SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 1997
or
[ ] Transition Report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from___ to___
Commission File Number: 1-11859
PEGASYSTEMS INC.
(Exact name of Registrant as specified in its charter)
Massachusetts 04-2787865
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
101 Main Street
Cambridge, MA 02142-1590
(Address of principal executive offices) (zip code)
(617) 374-9600
(Registrant's telephone number including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
There were 28,541,000 shares of the Registrant's common stock, $.01 par value
per share, outstanding on September 30, 1997.
<PAGE>
PEGASYSTEMS INC. AND SUBSIDIARY
Index to Form 10-Q
Part I - Financial Information
<TABLE>
<CAPTION>
Page
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<S> <C> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at December 31, 1996 3
and September 30, 1997
Condensed Consolidated Statements of Income for the three 4
and nine months ended: September 30, 1996 and September 30, 1997
Condensed Consolidated Statements of Cash Flows for the nine 5
months ended: September 30, 1996 and September 30, 1997
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial 7
Condition and Results of Operations
Part II - Other Information
Item 1. Legal Proceedings 11
Item 2. Changes in Securities 11
Item 3. Defaults upon Senior Securities 11
Item 4. Submission of Matters to a Vote of Security Holders 11
Item 5. Other Information 11
Item 6. Exhibits and Reports on Form 8-K 11
SIGNATURES 12
</TABLE>
<PAGE>
Form 10-Q Page 3 of 12
PEGASYSTEMS INC.
Condensed Consolidated Balance Sheets
(in thousands, except share-related amounts)
(Unaudited)
<TABLE>
<CAPTION>
December 31, September 30,
1996 1997
------------------ -------------------
Assets
<S> <C> <C>
Current assets:
Cash and cash equivalents $24,201 $ 54,555
Trade and installment accounts receivable, net of allowance
for doubtful accounts of $939 at December 31, 1996 and
$545 at September 30, 1997 14,582 20,431
Prepaid expenses and other assets 1,235 4,616
------------------ -------------------
Total current assets 40,018 79,602
Long-term license installments, net 23,802 27,141
Equipment and improvements, net 3,035 4,679
Purchased software, net -- 9,601
------------------ -------------------
Total assets $66,855 $121,023
================== ===================
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 2,697 $ 2,566
Deferred revenue 53 1,291
Deferred income taxes 2,904 814
------------------ -------------------
Total current liabilities 5,654 4,671
------------------ -------------------
Deferred income taxes 8,816 10,085
------------------ -------------------
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; 26,392,200 shares and 28,541,000 shares
issued and outstanding at December 31, 1996 and
September 30, 1997, respectively 264 287
Additional paid-in capital 30,206 82,782
Deferred compensation (73) (59)
Stock warrant -- 2,897
Retained earnings 22,022 20,682
Cumulative foreign currency translation adjustment (34) (322)
------------------ -------------------
Total stockholders' equity 52,385 106,267
------------------ -------------------
Total liabilities and stockholders' equity $66,855 $121,023
================== ===================
</TABLE>
The accompanying Notes are an integral part of these Condensed Consolidated
Financial Statements.
<PAGE>
Form 10-Q Page 4 of 12
PEGASYSTEMS INC.
Condensed Consolidated Statements of Income
(in thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
Revenue 1996 1997 1996 1997
-------------- -------------- ------------- -------------
<S> <C> <C> <C> <C>
Software license $6,502 $ 3,273 $12,896 $13,734
Services 3,064 3,737 8,060 9,742
-------------- -------------- ------------- -------------
Total revenue 9,566 7,010 20,956 23,476
-------------- -------------- ------------- -------------
Cost of revenue
Cost of software license 118 86 354 106
Cost of services 2,017 2,786 5,006 7,151
-------------- -------------- ------------- -------------
Total cost of revenue 2,135 2,872 5,360 7,257
-------------- -------------- ------------- -------------
Gross Profit 7,431 4,138 15,596 16,219
Operating expenses
Research and development 2,361 3,992 5,883 9,418
Selling and marketing 1,614 4,480 3,870 11,070
General and administrative 541 675 1,329 1,833
-------------- -------------- ------------- -------------
Total operating expenses 4,516 9,147 11,082 22,321
-------------- -------------- ------------- -------------
Income from operations 2,915 (5,009) 4,514 (6,102)
License interest income 381 476 1,127 1,271
Other interest income 273 922 296 2,669
Interest expense (16) -- (85) --
-------------- -------------- ------------- -------------
Income before provision for
income taxes 3,553 (3,611) 5,852 (2,162)
Provision for income taxes 1,386 (1,372) 2,285 (822)
-------------- -------------- ------------- -------------
Net income $2,167 $(2,239) $ 3,567 $(1,340)
============== ============== ============= =============
Net income per common and common
equivalent share $ 0.08 $ (0.08) $ 0.14 $ (0.05)
============== ============== ============= =============
Weighted average number of common
and common equivalent shares
outstanding 26,991 29,756 25,952 29,528
============== ============== ============= =============
</TABLE>
The accompanying Notes are an integral part of these Condensed Consolidated
Financial Statements.
<PAGE>
Form 10-Q Page 5 of 12
PEGASYSTEMS INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1996 1997
-------------------- -------------------
<S> <C> <C>
Operating Activities
Net income $ 3,567 $ (1,340)
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Provision for deferred income taxes 2,037 (821)
Depreciation and amortization 1,152 1,647
Changes in operating assets and liabilities:
Increase in trade and installment accounts receivable (8,438) (9,188)
Increase in prepaid expenses and other assets (116) (484)
Decrease in accounts payable and accrued
expenses (198) (131)
Increase in deferred revenue 149 1,238
-------------------- -------------------
Net cash provided (used) by operating activities (1,847) (9,079)
-------------------- -------------------
Investing Activities
Purchase of equipment and improvements (1,067) (2,878)
Purchased software -- (10,000)
-------------------- -------------------
Net cash used by investing activities (1,067) (12,878)
-------------------- -------------------
Financing Activities
Repayments of long-term debt (1,598) --
Issuance of common stock, net 29,396 52,067
Exercise of stock options 60 532
-------------------- -------------------
Net cash provided (used) by financing activities 27,858 52,599
Effect of exchange rate on cash (36) (288)
-------------------- -------------------
Net increase in cash and equivalents 24,908 30,354
Cash and cash equivalents at beginning of period 511 24,201
-------------------- -------------------
Cash and cash equivalents at end of period $25,419 $ 54,555
==================== ===================
</TABLE>
The accompanying Notes are an integral part of these Condensed Consolidated
Financial Statements.
<PAGE>
Form 10-Q Page 6 of 12
PEGASYSTEMS INC.
Notes to Condensed Consolidated Interim Financial Statements
September 30, 1997
(Unaudited)
Note A - Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
Pegasystems Inc. (the "Company") presented herein have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three and nine-month periods ended September
30, 1997 are not necessarily indicative of the results that may be expected for
the year ended December 31, 1997. The Company suggests that these interim
condensed consolidated financial statements be read in conjunction with the
consolidated financial statements and notes thereto for the year ended December
31, 1996, included in the Company's Annual Report to Stockholders filed with the
Securities and Exchange Commission.
Note B - Net Income Per Share
Net income per common share is based on the weighted average number of common
shares and common share equivalents.
In February 1997, the Financial Accounting Standards Board issued Statement No.
128, "Earnings per Share," which is effective for the Company beginning with its
December 31, 1997 annual report. The Company will be required to change the
method currently used to compute earnings per share and to restate all prior
periods. Under the new requirements for calculating primary earnings per share,
the dilutive effect of stock options will be excluded. There is no change to
either primary or fully diluted net income per share for the quarters ended
September 30, 1996 and September 30, 1997 using the new method.
<PAGE>
Form 10-Q Page 7 of 12
PEGASYSTEMS INC.
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Results of Operations
Three and Nine Months Ended September 30, 1997 Compared to Three and Nine Months
Ended September 30, 1996
Revenue
Total revenue for the three months ended September 30, 1997 (the "1997 Three
Month Period") decreased 26.7% to $7.0 million from $9.6 million for the three
months ended September 30, 1996 (the "1996 Three Month Period"). This decrease
was primarily due to a decrease in software license revenue. Total revenue for
the nine months ended September 30, 1997 (the "1997 Nine Month Period")
increased 12.0% to $23.5 million from $21.0 million for the nine months ended
September 30, 1996 (the "1996 Nine Month Period"). This increase was primarily
due to an increase in software license revenue.
Software license revenue for the 1997 Three Month Period decreased 49.7% to $3.3
million from $6.5 million for the 1996 Three Month Period. This decrease in
software license revenue for the 1997 Three Month Period was primarily
attributable to fewer renewals of licenses by existing customers. Software
license revenue for the 1997 Nine Month Period increased 6.5% to $13.7 million
from $12.9 million for the 1996 Nine Month Period. This increase in software
license revenue for the 1997 Nine Month Period was primarily attributable to
software license acceptances by new customers, software license agreement
renewals, and extended software usage by existing customers.
Services revenue for the 1997 Three Month Period increased 22.0% to $3.7 million
from $3.1 million for the 1996 Three Month Period. Services revenue for the 1997
Nine Month Period increased 20.9% to $9.7 million from $8.1 million for the 1996
Nine Month Period. The increase in services revenue was primarily attributable
to increased implementation services for new customers, additional consulting
services provided to existing customers, and to a lesser extent, increased
maintenance revenue from a larger installed product base.
Cost of Revenue
Cost of software license for the 1997 Three Month Period decreased 27.2% to
$0.09 million from $0.12 million for the 1996 Three Month Period, and remained
constant as a percentage of total revenue at 1.2% for the 1997 Three Month
Period and for the 1996 Three Month Period. As a percentage of software license
revenue, cost of software license increased to 2.6% for the 1997 Three Month
Period from 1.8% for the 1996 Three Month Period. Cost of software license for
the 1997 Nine Month Period decreased 70.1% to $0.11 million from $0.35 million
for the 1996 Nine Month Period, and decreased as a percentage of total revenue
to 0.5% for the 1997 Nine Month Period from 1.7% for the 1996 Nine Month Period.
As a percentage of software license revenue, cost of software license decreased
to 0.8% for the 1997 Nine Month Period from 2.8% for the 1996 Nine Month Period.
During the 1997 Three Month Period, the Company began accruing expense to cover
a stock warrant to First Data Resources Corporation ("FDR") with a value of
approximately $2.9 million. Stock warrant amortization commenced in the 1997
Three Month Period and the Company expects to continue to incur these stock
warrant amortization costs until December 31, 2002. These amortization costs are
being treated as a cost of software license.
Cost of services for the 1997 Three Month Period increased 38.1% to $2.8 million
from $2.0 million for the 1996 Three Month Period, and increased as a percentage
of total revenue to 39.8% for the 1997 Three Month Period from 21.1% for the
1996 Three Month Period. As a percentage of service revenue, cost of services
increased to 74.6% for the 1997 Three Month Period from 65.8% for the 1996 Three
Month Period. Cost of services for the 1997 Nine Month Period increased 42.8% to
$7.2 million from $5.0 million for the 1996 Nine Month Period, and
<PAGE>
Form 10-Q Page 8 of 12
increased as a percentage of total revenue to 30.5% for the 1997 Nine Month
Period from 23.9% for the 1996 Nine Month Period. As a percentage of service
revenue, cost of services increased to 73.4% for the 1997 Nine Month Period from
62.1% for the 1996 Nine Month Period. These increases were primarily due to the
buildup of new staff, primarily in the Company's regional offices, and use of
the Company's service personnel to build templates which can be reused in other
customer applications.
Operating Expenses
Research and development expenses for the 1997 Three Month Period increased
69.1% to $4.0 million from $2.4 million for the 1996 Three Month Period. As a
percentage of total revenue, research and development expenses increased to
57.0% for the 1997 Three Month Period from 24.7% for the 1996 Three Month
Period. Research and development expenses for the 1997 Nine Month Period
increased 60.1% to $9.4 million from $5.9 million for the 1996 Nine Month
Period. As a percentage of total revenue, research and development expenses
increased to 40.1% for the 1997 Nine Month Period from 28.1% for the 1996 Nine
Month Period. During the 1997 Three Month Period, the Company received from FDR
a license to the requirements, designs, specifications, and code of FDR's ESP
product for which the Company paid $10.0 million, and which will be used to
support the development of the Company's software products. The Company
capitalized this software in the 1997 Three Month Period. The Company commenced
the amortization of these software amortization costs in the 1997 Three Month
Period, and expects to continue to amortize these software amortization costs
until December 31, 2002.
Selling and marketing expenses for the 1997 Three Month Period increased 177.6%
to $4.5 million from $1.6 million for the 1996 Three Month Period. As a
percentage of total revenue, selling and marketing expenses increased to 63.9%
for the 1997 Three Month Period from 16.9% for the 1996 Three Month Period.
Selling and marketing expenses for the 1997 Nine Month Period increased 186.1%
to $11.1 million from $3.9 million for the 1996 Nine Month Period. As a
percentage of total revenue, selling and marketing expenses increased to 47.2%
for the 1997 Nine Month Period from 18.5% for the 1996 Nine Month Period. These
increases were primarily attributable to the hiring of additional direct sales
and marketing personnel, commission payments on new sales, increased investment
in marketing support activities and materials, additional trade show activities,
preparations for the Company's User Meetings, and the opening of additional
regional offices. Although selling and marketing expenses increased as a
percentage of total revenue for both the Three Month and Nine Month Periods,
these increases were mainly due to slower growth in the Company's total revenue.
General and administrative expenses for the 1997 Three Month Period increased
24.9% to $0.7 million from $0.5 million for the 1996 Three Month Period. As a
percentage of total revenue, general and administrative expenses increased to
9.6% for the 1997 Three Month Period from 5.7% for the 1996 Three Month Period.
General and administrative expenses for the 1997 Nine Month Period increased
38.1% to $1.8 million from $1.3 million for the 1996 Nine Month Period. As a
percentage of total revenue, general and administrative expenses increased to
7.8% for the 1997 Nine Month Period from 6.3% for the 1996 Nine Month Period.
These increases were due to increased investment in the infrastructure needed to
support the Company's growth. Although general and administrative expenses
increased as a percentage of total revenue for both the Three Month and Nine
Month Periods, these increases were mainly due to slower growth in the Company's
total revenue.
License Interest Income
License interest income which is the portion of all license fees due under
software license agreements which was not recognized upon product acceptance or
license renewal increased 24.7% to $0.5 million for the 1997 Three Month Period
from $0.4 million for the 1996 Three Month Period. License interest income
increased 12.7% to $1.3 million for the 1997 Nine Month Period from $1.1 million
for the 1996 Nine Month Period due to the increase in the Company's installed
customer base.
<PAGE>
Form 10-Q Page 9 of 12
Provision for Income Taxes
The provision for federal, state and foreign taxes was $1.4 million for the 1996
Three Month Period. For the 1997 Three Month Period, there was a tax benefit of
$1.4 million. The provision for federal, state and foreign taxes was $2.3
million for the 1996 Nine Month Period. For the 1997 Nine Month Period, there
was a tax benefit of $0.8 million. The effective tax rate decreased from 39.0%
for 1996 Three and Nine Month Periods to 38.0% for the 1997 Three and Nine Month
Periods. These decreases were due to the reinstatement by the Internal Revenue
Service of the research and development tax credit in May 1996 and tax benefits
to the Company following employee stock option exercises.
Liquidity and Capital Resources
Since its inception, the Company had funded its operations primarily through
cash flow from operations and bank borrowings. In July 1996, the Company issued
and sold 2.7 million shares of Common Stock in connection with its initial
public offering. Proceeds to the Company from such offering were approximately
$30.1 million. In January 1997, the Company issued and sold 1.8 million shares
of Common Stock in connection with a second public offering. Proceeds to the
Company from such offering were approximately $52.4 million. At September 30,
1997, the Company had cash and cash equivalents of approximately $54.6 million
and working capital of approximately $74.9 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, prior to its initial public
offering, had limited the availability of working capital.
Net cash used by operating activities for the 1997 Nine Month period was $9.1
million, primarily due to an increase in accounts receivable, prepaid expenses
and other assets, and a decrease in accounts payable and accrued expenses,
partially offset by an increase in deferred revenue.
Net cash used by investing activities was $12.9 million during the 1997 Nine
Month Period due to the purchase of property and equipment consisting mainly of
computer hardware and software and furniture and fixtures to support the
Company's growing employee base. The Company also used cash by investing in
FDR's ESP software.
Net cash provided by financing activities was $52.6 million during the 1997 Nine
Month Period mainly due to the completion of the Company's second public
offering.
The Company's capital commitments consist primarily of operating leases for
office space and equipment. At September 30, 1997, the Company's commitments
under non-cancellable operating leases for office space with terms in excess of
one year totaled $0.4 million, $1.5 million and $0.6 million for 1997, 1998 and
1999, respectively. The Company's total payments under such leases was $1.1
million for the 1997 Nine Month Period.
The Company's $5.0 million revolving credit line, which expired on June 30,
1997, was renewed with the same bank and has a maturity date of June 30, 1999.
At September 30, 1997, 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.
The Company recorded no bad debt expense in the 1997 Nine Month Period.
The Company believes that the net proceeds from its two recent public offerings
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
the next year. 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.
<PAGE>
Form 10-Q Page 10 of 12
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.
Forward-Looking Statements
Certain statements contained in this Form 10-Q are "forward-looking statements"
as defined in the Private Securities Litigation Reform Act of 1995. These
statements involve various risks and uncertainties which could cause the
Company's actual results to differ from those expressed in such forward-looking
statements. These risks and uncertainties include the seasonal variation of the
Company's operations and fluctuations in the Company's quarterly results, rapid
technological change involving the Company's products, delays in product
development and implementation, the technological compatibility of the Company's
products with its customers' systems, the Company's dependence on customers in
the financial services market, intense competition in the markets for the
Company's products, risk of non-renewal by current customers, management of the
Company's growth, and other risks and uncertainties. Words such as "expects,"
"anticipates," "intends," "plans," "believes," "estimates," and "should" and
similar words and expressions are intended to identify the forward-looking
statements contained in this Form 10-Q. These statements are based on estimates,
projections, beliefs, and assumptions of the Company and its management and are
not guarantees of future performance. Further information regarding those
factors which could cause the Company's actual results to differ materially from
any forward-looking statements contained herein is included in the Company's
filings with the Securities and Exchange Commission.
<PAGE>
Form 10-Q Page 11 of 12
PEGASYSTEMS INC.
Part II - Other Information:
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule.
(b) Reports on Form 8-K:
None
<PAGE>
Form 10-Q Page 12 of 12
PEGASYSTEMS INC.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Pegasystems Inc.
Date: November 19, 1997 /s/ Ira Vishner
---------------
Ira Vishner
Vice President, Corporate Services,
Treasurer, Chief Financial Officer
and Director
(principal financial officer and
chief accounting officer)
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<EXCHANGE-RATE> 1
<CASH> 54,555
<SECURITIES> 0
<RECEIVABLES> 20,431
<ALLOWANCES> 545
<INVENTORY> 0
<CURRENT-ASSETS> 79,602
<PP&E> 18,366
<DEPRECIATION> (4,086)
<TOTAL-ASSETS> 121,023
<CURRENT-LIABILITIES> 4,671
<BONDS> 0
0
0
<COMMON> 287
<OTHER-SE> 82,782
<TOTAL-LIABILITY-AND-EQUITY> 106,267
<SALES> 23,476
<TOTAL-REVENUES> 23,476
<CGS> 7,257
<TOTAL-COSTS> 7,257
<OTHER-EXPENSES> 22,321
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (2,162)
<INCOME-TAX> (822)
<INCOME-CONTINUING> (1,340)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,340)
<EPS-PRIMARY> (0.05)
<EPS-DILUTED> (0.05)
</TABLE>
