SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the quarterly period ended March 31, 1998
or
[ ] Transition Report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from to
------ ------
Commission File Number: 1-11859
PEGASYSTEMS INC.
(Exact name of Registrant as specified in its charter)
Massachusetts 04-2787865
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
101 Main Street
Cambridge, MA 02142-1590
(Address of principal executive offices) (zip code)
(617) 374-9600
(Registrant's telephone number including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
There were 28,551,600 shares of the Registrant's common stock, $.01 par value
per share, outstanding on March 31, 1998.
<PAGE>
PEGASYSTEMS INC. AND SUBSIDIARY
Index to Form 10-Q
Part I - Financial Information
Page
Item 1. Financial Statements ----
Consolidated Balance Sheets at December 31, 1997 3
and March 31, 1998
Consolidated Statements of Income for the three 4
months ended: March 31, 1997 and 1998
Consolidated Statements of Cash Flows for the three 5
months ended: March 31, 1997 and 1998
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial 8
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 11
Part II - Other Information
Item 1. Legal Proceedings 12
Item 2. Changes in Securities 12
Item 3. Defaults upon Senior Securities 12
Item 4. Submission of Matters to a Vote of Security Holders 12
Item 5. Other Information 13
Item 6. Exhibits and Reports on Form 8-K 13
SIGNATURES 14
<PAGE>
Form 10-Q Page 3 of 14
PEGASYSTEMS INC.
Consolidated Balance Sheets
(in thousands, except share-related amounts)
(Unaudited)
<TABLE>
<CAPTION>
December 31, March 31,
1997 1998
------------ ---------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 52,005 $ 53,513
Trade and installment accounts receivable, net of
allowance for doubtful accounts of $2,200 at
December 31, 1997 and $2,350 at March 31, 1998 20,319 21,962
Prepaid expenses and other current assets 1,514 2,033
-------- --------
Total current assets 73,838 77,508
Long-term license installments, net 36,403 41,084
Equipment and improvements, net 5,578 5,897
Purchased software, net 11,701 11,116
-------- --------
Total assets $127,520 $135,605
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 5,398 $ 6,656
Deferred revenue 1,754 5,336
Deferred income taxes 3,978 5,192
-------- --------
Total current liabilities 11,130 17,184
-------- --------
Deferred income taxes 3,669 3,669
-------- --------
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; 28,545,100 shares and 28,551,600 shares
issued and outstanding in 1997 and in 1998, respectively 285 286
Additional paid-in capital 86,841 86,856
Deferred compensation (55) (51)
Stock warrant 2,897 2,897
Retained earnings 23,107 25,087
Cumulative foreign currency translation adjustment (354) (323)
-------- --------
Total stockholders' equity 112,721 114,752
-------- --------
Total liabilities and stockholders' equity $127,520 $135,605
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
Form 10-Q Page 4 of 14
PEGASYSTEMS INC.
Consolidated Statements of Income
(in thousands, except per share amounts)
(Unaudited)
Three Months Ended
March 31,
Revenue: 1997 1998
------- -------
(As Restated)
Software license $ 5,815 $11,388
Services 2,667 6,579
------- -------
Total revenue 8,482 17,967
------- -------
Cost of revenue:
Cost of software license 10 146
Cost of services 2,150 4,059
------- -------
Total cost of revenue 2,160 4,205
------- -------
Gross Profit 6,322 13,762
Operating expenses:
Research and development 2,586 5,211
Selling and marketing 2,693 5,287
General and administrative 605 1,249
------- -------
Total operating expenses 5,884 11,747
------- -------
Income from operations 438 2,015
License interest income 374 549
Other interest income 750 629
------- -------
Income before provision for
income taxes 1,562 3,193
Provision for income taxes 594 1,213
------- -------
Net income $ 968 $ 1,980
======= =======
Earnings per share:
Basic $ 0.04 0.07
======= =======
Diluted $ 0.03 0.07
======= =======
Weighted average number of common
shares outstanding:
Basic 27,497 28,547
======= =======
Diluted 29,490 30,218
======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
Form 10-Q Page 5 of 14
PEGASYSTEMS INC.
Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1997 1998
------- -------
(As Restated)
<S> <C> <C>
Cash Flows from Operating Activities:
Net income $ 968 $ 1,980
Adjustments to reconcile net income to net cash provided by (used
in) operating activities:
Provision for deferred income taxes 594 1,213
Depreciation and amortization 361 1,402
Provision for doubtful accounts 400 150
Changes in operating assets and liabilities:
Trade and installment accounts receivable (6,187) (6,475)
Prepaid expenses and other current assets 9 (519)
Accounts payable and accrued expenses 3,362 1,259
Deferred revenue (14) 3,582
------- -------
Net cash (used in) provided by operating activities (507) 2,592
------- -------
Cash Flows from Investing Activities:
Purchase of equipment and improvements (663) (1,131)
------- -------
Net cash used in investing activities (663) (1,131)
------- -------
Cash Flows from Financing Activities:
Issuance of common stock, net 51,943 --
Exercise of stock options 91 16
------- -------
Net cash provided by financing activities 52,034 16
Effect of exchange rate on cash and cash equivalents (44) 31
------- -------
Net increase in cash and cash equivalents 50,820 1,508
Cash and cash equivalents, at beginning of period 24,201 52,005
------- -------
Cash and cash equivalents, at end of period $75,021 $53,513
======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
Form 10-Q Page 6 of 14
PEGASYSTEMS INC.
Notes to Consolidated Interim Financial Statements
March 31, 1998
(Unaudited)
Note A - Basis of Presentation
The accompanying unaudited consolidated financial statements of Pegasystems Inc.
(the "Company") presented herein, have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three-month period ended March 31, 1998 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1998. The Company suggests that these interim condensed
consolidated financial statements be read in conjunction with the consolidated
financial statements and notes thereto for the year ended December 31, 1997,
included in the Company's Annual Report to Stockholders filed with the
Securities and Exchange Commission.
Note B - Earnings Per Share
The Company has adopted Statement of Financial Standards (SFAS) No. 128,
"Earnings Per Share." SFAS No. 128 establishes standards for computing and
presenting earnings per share and applies to entities with publicly held common
stock or potential common stock. In accordance with the Securities and Exchange
Commission's Staff Accounting Bulletin (SAB) No. 98, the Company has determined
that there were no nominal issuances of common stock or potential common stock
in the period prior to the Company's initial public offering (IPO). The Company
has applied the provisions of SFAS No. 128 and SAB No. 98 retroactively to all
periods presented. Calculations of diluted net income per share and potential
common shares are as follows:
March 31,
(in thousands, except per share data) 1997 1998
-------- -------
Diluted
Net income $ 968 $ 1,980
======== =======
Weighted average common shares outstanding 27,497 28,547
Effect of:
Assumed exercise of stock options 1,993 1,671
-------- -------
Weighted average common shares outstanding,
assuming dilution 29,490 30,218
======== =======
Diluted earnings per share $ 0.03 $ 0.07
======== =======
As of March 31, 1998, 914,604 options were excluded from the weighted average
common shares outstanding, assuming dilution, as their effect would be
anti-dilutive.
<PAGE>
Form 10-Q Page 7 of 14
PEGASYSTEMS INC.
Notes to Consolidated Interim Financial Statements - Continued
March 31, 1998
(Unaudited)
Note C - Comprehensive Income
The Company adopted SFAS No. 130,
Reporting Comprehensive Income, effective January 1, 1998. SFAS 130
establishes standards for reporting and display of comprehensive income and its
components in financial statements. The components of the Company's
comprehensive income are as follows:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
(in thousands)
1997 1998
------- ------
<S> <C> <C>
Net Income $968 $1,980
Foreign currency translation adjustments, net of income taxes 27 (19)
------ ------
Comprehensive income 995 $1,961
======= ======
</TABLE>
Note D - Restatement
The Company restated its consolidated financial statements for the unaudited
quarters ended March 31, 1997, June 30, 1997 and September 30, 1997. In the
opinion of management, all material adjustments necessary to correct the
financial statements have been recorded. The restatements reflect revenue
adjustments, as a result of a change in the timing of revenue recognition on
certain contracts. These adjustments resulted in revenue reversals or in an
increase of deferred revenue. Also included in the restated consolidated
financial statements are operating expenses, including a provision for bad debts
not previously recorded by the Company and the recording of certain other
expenses and reserves.
A summary of the impact of such restatements on the financial statements for the
unaudited three months ended March 31, 1997 is as follows:
<TABLE>
<CAPTION>
Unaudited
Three Months Ended
March 31, 1997
Previously As
Reported Restated
------------------ -------------------
<S> <C> <C>
Software license $6,478 $5,815
Services 2,754 2,667
Income from operations 1,720 438
Net income 1,763 968
Earnings per share: Basic $0.02 $0.04
Earnings per share: Diluted $0.02 $0.03
Total assets $124,945 $123,795
</TABLE>
<PAGE>
Form 10-Q Page 8 of 14
PEGASYSTEMS INC.
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Results of Operations
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31, 1997
Revenue
Total revenue for the three months ended March 31, 1998 (the "1998 Three Month
Period") increased 111.8% to $18.0 million from $8.5 million for the three
months ended March 31, 1997 (the "1997 Three Month Period"). The increase was
due to increases in both software license and services revenue.
Software license revenue for the 1998 Three Month Period increased 95.8% to
$11.4 million from $5.8 million for the 1997 Three Month Period. The increase in
software license revenue was primarily attributable to software license
acceptances by new customers, software license agreement renewals, and extended
software usage by existing customers.
Services revenue for the 1998 Three Month Period increased 146.7% to $6.6
million from $2.7 million for the 1997 Three Month Period. The increase in
services revenue was primarily attributable to increased implementation services
for new customers, additional consulting services provided to existing
customers, and to a lesser extent, increased maintenance revenue from a larger
installed product base.
Cost of Revenue
Cost of software license for the 1998 Three Month Period increased 1,360% to
$146,000 from $10,000 for the 1997 Three Month Period. As a percentage of
software license revenue, cost of software license increased from 0.2% for the
1997 Three Month Period to 1.3% for the 1998 Three Month Period. These increases
were due to costs associated with a stock purchase warrant issued by the Company
in June 1997, which cost is being amortized through December 31, 2002.
Cost of services for the 1998 Three Month Period increased 88.8% to $4.1 million
from $2.2 million for the 1997 Three Month Period. This increase was due to cost
associated with increased staffing in the Company's Client Services group
worldwide. Cost of services as a percentage of services revenue decreased from
80.6% for the 1997 Three Month Period to 61.7% for the 1998 Three Month Period.
This improved gross margin was due to more effective use of a larger Consulting
Services staff.
Operating Expenses
Research and development expenses for the 1998 Three Month Period increased
101.5% to $5.2 million from $2.6 million for the 1997 Three Month Period. This
increase was primarily due to costs associated with increased staffing in the
Company's Research and Development group.
<PAGE>
Form 10-Q Page 9 of 14
As a percentage of total revenue, research and development expenses declined
from 30.5% for the 1997 Three Month Period to 29.0% for the 1998 Three Month
Period due to the growth in the Company's total revenue.
Selling and marketing expenses for the 1998 Three Month Period increased 96.3%
to $5.2 million from $2.7 million for the 1997 Three Month Period. As a
percentage of total revenue, selling and marketing expenses decreased from 31.7%
for the 1997 Three Month Period to 29.4% for the 1998 Three Month Period. The
increase in selling and marketing expenses was primarily attributable to the
hiring of additional direct sales and marketing personnel, increased investment
in marketing support activities and materials, additional trade show activities,
preparations for the Company's User Meetings, and the opening of the Company's
Toronto, Canada office. The decrease in selling and marketing expenses as a
percentage of total revenue was due to the growth in the Company's total
revenue.
General and administrative expenses for the 1998 Three Month Period increased
106.4% to $1.3 million from $0.6 million for the 1997 Three Month Period. This
increase was primarily due to increased investment in the infrastructure needed
to support the Company's accelerated growth and increased professional fees.
General and administrative expenses declined as a percentage of total revenue
from 7.1% for the 1997 Three Month Period to 7.0% for the 1998 Three Month
Period due to the growth in the Company's total revenue.
License Interest Income
License interest income which is the portion of all license fees due under
software license agreements which was not recognized upon product acceptance or
license renewal increased 46.8% from $0.4 million for the 1997 Three Month
Period to $0.6 million for the 1998 Three Month Period due to the increase in
the Company's installed customer base.
Provision for Income Taxes
The provision for federal, state and foreign taxes was $0.6 million and $1.2
million for the 1997 Three Month Period and the 1998 Three Month Period,
respectively. The effective tax rate was 38.0% for the 1997 and 1998 Three
Month Periods, respectively.
Liquidity and Capital Resources
Since its inception, the Company had funded its operations primarily through
cash flow from operations and bank borrowings. In July 1996, the Company issued
and sold 2.7 million shares of Common Stock in connection with its initial
public offering. Net proceeds to the Company from this offering were
approximately $29.4 million. In January 1997, the Company issued and sold 1.8
million shares of Common Stock in connection with a second public offering. Net
proceeds to the Company from this second offering were approximately $51.9
million. At March 31, 1998, the
<PAGE>
Form 10-Q Page 10 of 14
Company had cash and cash equivalents of approximately $53.5 million and working
capital of approximately $60.3 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 1998 Three Month Period was
$2.6 million, primarily due to an increase in deferred revenue, accounts payable
and accrued expenses, mainly offset by an increase in accounts receivable and
prepaid expenses and other current assets.
Net cash used by investing activities was $1.1 million during the 1998 Three
Month Period due to the purchase of property and equipment consisting mainly of
computer hardware and software and furniture and fixtures to support the
Company's growing employee base.
Net cash provided by financing activities was $16,000 during the 1998 Three
Month Period due to the exercise of stock options.
The Company's capital commitments consist primarily of operating leases for
office space and equipment. At March 31, 1998, the Company's commitments under
non-cancellable operating leases for office space with terms in excess of one
year totaled $2.6 million, $3.6 million and $3.3 million for 1998, 1999 and
2000, respectively. The Company's total payments under such leases was $0.7
million for the 1998 Three Month Period.
The Company's $5.0 million revolving credit line has a maturity date of June 30,
1999. At March 31, 1998, the Company had no borrowings under such facility. The
Company's credit agreement prohibits the payment of dividends, has profitability
requirements and requires maintenance of specified levels of tangible net worth
and certain financial ratios. The Company intends to renegotiate the term and
the covenant requirements under the existing line of credit with the same bank.
The Company recorded bad debt expense of $150,000 in the 1998 Three Month
Period as a result of indications that certain receivables relating primarily to
consulting and installation services rendered by the Company would not be
collected in full.
The Company believes that the net proceeds from its two recent public offerings
together with cash generated by operations and availability under its bank
credit facility will be sufficient to fund the Company's operations for at least
the next year. However, there can be no assurance that additional capital beyond
the amounts currently forecasted by the Company will not be required or that any
such required additional capital will be available on reasonable terms, if at
all, at such time as required by the Company.
The "Year 2000 Issue" refers to the problems associated with computer programs
having been written using two digits rather than four to define the applicable
year. The Company has performed an assessment of the software it uses internally
and the software it licenses to customers and such assessment has not revealed
any major problems outstanding in this regard. There can be no assurance that
such problems will not develop or be revealed in the future which could
materially and adversely affect the Company"s business, operating results, and
financial condition.
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
<PAGE>
Form 10-Q Page 11 of 14
license and maintenance fees are typically subject to annual increases based on
recognized inflation indexes.
Forward-Looking Statements
Certain statements contained in this Form 10-Q are "forward-looking statements"
as defined in the Private Securities Litigation Reform Act of 1995. These
statements involve various risks and uncertainties which could cause the
Company's actual results to differ from those expressed in such forward-looking
statements. These risks and uncertainties include the seasonal variation of the
Company's operations and fluctuations in the Company's quarterly results, rapid
technological change involving the Company's products, delays in product
development and implementation, the technological compatibility of the Company's
products with its customers' systems, the Company's dependence on customers in
the financial services market, intense competition in the markets for the
Company's products, risk of non-renewal by current customers, management of the
Company's growth, and other risks and uncertainties. Words such as "expects,"
"anticipates," "intends," "plans," "believes," "estimates," and "should" and
similar words and expressions are intended to identify the forward-looking
statements contained in this Form 10-Q. These statements are based on estimates,
projections, beliefs, and assumptions of the Company and its management and are
not guarantees of future performance. Further information regarding those
factors which could cause the Company's actual results to differ materially from
any forward-looking statements contained herein is included in the Company's
filings with the Securities and Exchange Commission.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
None
<PAGE>
Form 10-Q Page 12 of 14
PEGASYSTEMS INC.
Part II - Other Information:
Disclosure concerning certain litigation pending against the Company is
contained in the Company's Form 10-K filed April 15, 1998. There have been no
material developments with respect to such litigation since such date.
In April 1998, a complaint purporting to be a class action was filed with the
United States District Court for the District of Massachusetts alleging that the
Company and several of its officers violated section 10(b) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), Rule 10b-5 promulgated by
the Commission thereunder, and Section 20(a) of the Securities Exchange Act. The
complaint names the Company itself and Alan Trefler, Ira Vishner, Kenneth W.
Olson and Michael R. Pyle, four officers of the Company, as defendants. The
Complaint alleges that the defendants issued false and misleading financial
statements and press releases concerning the Company's publicly reported
earnings. The Complaint seeks certification of a class of persons who purchased
the Company's Common Stock between April 28, 1997 and April 2, 1998, and does
not specify the amount of damages sought. The defendants have not filed any
answers, motions to dismiss or other responsive pleadings in this litigation,
but anticipate filing a motion to dismiss in the near future. The Company
intends to defend this matter vigorously.
Item 2. Changes in Securities
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Stockholders was held on May 6, 1998. The following
matters were voted upon:
(1) Edward A. Maybury and Leonard A. Schlesinger were both re-elected to
serve as Directors of the Company to hold office until the 2001 Annual
Meeting of Stockholders and until their successors are duly elected
and qualified. The following Directors' respective terms of office
continued after the Annual Meeting: Edward B. Roberts, Thomas E.
Swithenbank, Alan Trefler and Ira Vishner. Both Mr. Maybury and Mr.
Schlesinger were elected with 24,796,677 votes for, 0 votes against
and 5,453 votes abstained.
(2) The stockholders ratified the appointment by the Board of Directors of
Arthur Andersen LLP, independent public accountants, to audit the
financial statements of the Company for the fiscal year ending
December 31, 1998, with 24,801,927 votes for, 200 against and none
abstained.
<PAGE>
Form 10-Q Page 13 of 14
Part II - Other Information - Continued:
Item 4. Submission of Matters to a Vote of Security Holders - continued
(3) The stockholders approved the amendment and restatement of the
Company's 1994 Long-Term Incentive Plan increasing the number of
shares reserved for issuance from 5,000,000 to 7,500,000 with
23,129,844 votes for, 1,662,283 against, and 10,000 votes abstained.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule.
(b) Reports on Form 8-K:
None
<PAGE>
Form 10-Q Page 14 of 14
PEGASYSTEMS INC.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Pegasystems Inc.
Date: May 15, 1998 /s/ Ira Vishner
---------------
Ira Vishner
Vice President, Corporate Services,
Treasurer, Chief Financial Officer
and Director
(principal financial officer and
chief accounting officer)
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<EXCHANGE-RATE> 1
<CASH> 53,513
<SECURITIES> 0
<RECEIVABLES> 24,312
<ALLOWANCES> 2,350
<INVENTORY> 0
<CURRENT-ASSETS> 77,508
<PP&E> 24,004
<DEPRECIATION> 6,991
<TOTAL-ASSETS> 135,605
<CURRENT-LIABILITIES> 17,184
<BONDS> 0
0
0
<COMMON> 286
<OTHER-SE> 86,856
<TOTAL-LIABILITY-AND-EQUITY> 135,605
<SALES> 17,967
<TOTAL-REVENUES> 17,967
<CGS> 4,205
<TOTAL-COSTS> 4,205
<OTHER-EXPENSES> 11,747
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 3,193
<INCOME-TAX> 1,213
<INCOME-CONTINUING> 1,980
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,980
<EPS-PRIMARY> $0.07
<EPS-DILUTED> $0.07
</TABLE>
