubtful accounts of $0 and $434 at
December 31, 1994 and 1995, respectively, and $839
at September 30, 1996 8,315 8,896 12,701
Prepaid expenses and other assets 204 425 1,002
------- ------- -------
Total current assets 8,975 9,832 39,122
Long-term license installments, net 9,135 13,399 18,032
Equipment and improvements, net 1,564 2,172 2,451
Software development costs, net 1,113 473 123
------- ------- -------
Total assets $20,787 $25,876 $59,728
======= ======= =======
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 1,991 $ 1,747 $ 1,549
Deferred revenue 139 114 263
Current portion of long-term debt 378 782 --
Deferred income taxes 1,976 2,796 2,789
Note payable to stockholder 50 -- --
------- ------- -------
Total current liabilities 4,534 5,439 4,601
Deferred income taxes 3,931 4,947 6,991
Long-term debt 450 816 --
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 at December 31, 1995 and 1994,
26,372,000 shares issued and outstanding at
September 30, 1996 235 235 264
Additional paid-in-capital 15 106 29,994
Deferred compensation -- (91) (77)
Retained earnings 11,644 14,522 18,089
Cumulative foreign currency translation adjustment (22) (98) (134)
------- ------- -------
11,872 14,674 48,136
------- ------- -------
Total liabilities and stockholders' equity $20,787 $25,876 $59,728
======= ======= =======
</TABLE>
See accompanying notes.
F-3
<PAGE>
PEGASYSTEMS INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Nine Months Ended
Year Ended December 31, September 30,
----------------------------------------- --------------------------
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 $ 8,414 $ 12,896
Services 3,764 6,601 8,719 5,941 8,060
----------- ----------- ----------- ----------- -----------
Total Revenue 10,212 16,263 22,247 14,355 20,956
Cost of Revenue
Cost of software license 1,242 1,075 635 508 354
Cost of services 2,227 3,791 6,161 4,258 5,006
----------- ----------- ----------- ----------- -----------
Total cost of revenue 3,469 4,866 6,796 4,766 5,360
----------- ----------- ----------- ----------- -----------
Gross profit 6,743 11,397 15,451 9,589 15,596
Operating expenses
Research and development 3,766 5,440 7,061 4,949 5,883
Sales and marketing 1,350 2,629 3,592 2,542 3,870
General and administrative 834 1,092 1,541 1,088 1,329
----------- ----------- ----------- ----------- -----------
Total operating expenses 5,950 9,161 12,194 8,579 11,082
----------- ----------- ----------- ----------- -----------
Income from operations 793 2,236 3,257 1,010 4,514
License interest income 1,305 1,457 1,486 1,122 1,127
Other interest income 27 21 16 16 296
Interest expense (32) (56) (118) (68) (85)
----------- ----------- ----------- ----------- -----------
Income before provision for
income taxes 2,093 3,658 4,641 2,080 5,852
Provision for income taxes 860 1,465 1,763 790 2,285
------------- ----------- ----------- ----------- -----------
Net income $ 1,233 $ 2,193 $ 2,878 $ 1,290 $ 3,567
=========== =========== =========== =========== ===========
Net income per common and common
equivalent share $ .05 $ .09 $ .11 $ 0.05 $ 0.14
=========== =========== =========== =========== ===========
Weighted average number of
common and common equivalent
shares outstanding 24,231,000 24,102,000 25,551,000 25,600,000 25,952,000
=========== =========== =========== =========== ===========
</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
Issuance of common stock 2,700,000 27 29,369 -- -- -- 29,396
Exercise of stock options 182,000 2 58 -- -- -- 60
Tax benefit from exercise
of stock options 461 461
Foreign currency
translation adjustment -- -- -- -- -- (36) (36)
Amortization of deferred
compensation -- -- -- 14 -- -- 14
Net income (unaudited) -- -- -- -- 3,567 -- 3,567
---------- ---- ------- ----- ------- ----- --------
Balance at September 30,
1996 (unaudited) 26,372,000 $264 $29,994 $(77) $18,089 $(134) $48,136
========== ==== ======= ===== ======= ===== ========
</TABLE>
See accompanying notes.
F-5
<PAGE>
PEGASYSTEMS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine Months Ended
Year Ended December 31, September 30,
------------------------------- ---------------------
1993 1994 1995 1995 1996
---- ---- ---- ---- ----
(unaudited)
(in thousands)
<S> <C> <C> <C> <C> <C>
Operating activities
Net income $ 1,233 $ 2,193 $ 2,878 $ 1,393 $ 3,567
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Provision for deferred income taxes 629 961 1,836 819 2,037
Depreciation and amortization 1,536 1,511 1,455 975 1,152
Provision for doubtful accounts 326 -- 793 -- --
Change in operating assets and liabilities:
(Increase) in trade and installment accounts
receivable (2,149) (3,988) (5,638) (3,240) (8,438)
(Increase) in prepaid expenses and other assets (121) (16) (221) (206) (116)
Decrease (increase) in inventory (215) 215 -- -- --
Increase (decrease) in accounts payable and
accrued expenses 8 971 (244) (895) (198)
Increase (decrease) in deferred revenue 333 (336) (25) 769 149
------- ------- ------- ------- -------
Net cash provided (used) by operating
activities 1,580 1,511 834 (385) (1,847)
Investing activities
Purchase of equipment and improvements (888) (1,131) (1,423) (851) (1,067)
Software development costs (1,060) (297) -- -- --
------- ------- ------- ------- -------
Net cash used in investing activities (1,948) (1,428) (1,423) (851) (1,067)
Financing activities
Repayment of note payable to shareholder -- (180) (50) (50) --
Proceeds from issuance of long-term debt 710 380 1,345 1,347 --
Repayments of long-term debt (243) (263) (575) (299) (1,598)
Issuance of common stock 29,396
Exercise of stock options -- 23 -- -- 60
------- ------- ------- ------- -------
Net cash provided (used) by financing activities 467 (40) 720 998 27,858
Effect of exchange rate on cash -- (22) (76) (17) (36)
------- ------- ------- ------- -------
Net increase (decrease) in cash 99 21 55 (255) 24,908
Cash and equivalents at beginning of year 336 435 456 456 511
------- ------- ------- ------- -------
Cash and equivalents at end of period $ 435 $ 456 $ 511 $ 201 $25,419
======= ======= ======= ======= =======
Supplemental Disclosure of Cash Flow Information:
Cash paid during period:
Interest $ 32 $ 56 $ 119 $ 69 $ 85
======= ======= ======= ======= =======
Income taxes $ 553 $ 135 $ 315 $ 274 $ 28
======= ======= ======= ======= =======
</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 the three months ended
March 31, 1996 was 7%. The discount rate for the six month period ended
September 30, 1996 was 6.75%. The trade and installment accounts receivable
recorded on the balance sheet are net of $3,477,000, $3,937,000 and
$3,779,000 as of December 31, 1994 and 1995, and September 30, 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 September 30, 1996, the consolidated
statements of income and consolidated statements of cash flows for the nine
months ended September 30, 1995 and 1996 and the consolidated statement of
stockholders' equity for the nine months ended September 30, 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 nine months ended September 30, 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 nine months ended September 30,
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
$350,000 during 1993, 1994 and 1995 and the nine months ended September 30,
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 July 10, 1996.
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:
December 31,
--------------------
(in thousands)
1994 1995
---- ----
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
====== =======
F-9
<PAGE>
PEGASYSTEMS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1995
3. ACCOUNTS PAYABLE AND ACCRUED EXPENSE
Accounts payable and accrued expenses consist of the following:
December 31,
-----------------
(in thousands)
1994 1995
---- ----
Trade accounts payable $ 744 $ 557
Employee compensation and benefits 508 568
Accrued income taxes 253 --
Other 486 622
------ ------
$1,991 $1,747
====== ======
4. DEBT AND OTHER FINANCIAL INSTRUMENTS
Long-term debt consists of the following:
December 31,
--------------
(in thousands)
1994 1995
---- ----
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
==== ======
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.
As of September 30, 1996, the Company had repaid all of the notes.
As of December 31, 1995, the Company had a line of credit with a bank
allowing for borrowings up to $2,500,000 at the prime rate, which line of
credit was scheduled to expire on 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. As of September 30, 1996, the
Company's bank line of credit had been increased to $5,000,000 and extended
until June 30, 1997. The Company had no drawings against the line of credit
at September 30, 1996.
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:
Carrying Fair
Amount Value
------ -----
(in thousands)
Assets
Cash and cash equivalents $ 511 $ 511
Liabilities
Notes payable to bank ($1,598) ($1,598)
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. At December 31, 1995, 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.
As of September 30, 1996, the Company had approved an increase in the
number of shares issuable under the 1994 Long-Term Incentive Plan from
2,400,000 to 5,000,000.
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>
September 30,
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 -- 1,635,750 335,250 885,250
Exercised (117,000) (873,000) -- (182,000)
Canceled (108,000) (360,000) (82,500) (109,800)
--------- --------- --------- -----------
Outstanding at end of period 1,269,000 1,671,750 1,924,500 2,517,950
========= ========= ========= ===========
Price range of outstanding options $.01-$.69 $.33-$.69 $.33-$.39 $.33-$26.50
========= ========= ========= ===========
Exercisable at end of period 1,216,125 396,000 605,850 521,390
========= ========= ========= ===========
Available for grant at end of period -- 764,250 475,500 382,050
========= ========= ========= ===========
</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:
Year ended December 31, (in thousands)
1996 $1,016
1997 1,090
1998 1,090
1999 579
------
Total $3,775
======
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:
1993 1994 1995
---- ---- ----
(in thousands)
Domestic $2,093 $3,512 $4,318
Foreign 0 146 323
------ ------ ------
Total $2,093 $3,658 $4,641
====== ====== ======
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:
1993 1994 1995
---- ---- ----
(in thousands)
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
==== ===== =====
The effective income tax rate differed from the statutory federal income
tax rate due to:
1993 1994 1995
---- ---- ----
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%
==== ==== ====
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)
December 31,
1994 1995
---- ----
(in thousands)
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)
====== =======
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:
1993 1994 1995
---- ---- ----
(in thousands)
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
====== ====== ======
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. As of September 30, 1996, options for the purchase of 90,000 shares
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.
Initial Public Offering On July 24, 1996, the Company completed an initial
public offering of 2.7 million shares of its common stock at $12.00 per
share.
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:
Number of
Shares of
Underwriter Common Stock
----------- ------------
Goldman, Sachs & Co.
Cowen & Company
Montgomery Securities
---------
Total 2,245,000
=========
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 public offering price set forth on the cover
page of this Prospectus and in part to certain securities dealers at such
price less a concession of $ per share. The Underwriters may allow, and
such dealers may reallow, a concession not in excess of per share to
certain brokers and dealers. After the shares of Common Stock are released
for sale to the public, the offering price and other selling terms may from
time to time be varied by the representatives.
The Company has granted the Underwriters an option exercisable for 30 days
after the date of this Prospectus to purchase up to an aggregate of 336,750
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 2,245,000 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 120 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 Company and the Selling Stockholders have agreed to indemnify the
several Underwriters against certain liabilities, including liabilities under
the Securities Act.
In connection with this offering, certain Underwriters and selling group
members (if any) or their respective affiliates who are qualifying registered
market makers on Nasdaq, may engage in passive market making transactions in
the Common Stock of the Company on Nasdaq in accordance with Rule 10b-6A
under the Securities Exchange Act of 1934 during the two business day period
before commencement of offers or sales of the Common Stock offered hereby.
The passive market making transactions must comply with applicable volume and
price limits and be identified as such. In general, a passive market maker
may display its bid at a price not in excess of the highest independent bid
for the security; if all independent bids are lowered below the passive
market maker's bid, however, such bid must then be lowered when certain
purchase limits are exceeded.
U-1
<PAGE>
Picture of Pegasus, the winged horse of mythology, flying out of a computer
terminal screen, against a background of stars.
Service Excellence
Through Automation
<PAGE>
================================================================================
No person has been authorized to give any information or to make any
representations other than those contained in this Prospectus, and, if given
or made, such information or representations must not be relied upon as
having been authorized. This Prospectus does not constitute an offer to sell
or the solicitation of an offer to buy any securities other than the
securities to which it relates or an offer to sell or the solicitation of an
offer to buy such securities in any circumstances in which such offer or
solicitation is unlawful. Neither the delivery of this Prospectus nor any
sale made hereunder shall, under any circumstances, create any implication
that there has been no change in the affairs of the Company since the date
hereof or that the information contained herein is correct as of any time
subsequent to its date.
-------------
TABLE OF CONTENTS
Page
---------
Prospectus Summary 3
Risk Factors 5
Use of Proceeds 12
Price Range of Common Stock 12
Dividend Policy 12
Capitalization 13
Selected Consolidated Financial Data 14
Management's Discussion and Analysis
of Financial Condition and Results
of Operations 15
Business 24
Management 35
Certain Transactions 40
Principal and Selling Stockholders 41
Description of Capital Stock 42
Shares Eligible for Future Sale 44
Legal Matters 45
Experts 45
Available Information 45
Additional Information 45
Index to Consolidated Financial
Statements F-1
Underwriting U-1
2,245,000 Shares
Pegasystems Inc.
Common Stock
(par value $.01 per share)
-------------
[PEGASYSTEMS INC. LOGO]
-------------
Goldman, Sachs & Co.
Cowen & Company
Montgomery Securities
Representatives of the Underwriters
================================================================================
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
Estimated expenses (other than underwriting discounts and commissions)
payable in connection with the sale of the Common Stock offer hereby are as
follows:
SEC registration fee $ 25,525
NASD filing fee 8,923
Nasdaq National Market listing fee 17,500
Printing and engraving expenses 80,000
Legal fees and expenses 75,000
Accounting fees and expenses 75,000
Blue Sky fees and expenses 10,000
Transfer agent and registrar fees and expenses 5,000
Miscellaneous 3,052
--------
Total $300,000
========
The Registrant will bear all expenses shown above.
Item 14. Indemnification of Directors and Officers.
Section 67 of Chapter 156B of the Massachusetts General Laws provides that
a corporation may indemnify its directors and officers to the extent
specified in or authorized by (i) the articles of organization, (ii) a by-law
adopted by the stockholders, or (iii) a vote adopted by the
holders of a majority of the shares of stock entitled to vote on the election
of directors. In all instances, the extent to which a corporation provides
indemnification to its directors and officers under Section 67 is optional.
In its Restated Articles of Organization, the Registrant has elected to
commit to provide indemnification to its directors and officers in specified
circumstances. Generally, the Restated Articles of Organization provide that
the Registrant shall indemnify directors and officers of the Registrant
against liabilities and expenses arising out of legal proceedings brought
against them by reason of their status as directors or officers or by reason
of their agreeing to serve, at the request of the Registrant, as a director
or officer with another organization. Under this provision, a director or
officer of the Registrant shall be indemnified by the Registrant for all
costs and expenses (including attorneys' fees), judgments, liabilities and
amounts paid in settlement of such proceedings, even if he is not successful
on the merits, if he acted in good faith in the reasonable belief that his
action was in the best interests of the Registrant. The Board of Directors
may authorize advancing litigation expenses to a director or officer at his
request upon receipt of an undertaking by any such director or officer to
repay such expenses if it is ultimately determined that he is not entitled to
indemnification for such expenses.
Article VI of the Registrant's Restated Articles of Organization
eliminates the personal liability of the Registrant's directors to the
Registrant or its stockholders for monetary damages for breach of a
director's fiduciary duty, except for liability (i) for any breach of a
director's duty of loyalty to the Registrant or its stockholders, (ii) for
acts or omissions not in good faith or which involve intentional misconduct
or a knowing violation of laws, (iii) for authorization of illegal dividends
or redemptions, or (iv) for any transaction in which a director derived an
improper personal benefit.
Section 8 of the Underwriting Agreement provides that the Underwriters are
obligated, under certain circumstances, to indemnify the Company, directors,
officers and controlling persons of the Company against certain liabilities,
including liabilities under the Securities Act. Reference is made to the form
of Underwriting Agreement filed as Exhibit 1.1 hereto.
The Company maintains directors and officers liability insurance for the
benefit of its directors and certain of its officers.
II-1
<PAGE>
Item 15. Recent Sales of Unregistered Securities.
In the three years preceding the filing of this registration statement,
the Company has issued the below-listed securities that were not registered
under the Securities Act. The numbers below have been adjusted to give effect
to (i) the 15-for-1 split of the Registrant's Common Stock, in the form of a
dividend, which became effective on December 9, 1994 and (ii) the 3-for-1
split of the Registrant's Common Stock, in the form of a dividend, which
became effective on July 10, 1996.
Between December 1993 and July 31, 1996, the Registrant issued an
aggregate of 1,090,800 shares of Common Stock upon the exercise of options,
at a weighted average exercise price of approximately $0.05 per share, to
certain officers and employees of the Registrant for total consideration of
$57,728.
Between December 1994 and July 31, 1996, the Registrant issued options to
certain officers, directors and employees of the Registrant to purchase an
aggregate of 2,339,700 shares of Common Stock under the Registrant's 1994
Long-Term Incentive Plan and 1996 Non-Employee Director Stock Option Plan at
a weighted average exercise price of approximately $3.13 per share.
No underwriters were involved in the foregoing sales of securities. Such
sales were made in reliance upon an exemption from the registration
provisions of the Securities Act set forth in Section 4(2) thereof relative
to sales by an issuer not involving any public offering or the rules and
regulations thereunder, or, in the case of options, Rule 701 of the
Securities Act. All of the foregoing securities are deemed restricted
securities for the purposes of the Securities Act.
Item 16. Exhibits and Financial Statement Schedules.
(a) Exhibits:
<TABLE>
<CAPTION>
Exhibit
No. Description
- --- -----------
<S> <C>
1.1.+ Form of Underwriting Agreement.
3.3.* Restated Articles of Organization of the Registrant.
3.4.* Restated By-Laws of the Registrant.
4.1.* Specimen certificate representing the Common Stock.
5.1.+ Opinion of Choate, Hall & Stewart with respect to the legality of the securities of the
Registrant being registered.
10.1.* Amended and Restated 1994 Long-Term Incentive Plan.
10.2.* 1996 Non-Employee Director Stock Option Plan.
10.3.* 1996 Employee Stock Purchase Plan.
10.4.* Loan Agreement dated as of December 16, 1993 between the Registrant and Fleet Bank of
Massachusetts, N.A.
10.5.* Loan Modification Agreement dated as of May 5, 1995 between the Registrant and Fleet Bank of
Massachusetts, N.A.
10.6.* Second Loan Modification Agreement dated May 15, 1996 between the Registrant and Fleet National
Bank (successor by merger to Fleet Bank of Massachusetts, N.A.).
10.11.* Promissory Note dated May 15, 1996 in the amount of $5,000,000 made by the Registrant to the
order of Fleet National Bank.
10.13.* Lease Agreement dated February 26, 1993 between the Registrant and Riverside Office Park Joint
Venture.
10.14.* Amendment Number 1 to Lease Agreement dated August 7, 1994 between the Registrant and Riverside
Office Park Joint Venture.
21.1.* Subsidiaries of the Registrant.
23.1. Consent of Ernst & Young LLP.
23.2.+ Consent of Choate, Hall & Stewart (included in Exhibit 5.1).
23.6.+ Consent of the Aberdeen Group, Inc.
24.1.+ Powers of Attorney.
II-2
<PAGE>
Exhibit
No. Description
- --- -----------
27.1.+ Financial Data Schedule.
99.1.+ Valuation and Qualifying Accounts of the Registrant.
</TABLE>
- -------------
+Previously filed.
*Filed as an exhibit to the Registrant's Registration Statement on Form S-1
(Registration No. 333-03807) or an amendment thereto and incorporated herein
by reference to the same exhibit number.
(b) Financial Statement Schedules:
Schedule II--Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable, not
required under the instructions, or all of the information required is set
forth in the financial statements or notes thereto.
Item 17. Undertakings.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Registrant pursuant to provisions described in Item 14 above, or otherwise,
the Registrant has been advised that in the opinion of the Securities and
Exchange Commission, such indemnification is against public policy as
expressed in the Securities Act and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities (other than
the payment by the Registrant of expenses incurred or paid by a director,
officer or controlling person of the Registrant in the successful defense of
any action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, the
Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against
public policy as expressed in the Securities Act and will be governed by the
final adjudication of such issue.
The Registrant hereby undertakes (1) to provide to the Underwriters at the
closing specified in the Underwriting Agreement certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser; (2) that for purposes of
determining any liability under the Securities Act, the information omitted
from the form of prospectus filed as part of this Registration Statement in
reliance upon Rule 430A and contained in a form of prospectus filed by the
Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities
Act shall be deemed to be part of this Registration Statement as of the time
it was declared effective; and (3) that for the purpose of determining any
liability under the Securities Act, each post-effective amendment that
contains a form of prospectus shall be deemed to be a new registration
statement relating to the securities offered therein, and the offering of
such securities at that time shall be deemed to be the initial bona fide
offering thereof.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Amendment No. 2 to the Registration Statement to be signed
on its behalf by the undersigned, thereunto duly authorized, in Cambridge,
Massachusetts on January 21, 1997.
PEGASYSTEMS INC.
By /s/ Alan Trefler
----------------------------------
Alan Trefler
President
Pursuant to the requirements of the Securities Act of 1933, this
Amendment No. 2 has been signed below by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title(s) Date
--------- -------- ----
<S> <C> <C>
/s/ Alan Trefler President and Director
- ------------------------------- (Principal Executive Officer) January 21, 1997
Alan Trefler
Ira Vishner* Vice President of Corporate Services,
- ------------------------------- Treasurer and Director (Principal
Ira Vishner Financial and Accounting Officer) January 21, 1997
Edward A. Maybury* Director January 21, 1997
- -------------------------------
Edward A. Maybury
- ------------------------------- Director
Edward B. Roberts
Leonard A. Schlesinger* Director January 21, 1997
- -------------------------------
Leonard A. Schlesinger
Thomas E. Swithenbank* Director January 21, 1997
- -------------------------------
Thomas E. Swithenbank
*/s/ Alan Trefler
- ------------------------------
Alan Trefler
Attorney-in-Fact
</TABLE>
II-4
<PAGE>
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------
EXHIBITS
TO
FORM S-1
REGISTRATION STATEMENT
Under
The Securities Act of 1933
-------------
PEGASYSTEMS INC.
(Exact Name of Registrant As Specified In its Charter)
-------------
101 Main Street
Cambridge, Massachusetts 02142
(Address of Principal Executive Offices)
================================================================================
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the captions "Experts" and
"Selected Consolidated Financial Data" and to the use of our report dated May 6,
1996 (except for Note 10 as to which the date is July 10, 1996 and Note 11 as to
which the date is November 19, 1996), in the Registration Statement (Post
Effective Amendment No. 2 to Form S-1 No. 333-16475) and the related Prospectus
of Pegasystems Inc. for the registration of 2,581,750 shares of its common
stock.
Our audits also included the financial statement schedule of Pegasystems
Inc. located at Exhibit 99.1. This schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits. In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Boston, Massachusetts
January 17, 1997
