SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 1996
Commission File No. 1-11859
PEGASYSTEMS INC.
(Exact name of Registrant as specified in its charter)
Massachusetts 4-2787865
(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)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $.01 par value per share
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 by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
As of March 24, 1997, the aggregate market value of the Registrant's
voting stock held by non-affiliates of the Registrant was approximately $589.7
million (without admitting that any person whose shares are not included in
determining such value is an affiliate).
There were 28,418,800 shares of the Registrant's common stock, $.01 par
value per share, outstanding on March 24, 1997.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Definitive Proxy Statement for its 1997
Annual Meeting of Stockholders to be held on May 13, 1997 (the "1997 Proxy
Statement") are incorporated by reference into Part III of this Form 10-K and
portions of the Registrant's Annual Report to Stockholders for the Registrant's
fiscal year ended December 31, 1996 (the "1996 Annual Report") are incorporated
by reference into Part II and Part IV of this Form 10-K. With the exception of
the portions of the 1997 Proxy Statement and the 1996 Annual Report expressly
incorporated into this Form 10-K by reference, such documents shall not be
deemed filed as part of this Form 10-K.
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TABLE OF CONTENTS
PART 1
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Item Page
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1 Business 3
2 Facilities 15
3 Legal Proceedings 15
4 Submission of Matters to a Vote of Security Holders 15
Executive Officers of the Registrant 16
PART II
5 Market for Registrant's Common Stock and Related 24
Stockholder Matters
6 Selected Consolidated Financial Data 24
7 Management's Discussion and Analysis of Financial 24
Condition and Results of Operations
8 Financial Statements and Supplementary Data 24
9 Changes in and Disagreements with Accountants on 24
Accounting and Financial Disclosure
PART III
10 Directors and Executive Officers of the Registrant 25
11 Executive Compensation 25
12 Security Ownership of Certain Beneficial Owners and 25
Management
13 Certain Relationship and Related Transactions 25
PART IV
14 Exhibits, Financial Statement Schedules, and Reports on 26
Form 8-K
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PART I
Item 1 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-
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wide basis to facilitate consistent, cost-effective customer service management.
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.
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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.
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
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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 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.
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
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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.
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
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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 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:
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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 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.
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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.
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.
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Customers
During 1994 Chemical Bank accounted for 16.8% of the Company's
consolidated revenue. Chemical Bank also accounted for 12.6% of the Company's
1995 consolidated revenue. In 1995 Citibank and Household Credit Services
accounted for 16.2% and 14.9%, respectively, of the Company's consolidated
revenue. In 1996, Bank of America, Chase Manhattan Bank and Fleet Bank accounted
for 14.5%, 11.4% and 10.5%, respectively, of the Company's consolidated revenue.
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, collections, and 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, and 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 PLC - Institutional funds transfer and foreign exchange
customer service for international operations. Credit card (merchant and
individual) service including telephony center, correspondence, and dispute and
chargeback processing.
Cedel Bank - Global custody and securities movement customer service.
Citibank - Global funds transfer and foreign exchange customer service.
Check-related customer service and research. Domestic MasterCard and Visa
service including image integration, correspondence, and dispute and chargeback
processing.
Colonial Group - Mutual fund customer service supporting telephony
center and correspondence.
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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 Chicago NBD - Retail/check customer service and research.
Wholesale banking, funds transfer, check, corporate lockbox, and interbank
compensation service for global operations.
Franklin Templeton Group - 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 Bank - Institutional funds transfer customer service.
Mellon Bank Corporation - 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.
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.
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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 1994, 1995 and 1996, international sales represented 24.2%, 10.5%
and 17.7%, respectively, of the Company's total revenue. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations Results
of Operations" incorporated herein by reference from the 1996 Annual Report.
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 1994, 1995 and 1996 the Company's research and development expenses
were approximately $5.4 million, $7.1 million and $8.2 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
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beneficial contract terms, reduced gross margins and loss of market share, any
of which could materially and adversely affect the Company's business, operating
results and financial condition.
The Company believes that the principal competitive factors affecting
its market include product features such as adaptability, scalability, ability
to integrate with other products and technologies, functionality and
ease-of-use, the timely development and introduction of new products and product
enhancements, as well as product reputation, quality, performance, price,
customer service and support, and the vendor's reputation. Although the Company
believes that its products currently compete favorably 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.
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,
Page 14
<PAGE>
result in costly litigation, cause product shipment delays or require the
Company to enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, may not be available on terms acceptable to the Company
or at all, which could have a material adverse effect upon the Company's
business, operating results and financial condition.
From time to time, the Company licenses software from third parties for
use with its products. The Company believes that no such license agreement to
which it is presently a party is material and that if any such license agreement
were to terminate for any reason, the Company would be able to obtain a license
or otherwise acquire other comparable technology or software on terms and on a
timetable that would not be materially adverse to the Company.
Employees
As of 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.
Item 2 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.
Item 3 LEGAL PROCEEDINGS
The Company is not a party to any material pending litigation or other
legal proceedings.
Item 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of fiscal 1996 there were no matters
submitted to a vote of security holders.
Page 15
<PAGE>
EXECUTIVE OFFICERS OF THE REGISTRANT
The names of the Company's executive officers and certain information
about them are set forth below as of December 31, 1996:
<TABLE>
<CAPTION>
Name Age Position(s) and Office(s) Held
- ---- --- ------------------------------
<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
</TABLE>
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.
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 Delivery. 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.
Page 16
<PAGE>
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 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.
Page 17
<PAGE>
CERTAIN STATEMENTS FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF
THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company, desiring to avail itself of the "safe harbor" provisions
of the Private Securities Litigation Reform Act of 1995, wishes to caution
readers that the following important factors, among others, in some cases have
caused and in the future could cause the Company's actual results to differ
materially from those expressed in forward-looking statements made by or on
behalf of the Company in filings with the Securities and Exchange Commission,
press releases and oral statements.
RISK FACTORS
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.
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<PAGE>
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.
Dependence on New Products; Rapid Technological Change; Product Development and
Implementation Risks
The market for customer management software and related consulting and
training services is subject to rapid technological change, changing customer
needs and preferences, frequent new product introductions, and evolving
programming languages and industry standards that may render existing products
and services obsolete. The Company's position in its current market or other
markets that it may enter could be eroded rapidly by product advances. The life
cycles of the Company's products are difficult to estimate, and the Company's
growth and future performance will depend in part upon its ability to enhance
existing products, and to develop and introduce new products that keep pace with
technological advancements, meet changing customer requirements, respond to
competitive products, and achieve market acceptance. The Company's product
development efforts require and are expected to continue to require substantial
investments by the Company for research, refinement and testing, and there can
be no assurance that the Company will have the resources sufficient to make such
investments. The Company has in the past experienced developmental delays, and
there can be no assurance that the 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.
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++
Page 19
<PAGE>
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.
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.
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
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<PAGE>
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.
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 has
historically accounted for a significant portion of the Company's total revenue.
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.
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
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<PAGE>
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.
Management of Growth
The growth in the size, geographic scope and complexity of the
Company's business and the expansion of its product offerings and customer base
have placed and are expected to continue to place a significant strain on the
Company's management, operations and capital needs. The Company's continued
growth, if any, will require it to hire, train and retain many employees both in
the United States and abroad, particularly additional sales and financial
personnel, and will also require the Company to enhance its financial and
managerial controls and reporting systems. There is no assurance that the
Company can manage its growth effectively or that the Company will be able to
attract and retain the necessary personnel to meet its business challenges. If
the Company is unable to manage its growth effectively, the Company's business,
operating results and financial condition could be materially and adversely
affected.
Risks Associated with International Operations; Currency and Other Risks
Sales to customers headquartered outside of the United States
represented approximately 10.5% and 17.7% of the Company's total revenue in 1995
and 1996, 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
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<PAGE>
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.
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.
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PART II
Item 5 MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
Information relating to the market for the Company's Common Stock and
related stockholder matters is contained on page 35 of the 1996 Annual Report in
the section entitled "Stock Price History and Related Stockholder Matters,"
which section is incorporated herein by reference.
Item 6 FIVE YEAR COMPARISON OF SELECTED CONSOLIDATED FINANCIAL DATA
Selected consolidated financial data is contained on page 15 of the
1996 Annual Report in the section entitled "Five Year Comparison of Selected
Consolidated Financial Data," which section is incorporated herein by reference.
Item 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Information is contained on pages 16 to 21 of the 1996 Annual Report in
the section entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations," which section is incorporated herein by
reference.
Item 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements and supplementary data are contained on pages 22
to 34 of the 1996 Annual Report in the sections entitled "Consolidated Balance
Sheets," "Consolidated Statements of Income," "Consolidated Statements of
Stockholders' Equity," "Consolidated Statements of Cash Flows," "Notes to
Consolidated Financial Statements" and "Report of Independent Auditors" which
sections are incorporated herein by reference. Financial statement schedules are
set forth in Item 14, "Exhibits, Financial Statement Schedules, and Reports on
Form 8-K" of this Form 10-K and are filed herewith.
Item 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None
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PART III
Item 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to the Directors of the Company is set forth in
the section entitled "Management - Directors" in the 1997 Proxy Statement, which
section is incorporated herein by reference. Information relating to the
executive officers of the Company is set forth in Part I, immediately following
Item 4, of this Report under the caption "Executive Officers of the Registrant."
Information relating to compliance with Section 16(a) of the Securities Exchange
Act of 1934 is set forth in the section entitled "Section 16(a) Beneficial
Ownership Reporting Compliance" in the 1997 Proxy Statement, which section is
incorporated herein by reference.
Item 11 EXECUTIVE COMPENSATION
Information relating to executive compensation is set forth in the
sections entitled "Management - Directors - Director Compensation," "Executive
Compensation," "Option Grants," "Aggregated Option Exercises and Year-End Option
Table," "Change in Control Arrangements," and "Compensation Committee Interlocks
and Insider Participation" in the 1997 Proxy Statement, which sections are
incorporated herein by reference.
Item 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information relating to ownership of equity securities of the Company
by certain beneficial owners and management is set forth in the section entitled
"Principal and Management Stockholders" in the 1997 Proxy Statement, which
section is incorporated herein by reference.
Item 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information relating to certain relationships and related transactions
is set forth in the section entitled "Management - Certain Relationships and
Related Transactions" in the 1997 Proxy Statement, which section is incorporated
herein by reference.
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PART IV
Item 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
(a) (1) Financial Statements of Pegasystems Inc.
The following consolidated financial statements required by Item 8 of
this Form 10-K are incorporated by reference from the 1996 Annual Report.
<TABLE>
<CAPTION>
Location in 1996
Item Annual Report
---- -------------
<S> <C>
Consolidated Balance Sheets at December 31, 1995 and 1996 Page 22
Consolidated Statements of Income for the years ended Page 23
December 31, 1994, 1995 and 1996
Consolidated Statements of Stockholders' Equity for the years ended Page 24
December 31, 1994, 1995 and 1996
Consolidated Statements of Cash Flows for the years ended Page 25
December 31, 1994, 1995 and 1996
Notes to Consolidated Financial Statements Page 26 - 33
Report of Independent Auditors Page 34
(2) Financial Statement Schedules of Pegasystems Inc.
The following financial statement schedule as of December 31, 1995 and
1996 and for the years ended December 31, 1994, 1995 and 1996 is required to be
filed by Item 8 of this Form 10-K, and is filed herewith as noted below. The
financial statement schedule should be read in conjunction with the consolidated
financial statements of Pegasystems.
Schedule II - Valuation and Qualifying Accounts Page 28
</TABLE>
All other schedules are omitted because the required information is not
present or not present in sufficient amounts to require submission of the
schedule or because the information is reflected in the consolidated financial
statements or notes thereto.
(3) Exhibits
The exhibits filed as part of this Report are listed in the Exhibit
Index immediately following the financial statement schedule included in this
Report.
(b) Reports on Form 8-K
The Registrant did not file any reports on Form 8-K during the fourth
quarter of 1996.
Page 26
<PAGE>
SIGNATURES
Pursuant to the requirements to Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
PEGASYSTEMS INC.
Date: March 28, 1997
By: /s/ Ira Vishner
----------------------------------------
Ira Vishner, Vice President of Corporate
Services, Treasurer, Chief Financial
Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report on Form 10-K has been signed below on March 28, 1997 by the
following persons on behalf of the Registrant and in the capacities indicated.
/s/ Alan Trefler
- ---------------------------
Alan Trefler President, Clerk and Director (principal
executive officer)
/s/ Ira Vishner
- ---------------------------
Ira Vishner Vice President of Corporate Services, Treasurer,
Chief Financial Officer and Director (principal
financial and accounting officer)
/s/ Edward A. Maybury
- ---------------------------
Edward A. Maybury Director
/s/ Edward B. Roberts
- ---------------------------
Edward B. Roberts Director
/s/ Leonard A. Schlesinger
- ---------------------------
Leonard A. Schlesinger Director
/s/ Thomas E. Swithenbank
- ---------------------------
Thomas E. Swithenbank Director
Page 27
<PAGE>
SCHEDULE II
PEGASYSTEMS INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Three Years Ended December 31, 1996
<TABLE>
<CAPTION>
Balance Additions Charged Balance
at beg- charged to to other at
inning costs and account Deductions end
Description of period expenses (a) (b) of period
- --------------------------------- --------- ---------- -------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts:
Year ended December 31, 1994 $340,041 $0 $0 $340,041 $0
Year ended December 31, 1995 0 793,310 0 359,423 433,887
Year ended December 31, 1996 433,887 300,000 204,685 0 938,572
</TABLE>
(a) Amount reclassified from liabilities during the year.
(b) Deductions are related to accounts receivable write-offs.
Page 28
<PAGE>
PEGASYSTEMS INC.
Exhibit Index
<TABLE>
<CAPTION>
Exhibit No. Description
<S> <C>
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.
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.
13.1 Portions of the 1996 Annual Report to Stockholders incorporated by reference
into this Report.
21.1.* Subsidiaries of the Registrant.
23.1. Consent of Ernst & Young LLP.
27.1. Financial Data Schedule.
</TABLE>
*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.
Exhibit 13.1.
STOCK PRICE HISTORY AND RELATED STOCKHOLDER MATTERS (unaudited)
The following table sets forth the range of high and low sales prices on the
National Association of Security Dealers Automatic Quotation ("Nasdaq") National
Market System under the Nasdaq symbol PEGA, for 1996. The Company's common stock
has been traded on the Nasdaq National Market System since its initial public
offering in July 1996. Prior to that date, there was no public market for the
Company's common stock. As of February 20, 1997, the Company had approximately
23 stockholders of record and approximately 2,300 beneficial owners of the
Company's common stock. On February 20, 1997, the closing sale price of the
common stock was $35.63. The Company has never declared or paid any dividends on
its common stock. The Company intends to retain its earnings to finance future
growth, and therefore does not anticipate paying any dividends in the
foreseeable future.
1996 High Low
- --------------------------------------- ------------ ------------
Third Quarter (beginning July 19, 1996) $27.00 $10.00
Fourth Quarter $37.00 $26.13
<PAGE>
PEGASYSTEMS INC.
FIVE YEAR COMPARISON OF SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below at December 31, 1992,
1993, 1994, 1995 and 1996 have been derived from the consolidated financial
statements of Pegasystems Inc. ("Pegasystems" or the "Company"). This data may
not be indicative of the Company's future condition or results of operations and
should be read in conjunction with the consolidated financial statements and
related notes included herein.
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------------------------------
1992 1993 1994 1995 1996
----------- ----------- ----------- ----------- ----------
Consolidated Statement of Income Data: (in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Total revenue $8,963 $10,212 $16,263 $22,247 $33,545
Income from operations 1,944 793 2,236 3,257 10,019
License interest income 1,220 1,305 1,457 1,486 1,565
Net income 1,867 1,233 2,193 2,878 7,500
Net income per share and common $0.08 $0.05 $0.09 $0.11 $0.28
equivalent share
Weighted average number of
common and common
equivalent shares outstanding 24,471 24,231 24,102 25,551 26,397
Dividends declared -- -- -- -- --
</TABLE>
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------------------
1992 1993 1994 1995 1996
----------- ----------- ----------- ----------- ----------
Consolidated Balance Sheet Data: (in thousands)
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents $336 $435 $456 $511 $24,201
Working capital 3,428 4,231 4,441 4,393 34,364
Long-term license installments, net 6,319 6,782 9,135 13,399 23,802
Total assets 14,387 17,057 20,787 25,876 66,855
Long-term debt 118 458 450 816 --
Stockholders' equity 8,444 9,676 11,872 14,674 52,385
</TABLE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 generally 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 periods 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 1994, 1995 and the three months ended March 31, 1996, the
discount rate for purposes of the present value calculation was 7%; for the nine
months ended December 31, 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 as a function of the
Company's then current marginal borrowing rate. 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. The fact that a
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.
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. In 1996, export revenue increased to $5.9 million, as a result
of new customers in the European marketplace.
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.
<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 generally 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.
RESULTS OF OPERATIONS
The following table sets forth for the years indicated the percentage of total
revenue represented by certain items reflected in the Statements of Income of
the Company:
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------------------------------
1994 1995 1996
-------- -------- --------
(as a percentage of total revenue)
<S> <C> <C> <C>
Revenue:
Software license 59.4% 60.8% 66.4%
Services 40.6 39.2 33.6
-------- ------- --------
Total revenue 100.0 100.0 100.0
-------- ------- --------
Cost of revenue:
Cost of software license 6.6 2.9 1.4
Cost of services 23.3 27.7 20.8
-------- ------- --------
Total cost of revenue 29.9 30.6 22.2
-------- ------- --------
Gross profit 70.1 69.4 77.8
-------- ------- --------
Operating expenses:
Research and development 33.5 31.7 24.5
Sales and marketing 16.2 16.1 17.9
General and administrative 6.7 6.9 5.5
-------- ------- --------
Total operating expenses 56.4 54.7 47.9
-------- ------- --------
Income from operations 13.7 14.7 29.9
License interest income 9.0 6.7 4.7
Other interest income 0.1 0.1 1.8
Interest expense (0.3) (0.5) (0.3)
-------- ------- --------
Income before provision for
income taxes 22.5 21.0 36.1
Provision for income taxes 9.0 7.9 13.7
-------- ------- --------
Net income 13.5% 13.1% 22.4%
======== ======== ========
</TABLE>
<PAGE>
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Revenue
Total revenue for 1996 increased 50.8% to $33.5 million from $22.2 million for
1995. The increase was primarily due to an increase in software license revenue.
Software license revenue for 1996 increased 64.5% to $22.3 million from $13.5
million in 1995. 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 1996 increased 29.5% to $11.3 million from $8.7 million for
1995. 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 1996 decreased 24.9% to $0.5 million from $0.6 million for 1995, and
decreased as a percentage of total revenue from 2.9% for 1995 to 1.4% for 1996.
As a percentage of software license revenue, cost of software license decreased
from 4.7% for 1995 to 2.1% for 1996. Such decreases were due to decreased
amortization expense related to capitalized software development costs. No
software development costs were capitalized in 1995 or 1996.
Cost of services consists primarily of the costs of providing implementation,
consulting, maintenance, and training services. Cost of services for 1996
increased 13.2% to $7.0 million from $6.2 million for 1995, 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 27.7% for 1995 to 20.8% for 1996, and declined as a percentage of
services revenue from 70.7% for 1995 to 61.8% for 1996, 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 1996 increased 16.4% to $8.2 million from
$7.1 million for 1995. 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 31.7% for 1995 to 24.5%
for 1996, reflecting the Company's strategy of leveraging existing product
functionality by balancing its historical focus on research and development with
an increased emphasis on sales and marketing. In addition, research and
development expenses declined as a percentage of total revenue due to the growth
in the Company's total revenue.
Sales and marketing expenses for 1996 increased 67.0% to $6.0 million from $3.6
million for 1995. As a percentage of total revenue, sales and marketing expenses
increased from 16.1% for 1995 to 17.9% for 1996. 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 1996 increased 20.5% to $1.9
million from $1.5 million for 1995 due to increased investment in the
infrastructure needed to support the Company's growth. Such expenses declined as
a percentage of total revenue from 6.9% for 1995 to 5.5% for 1996 due to the
growth in the Company's total revenue.
<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 1996 increased 5.3% to $1.6 million
from $1.5 million for 1995 reflecting a larger installed product base.
Provision for Income Taxes
The provisions for federal, state and foreign taxes were $1.8 million and $4.6
million for 1995 and 1996, respectively. The effective tax rates were 38.0% for
1995 and 38.1% for 1996. At December 31, 1996, the Company had $0.8 million in
research and development tax credit carryforwards available to offset future
federal taxable income. See Note 7 of Notes to Consolidated Financial
Statements.
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 $0.6 million 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 6.7% in 1994 and 6.9% of total revenue in 1995.
<PAGE>
License Interest Income
License interest income for 1995 and 1994 remained constant at $1.5 million.
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 40.0% for
1994 and 38.0% 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.
<PAGE>
General and administrative expenses for 1994 increased 30.8% to $1.1 million
from $0.8 million 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 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 $0.9 million and $1.5
million for 1993 and 1994, respectively. The effective tax rates were 41.1% for
1993 and 40.0% 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.
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 2.7 million 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 December 31, 1996, the Company had cash and cash
equivalents of approximately $24.2 million and working capital of approximately
$34.4 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, limited the availability of
working capital.
Net cash provided by operating activities for the years ended December 31, 1994
and 1995 was $1.5 million and $0.8 million, respectively. Net cash used by
operating activities for the year ended December 31, 1996 was $2.9 million. Such
amounts were used to support the Company's working capital requirements.
The Company used $1.1 million, $1.4 million and $2.0 million of net cash during
1994, 1995 and 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. At December
31, 1996, the Company's commitments under non-cancellable operating leases for
office space with terms in excess of one year totaled $1.2 million, $1.1 million
and $0.6 million for 1997, 1998 and 1999, respectively. The Company's total
payments under such leases was $0.9 million, $1.1 million and $1.4 million for
1994, 1995 and 1996, 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 December 31, 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.
The Company recorded no bad debt expense in 1994. The Company recorded bad debt
expense in the amounts of $0.8 million and $0.3 million in 1995 and 1996,
respectively, as a result of indications 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 related
primarily to maintenance and installation services provided by the Company. At
the time such services were rendered (and the resulting revenue was recognized)
there was no significant uncertainty regarding the acceptance thereof and the
collectibility of the related receivables was probable.
The Company believes that the net proceeds from its initial public offering and
its public offering which was completed in January 1997 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>
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
During 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. In 1995 two other customers accounted for 16.2% and 14.9%,
respectively, of the Company's consolidated revenue. In 1996, the Company had
three customers that accounted for 14.5%, 11.4% and 10.5%, respectively, of the
Company's consolidated revenue.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Annual Report 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. Works 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 Annual Report. 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>
PEGASYSTEMS INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share-related data)
<TABLE>
<CAPTION>
Assets December 31,
-------------------------------------
1995 1996
------------------ -----------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $511 $24,201
Trade and installment accounts receivable, net of
allowance for doubtful accounts of $434 and
$939 at December 31, 1995 and 1996, respectively 8,896 14,582
Prepaid expenses and other assets 425 1,235
------------------ -----------------
Total current assets 9,832 40,018
Long-term license installments, net 13,399 23,802
Equipment and improvements, net 2,172 3,035
Software development costs, net 473 --
------------------ -----------------
Total assets $25,876 $66,855
================== =================
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses $1,747 $2,697
Deferred revenue 114 53
Current portion of long-term debt 782 --
Deferred income taxes 2,796 2,904
------------------ -----------------
Total current liabilities 5,439 5,654
Deferred income taxes 4,947 8,816
Long-term debt 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 and 26,392,200
shares issued and outstanding at December 31, 1995
and December 31, 1996, respectively 235 264
Additional paid-in capital 106 30,206
Deferred compensation (91) (73)
Retained earnings 14,522 22,022
Cumulative foreign currency translation adjustment (98) (34)
------------------ -----------------
14,674 52,385
------------------ -----------------
Total liabilities and stockholders' equity $25,876 $66,855
================== =================
</TABLE>
The accompanying Notes are an integral part of these Consolidated
Financial Statements.
<PAGE>
PEGASYSTEMS INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------
1994 1995 1996
------------------ ----------------- -----------------
<S> <C> <C> <C>
Revenue
Software license $9,662 $13,528 $22,258
Services 6,601 8,719 11,287
------------------ ----------------- -----------------
Total revenue 16,263 22,247 33,545
------------------ ----------------- -----------------
Cost of revenue
Cost of software license 1,075 635 477
Cost of services 3,791 6,161 6,975
------------------ ----------------- -----------------
Total cost of revenue 4,866 6,796 7,452
------------------ ----------------- -----------------
Gross profit 11,397 15,451 26,093
Operating expenses
Research and development 5,440 7,061 8,218
Sales and marketing 2,629 3,592 5,999
General and administrative 1,092 1,541 1,857
------------------ ----------------- -----------------
Total operating expenses 9,161 12,194 16,074
------------------ ----------------- -----------------
Income from operations 2,236 3,257 10,019
License interest income 1,457 1,486 1,565
Other interest income 21 16 619
Interest expense (56) (118) (85)
------------------ ----------------- -----------------
Income before provision for
income taxes 3,658 4,641 12,118
Provision for income taxes 1,465 1,763 4,618
------------------ ----------------- -----------------
Net income $2,193 $2,878 $7,500
================== ================= =================
Net income per common and
common equivalent share $0.09 $0.11 $0.28
================== ================= =================
Weighted average number of
common and common
equivalent shares outstanding 24,102 25,551 26,397
================== ================= =================
</TABLE>
The accompanying Notes are an integral part of these Consolidated
Financial Statements.
<PAGE>
PEGASYSTEMS INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Common Stock Cumulative
------------------------ Foreign
Number Additional Currency Total
of Paid-in Deferred Retained Translation Stockholders'
Shares Amount Capital Compensation Earnings Adjustment Equity
----------- ----------- ------------ -------------- ----------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1993 22,617 $226 -- -- $9,451 -- $9,677
Exercise of stock options 873 9 $15 -- -- -- 24
Foreign currency
translation adjustment -- -- -- -- -- $(22) (22)
Net income -- -- -- -- 2,193 -- 2,193
---------- --------- ----------- --------- ---------- ----------- ----------
Balance at December 31,
1994 23,490 235 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 23,490 235 106 (91) 14,522 (98) 14,674
Issuance of common
stock 2,700 27 29,339 -- -- -- 29,366
Exercise of stock options 202 2 64 -- -- -- 66
Tax benefit from exercise
of stock options -- -- 697 -- -- -- 697
Foreign currency
translation adjustment -- -- -- -- -- 64 64
Amortization of deferred
compensation -- -- -- 18 -- -- 18
Net income -- -- -- -- 7,500 -- 7,500
---------- --------- ----------- --------- ---------- ----------- ----------
Balance at December 31,
1996 26,392 $264 $30,206 $(73) $22,022 $(34) $52,385
========== ========= =========== ========= ========== =========== ==========
</TABLE>
The accompanying Notes are an integral part of these Consolidated
Financial Statements.
<PAGE>
PEGASYSTEMS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------
1994 1995 1996
----------------- ------------------ -----------------
<S> <C> <C> <C>
Operating activities
Net income $2,193 $2,878 $7,500
Adjustments to reconcile net income to
net cash provided (used) by operating
activities:
Provision for deferred income taxes 961 1,836 3,977
Depreciation and amortization 1,511 1,455 1,633
Provision for doubtful accounts -- 793 300
Change in operating assets and liabilities:
Increase in trade and installment
accounts receivable (3,988) (5,638) (16,389)
Increase in prepaid expenses and
other assets (16) (221) (810)
Decrease in inventory 215 -- --
Increase (decrease) in accounts
payable and accrued expenses 971 (244) 950
Decrease in deferred revenue (336) (25) (61)
----------------- ------------------ -----------------
Net cash provided (used) by
operating activities 1,511 834 (2,900)
Investing activities
Purchase of equipment and
improvements (1,131) (1,423) (2,005)
Software development costs (297) -- --
----------------- ------------------ -----------------
Net cash used in investing
activities (1,428) (1,423) (2,005)
Financing activities
Repayment of note payable to shareholder (180) (50) --
Proceeds from issuance of long-term debt 380 1,345 --
Repayments of long-term debt (263) (575) (1,598)
Issuance of common stock, net -- -- 29,366
Exercise of stock options 23 -- 66
Tax benefit from exercise of stock options -- -- 697
----------------- ------------------ -----------------
Net cash provided (used) by
financing activities (40) 720 28,531
Effect of exchange rate on cash (22) (76) 64
----------------- ------------------ -----------------
Net increase in cash 21 55 23,690
Cash and cash equivalents at beginning of year 435 456 511
----------------- ------------------ -----------------
Cash and cash equivalents at end of year $456 $511 $24,201
================= ================== =================
Supplemental Disclosures of Cash Flow Information:
Cash paid during period:
Interest $56 $119 $86
================= ================== =================
Income taxes $135 $315 $90
================= ================== =================
</TABLE>
The accompanying Notes are an integral part of these Consolidated
Financial Statements.
<PAGE>
PEGASYSTEMS INC.- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - December 31, 1996
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 subsidiaries, Pegasystems Limited and Pegasystems Investment
Inc. 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 stockholders' 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 generally
recognized upon product acceptance pursuant to non-cancellable 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.
<PAGE>
Software license revenue represents the present value of future payments under
non-cancellable 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.
The discount rate in effect for 1994, 1995 and the three months ended March 31,
1996 was 7%. The discount rate for the nine month period ended December 31, 1996
was 6.75%. The trade and installment accounts receivable recorded on the balance
sheet are net of $3.9 million and $5.1 million as of December 31, 1995 and 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 a concentration of
credit risk consist of substantially all of the trade accounts receivable and
long-term license installments receivable. 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.
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 $0.3 million of software costs. No costs were capitalized
during 1995 or 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 $1.1 million, $0.6 million and $0.5 million during 1994, 1995 and
1996, respectively.
<PAGE>
Net Income Per Share
Net income per common and common equivalent share is computed using the weighted
average number of common and common equivalent shares outstanding during each
period, assuming the exercise of stock options into common stock under the
treasury stock method. Common stock equivalent shares are excluded from the
computation if their effect is anti-dilutive; however, pursuant to the
requirements of the Securities and Exchange Commission, common stock equivalent
shares relating to stock options (using the treasury stock method and the
initial public offering price) issued during the twelve months prior to the
registration statement filed with respect to the initial filing of the initial
public offering are included for all periods presented whether or not they are
anti-dilutive. 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 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 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. During 1995, the Company granted stock options for a fixed
number of shares to employees with an exercise price less than the then fair
market value of the shares at the date of the grant. For the difference between
the fair market value and the exercise price, the Company recorded deferred
compensation which is being expensed over the vesting period.
The Company has adopted the disclosure provisions only of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS
123") and will continue to account for its stock option plans in accordance with
the provisions of APB 25, "Accounting for Stock Issued to Employees."
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Some of the areas where estimates are
utilized included allowance for bad debts, capitalized software, income taxes,
revenue and various accrued expenses. Actual results could differ from those
estimates.
2. EQUIPMENT AND IMPROVEMENTS
The cost and accumulated depreciation of equipment and improvements consist of
the following:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------
(in thousands)
1995 1996
----------------- ---------------
<S> <C> <C>
Equipment $2,186 $3,956
Furniture and fixtures 863 1,005
Leasehold improvements 434 527
---------------- ---------------
3,483 5,488
Less accumulated depreciation (1,311) (2,453)
---------------- ---------------
Equipment and improvements, net $2,172 $3,035
================ ===============
</TABLE>
<PAGE>
Depreciation expense was approximately $0.4 million, $0.8 million and $1.2
million for the years ended December 31, 1994, 1995 and 1996, respectively.
3. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of the following:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------
(in thousands)
1995 1996
----------------- ---------------
<S> <C> <C>
Trade accounts payable $557 $692
Employee compensation and benefits 568 1,257
Accrued income taxes -- 160
Other 622 588
---------------- ---------------
$1,747 $2,697
================ ===============
</TABLE>
4. DEBT AND OTHER FINANCIAL INSTRUMENTS
Long-term debt consists of the following:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------
(in thousands)
1995 1996
----------------- ---------------
<S> <C> <C>
Note payable to bank, with originally scheduled monthly payments of
$17 thousand plus interest through December 1, 1996 $207 --
Note payable to bank, with originally scheduled monthly payments of
$11 thousand plus interest through December 1, 1997 243 --
Note payable to bank, with originally scheduled monthly payments of
$33 thousand plus interest through June 28, 1998 983 --
Note payable to bank, with originally scheduled monthly payments of
$5 thousand plus interest through December 28, 1998 165 --
---------------- ---------------
1,598 --
Less current portion (782) --
---------------- ---------------
$816 --
================ ===============
</TABLE>
The notes bore interest at the bank's prime rate (8.5% at December 31, 1995)
plus 1/2%. The notes were secured by all computer equipment and furniture and
fixtures of the Company. As of December 31, 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 $2.5 million at the prime rate, which line of credit was
scheduled to expire on June 1, 1996. As of December 31, 1996, the Company's bank
line of credit had been increased to $5.0 million and extended until June 30,
1997. The Company had no drawings against the line of credit at December 31,
1995 and 1996. 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.
<PAGE>
Financial instruments outstanding at December 31, 1995 and 1996 are as follows:
<TABLE>
<CAPTION>
December 31, December 31,
------------------------------------ ---------------------------------
(in thousands) (in thousands)
1995 1995 1996 1996
---------------- ---------------- -------------- ---------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------------- ---------------- -------------- ---------------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents $511 $511 $24,201 $24,201
Liabilities:
Notes payable to a bank (1,598) (1,598) -- --
</TABLE>
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, 1996, 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, 2.4 million shares were reserved for issuance under the 1994
Plan. As of December 31, 1996, the Company had approved an increase in the
number of shares issuable under the 1994 Plan from 2.4 million to 5.0 million.
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 1994 Plan to exceed the 5.0
million shares of stock reserved for issuance under the 1994 Plan.
The option price per share is to be determined at the date of grant. For
incentive stock options, the option price may not be less than 100% of the fair
market value of the Company's common stock at the grant date. Incentive stock
options granted to a person having greater than 10% of the voting power of all
classes of stock must have an exercise price of at least 110% of fair market
value of the Company's common stock.
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.
<PAGE>
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.
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. To date, there have been no offerings under the
Stock Purchase Plan and no shares of Common Stock have been issued thereunder.
The following table presents the combined activity of the two option plans in
which offerings have occurred for the years ended December 31, 1994, 1995 and
1996:
<TABLE>
<CAPTION>
1994 1995 1996
----------------------- --------------------------- ---------------------------
Weighted Weighted Weighted
Number Average Number Average Number Average
of Exercise of Exercise of Exercise
Options Price Options Price Options Price
------------- -------- ------------- --------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding options (in thousands) (in thousands) (in thousands)
at beginning of year 1,269 $0.23 1,672 $0.33 1,924 $0.34
Granted 1,636 $0.33 335 $0.39 993 $13.19
Exercised (873) $0.03 -- -- (202) $0.33
Cancelled (360) $0.66 (83) $0.48 (133) $4.94
------------- -------- ------------- --------- ------------- ---------
Outstanding options at
end of year 1,672 $0.33 1,924 $0.34 2,582 $5.04
============= ======== ============= ========= ============= =========
Exercisable options at
end of year 396 $0.36 606 $0.33 679 $0.33
============= ======== ============= ========= ============= =========
Weighted average fair
value of options granted
during the year $0.10 $0.09 $8.84
============= ============= =============
</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 $91,000 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.
<PAGE>
The following table presents weighted average price and life information about
significant option groups outstanding at December 31, 1996:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------- --------------------------
<S> <C> <C> <C> <C> <C>
Weighted Weighted Weighted
Number Average Average Number Average
Range of exercise prices Outstanding Remaining Exercise Exercisable Exercise
(in thousands) Contractual Price (in thousands)
Life (years)
- ------------------------ ------------- ------------ -------- -------------- --------
$0.33 - $0.39 1,620 8.2 $0.34 679 $0.33
$6.00 - $10.00 698 9.4 $9.60 -- --
$12.50 - $26.50 158 9.6 $16.52 -- --
$29.00 - $30.50 106 9.9 $29.86 -- --
------------- --------------
2,582 679
============= ==============
</TABLE>
Pursuant to the requirements of FAS 123, the following are the pro forma net
income and net income per share for 1995 and 1996, as if the compensation
expense for the option plans had been determined based on the fair value at
the grant date for grants in 1995 and 1996, consistent with the provisions of
FAS 123:
<TABLE>
<CAPTION>
1995 1996
--------------------------------------- ---------------------------------------
As Reported Pro Forma As Reported Pro Forma
----------------- ------------------ ----------------- ------------------
<S> <C> <C> <C> <C>
Net income (in thousands) $2,878 $2,878 $7,500 $7,122
Net income per share $0.11 $0.11 $0.28 $0.27
</TABLE>
A range of expected vesting percentages were given to each range of exercise
prices. For the range of exercise prices from $0.33 to $0.39, $6.00 to $10.00,
$12.50 to $26.50 and $29.00 to $30.50, it is expected that 95 percent, 90
percent, 75 percent and 50 percent of those options will vest, respectively.
These ranges were based upon the Company's estimates that a more significant
number of lower priced options as compared to higher priced options will vest.
The fair value of options at the date of grant were estimated using the
Black-Scholes model with the following weighted-average assumptions:
Option
---------------------------------------
1995 1996
----------------- ------------------
Volatility 0.0 0.0 - 9.9
Expected option life (years) 5.0 5.0
Interest rate (risk free) 5.51% 5.38 - 6.69%
Volatility was calculated on a monthly basis. Exclusive of one month's data
where volatility was 9.9, volatility ranged from 0.0 to 1.4. The Company has
never declared nor paid dividends on any of its capital stock and does not
expect to in the foreseeable future.
The effects on 1995 and 1996 pro forma net income and net income per share of
expensing the estimated fair value of stock options and shares are not
necessarily representative of the effects on reporting the results of operations
for future years as the periods presented include only one and two years of
option grants under the Company's plans.
<PAGE>
6. LEASES
The Company leases certain equipment and office space under non-cancellable
operating leases. Future minimum rental payments required under the operating
leases with non-cancellable terms in excess of one year at December 31, 1996 are
as follows:
Year ended December 31, (in thousands)
---------------
1997 $1,198
1998 1,125
1999 580
2000 322
---------------
Total $3,225
===============
Total rent expense under operating leases was approximately $0.9 million, $1.1
million and $1.4 million for the years ended December 31, 1994, 1995 and 1996,
respectively.
7. INCOME TAXES
Income before income taxes consists of the following:
(in thousands)
1994 1995 1996
---------------- --------------- ----------------
Domestic $3,512 $4,318 $11,546
Foreign 146 323 572
---------------- --------------- ----------------
Total $3,658 $4,641 $12,118
================ =============== ================
The provision (benefit) for income taxes for the years ended December 31, 1994,
1995 and 1996 consisted of the following:
(in thousands)
1994 1995 1996
---------------- --------------- ----------------
Current:
Federal $297 $(107) $6
State 176 (39) 212
Foreign 31 73 160
---------------- --------------- ----------------
Total current 504 (73) 378
---------------- --------------- ----------------
Deferred:
Federal 691 1,563 3,662
State 270 273 578
--------------- ----------------
----------------
Total deferred 961 1,836 4,240
---------------- --------------- ----------------
$1,465 $1,763 $4,618
================= ================ ================
<PAGE>
The effective income tax rate differed from the statutory federal income tax
rate due to:
<TABLE>
<CAPTION>
1994 1995 1996
------------- ------------ ------------
<S> <C> <C> <C>
Statutory federal income tax rate 34.0% 34.0% 35.0%
State income taxes, net of federal benefit 7.3 5.8 4.2
Permanent differences 2.0 0.7 0.3
Tax credits (3.3) (2.5) (0.6)
Other -- -- (0.8)
------------- ------------ ------------
Effective income tax rate 40.0% 38.0% 38.1%
============= ============ ============
</TABLE>
At December 31, 1994, 1995 and 1996, the Company had alternative minimum tax
(AMT) and research and development (R&D) credit carryforwards of approximately
$0.6 million, $0.6 million and $0.8 million, respectively, available to offset
future federal taxable income. The carryforward period for the AMT credit is
unlimited. The R&D credit carryforwards generally expire from 2004 to 2008.
Deferred income taxes at December 31, 1995 and 1996 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, 1995 and 1996 are as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------
(in thousands)
1995 1996
------------------- -------------------
<S> <C> <C>
Deferred tax liabilities:
Software revenue $(9,303) $(14,103)
Capitalized software (213) --
Depreciation (142) (215)
Other (41) (71)
------------------- -------------------
Total deferred tax liabilities (9,699) (14,389)
------------------- -------------------
Deferred tax assets:
Deferred state taxes 729 836
License fees 119 --
Vacation accrual 109 380
Other 274 655
Tax credits 725 798
------------------- -------------------
Total deferred tax assets 1,956 2,669
------------------- -------------------
Net deferred tax liabilities (7,743) (11,720)
Less current portion (2,796) (2,904)
------------------- -------------------
$(4,947) $(8,816)
=================== ===================
</TABLE>
<PAGE>
8. SIGNIFICANT CUSTOMERS
During 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. In 1995 two other customers accounted for 16.2% and 14.9%,
respectively, of the Company's consolidated revenue. In 1996, the Company had
three customers that accounted for 14.5%, 11.4% and 10.5%, respectively, of the
Company's consolidated revenue.
9. INTERNATIONAL OPERATIONS
The Company's export sales from the United States for 1994, 1995 and 1996 are as
follows:
<TABLE>
<CAPTION>
(in thousands)
1994 1995 1996
--------------- -------------- --------------
<S> <C> <C> <C>
United Kingdom $1,515 $1,343 $3,698
Continental Europe 1,409 877 2,017
Other 1,008 114 232
--------------- -------------- --------------
$3,932 $2,334 $5,947
=============== ============== ==============
</TABLE>
10. RECAPITALIZATION AND STOCK SPLIT
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 7.8 million 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 9.0 million to 45.0 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 1.0 million 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
Secondary Public Offering: On January 28, 1997, the Company completed a
secondary public offering of 1.8 million shares of its common stock at $30.125
per share.
<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, 1995 and 1996 and the related consolidated statements of
income, stockholders' equity, and cash flows for each of the three years in the
period ended December 31, 1996. 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, 1995 and 1996, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Boston, Massachusetts
February 24, 1997
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report
(Form 10-K) of Pegasystems Inc. of our report dated February 24, 1997, included
in the 1996 Annual Report to Stockholders of Pegasystems Inc.
Our audits also included the financial statement schedule of
Pegasystems Inc. listed in Item 14(a). 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.
We also consent to the incorporation by reference in the Registration
Statement (Form S-8 No. 333-09305) pertaining to the Amended and Restated 1994
Long-Term Incentive Plan, the 1996 Employee Stock Purchase Plan, and the 1996
Non-Employee Director Stock Option Plan, of Pegasystems Inc. of our report dated
February 24, 1997, with respect to the consolidated financial statements
incorporated herein by reference, and our report included in the preceding
paragraph with respect to the financial statement schedule included in this
Annual Report (Form 10-K) for the year ended December 31, 1996 of Pegasystems
Inc.
ERNST & YOUNG LLP
Boston, Massachusetts
March 26, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1
<CASH> 24,201
<SECURITIES> 0
<RECEIVABLES> 14,582
<ALLOWANCES> 939
<INVENTORY> 0
<CURRENT-ASSETS> 40,018
<PP&E> 5,488
<DEPRECIATION> (2,453)
<TOTAL-ASSETS> 66,855
<CURRENT-LIABILITIES> 5,654
<BONDS> 0
0
0
<COMMON> 264
<OTHER-SE> 30,206
<TOTAL-LIABILITY-AND-EQUITY> 66,855
<SALES> 33,545
<TOTAL-REVENUES> 33,545
<CGS> 7,452
<TOTAL-COSTS> 7,452
<OTHER-EXPENSES> 16,074
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 85
<INCOME-PRETAX> 12,118
<INCOME-TAX> 4,618
<INCOME-CONTINUING> 7,500
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,500
<EPS-PRIMARY> $0.28
<EPS-DILUTED> $0.28
</TABLE>
