<PAGE>
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 JUNE 30, 2000
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 29,283,777 shares of the Registrant's common stock, $.01 par value
per share, outstanding on August 10, 2000.
<PAGE>
PEGASYSTEMS INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at June 30, 2000
and December 31, 1999 3
Condensed Consolidated Statements of Operations for the three- and six-
month periods ended June 30, 2000 and June 30, 1999 4
Condensed Consolidated Statements of Cash Flows for the six-
month periods ended June 30, 2000 and June 30, 1999 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 2. Changes in Securities and Use of Proceeds 20
Item 3. Defaults upon Senior Securities 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 21
SIGNATURES 22
</TABLE>
<PAGE>
FORM 10-Q PAGE 3 OF 22
PEGASYSTEMS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE-RELATED AMOUNTS)
<TABLE>
<CAPTION>
JUNE 30, December 31,
2000 1999
-------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 34,065 $ 30,004
Trade and installment accounts receivable, net of
allowance for doubtful accounts of $1,054 in
2000 and $1,026 in 1999 31,449 40,716
Prepaid expenses and other current assets 1,884 1,676
-------- --------
Total current assets 67,398 72,396
Long-term license installments 41,768 36,744
Equipment and improvements, net 7,080 8,335
Purchased software and other assets, net 6,273 7,516
-------- --------
Total assets $122,519 $124,991
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 12,921 $ 13,643
Accrued litigation settlement 17,700 --
Deferred revenue 3,448 8,765
Current portion of capital lease obligations 207 198
-------- --------
Total current liabilities 34,276 22,606
Commitments and contingencies (Note F)
Deferred income taxes 1,000 1,000
Capital lease obligations, net of current portion 147 253
Other long-term liabilities 69 87
-------- --------
Total liabilities 35,492 23,946
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; 29,252,677 shares and 28,995,821 shares issued
and outstanding in 2000 and 1999, respectively 293 290
Additional paid-in capital 90,063 88,941
Deferred compensation (9) (18)
Stock warrant 2,897 2,897
(Accumulated deficit) retained earnings (5,997) 9,079
Accumulated other comprehensive income (220) (144)
-------- --------
Total stockholders' equity 87,027 101,045
-------- --------
Total liabilities and stockholders' equity $122,519 $124,991
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
<PAGE>
FORM 10-Q PAGE 4 OF 22
PEGASYSTEMS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2000 1999 2000 1999
------- ------- -------- --------
<S> <C> <C> <C> <C>
REVENUE:
Software license $ 9,168 $ 9,125 $ 15,264 $ 15,145
Services 12,112 12,222 24,022 21,267
--------- ------- --------- --------
Total revenue 21,280 21,347 39,286 36,412
--------- ------- --------- --------
COST OF REVENUE:
Cost of software license 586 586 1,171 1,171
Cost of services 8,356 7,842 16,937 16,640
--------- ------- --------- --------
Total cost of revenue 8,942 8,428 18,108 17,811
--------- ------- --------- --------
GROSS PROFIT 12,338 12,919 21,178 18,601
OPERATING EXPENSES:
Research and development 3,933 5,026 7,868 10,230
Selling and marketing 6,559 5,395 11,596 10,919
General and administrative 2,608 2,696 5,205 5,264
Litigation settlement 14,088 -- 14,088 --
--------- ------- --------- --------
Total operating expenses 27,188 13,117 38,757 26,413
--------- ------- --------- --------
LOSS FROM OPERATIONS (14,850) (198) (17,579) (7,812)
Installment receivable interest income 900 837 1,843 1,665
Other interest income, net 485 162 888 327
Other (expense) income, net (206) 224 (178) 135
--------- ------- --------- --------
(LOSS) INCOME BEFORE PROVISION FOR (13,671) 1,025 (15,026) (5,685)
INCOME TAXES
Provision for income taxes 28 -- 50 --
--------- ------- --------- --------
NET (LOSS) INCOME ($13,699) $ 1,025 ($15,076) ($5,685)
========= ======= ========= ========
(LOSS) EARNINGS PER SHARE:
Basic ($0.47) $ 0.04 ($0.52) ($0.20)
======= ======= ======== ========
Diluted ($0.47) $ 0.03 ($0.52) ($0.20)
======= ======= ======== ========
WEIGHTED AVERAGE NUMBER OF COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING:
Basic 29,152 28,752 29,144 28,732
======= ======= ======== ========
Diluted 29,152 30,291 29,144 28,732
======= ======= ======== ========
</TABLE>
See notes to condensed consolidated financial statements.
<PAGE>
FORM 10-Q PAGE 5 OF 22
PEGASYSTEMS INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
2000 1999
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ($15,076) ($5,685)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 3,217 3,378
Provision for doubtful accounts 190 1,429
Issuance of compensatory stock option -- 21
Changes in operating assets and liabilities:
Trade and installment accounts receivable 4,053 13,388
Prepaid expenses and other current assets (208) 709
Other long term assets 73 (207)
Accounts payable and accrued expenses (722) 642
Accrued litigation settlement 17,700 --
Deferred revenue (5,317) (7,259)
Other long term liabilities (18) --
-------- --------
Net cash provided by operating activities 3,892 6,416
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment and improvements (783) (1,340)
-------- --------
Net cash used in investing activities (783) (1,340)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of capital lease obligation (97) (50)
Exercise of stock options 725 329
Sale of stock under employee stock purchase plan 400 --
-------- --------
Net cash provided by financing activities 1,028 279
-------- --------
Effect of exchange rate on cash and cash equivalents (76) 264
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS 4,061 5,619
-------- --------
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 30,004 24,806
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 34,065 $ 30,425
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
<PAGE>
FORM 10-Q PAGE 6 OF 22
PEGASYSTEMS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Pegasystems Inc. (the "Company") presented herein have been prepared in
accordance with the Securities and Exchange Commission's ("SEC") rules and
regulations regarding interim financial reporting. In the opinion of
management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the three- and six-month periods ended June 30, 2000 are not
necessarily indicative of the results that may be expected for the full year
ending December 31, 2000. The Company suggests that these condensed
consolidated financial statements be read in conjunction with the
consolidated financial statements and notes thereto for the year ended
December 31, 1999, included in the Company's 1999 Annual Report on Form
10-K/A filed with the Securities and Exchange Commission.
NOTE B - REVENUE RECOGNITION
The Company's revenue is derived from two sources: software license fees and
services fees. Software license fees are generally payable on a monthly basis
under license agreements, which generally have a five-year term and may be
renewed for additional years at the customer's option. The present value of
future license payments is generally recognized as revenue upon customer
acceptance. A portion of the fee from each arrangement is deferred and
recognized as interest income over the license term. In the case of software
license agreement renewals, license fee revenue is recognized upon the
commencement of the new license term.
The Company's services revenue is comprised of fees for maintenance,
implementation, training and consulting services. Software license customers are
offered the option to enter into an annual maintenance contract requiring the
customer to pay a monthly maintenance fee renewable on a year-to-year basis.
Prepaid maintenance fees are deferred based on their estimated fair value and
are recognized ratably over the term of the maintenance agreement. The Company's
software implementation agreements typically require the Company to provide a
specified level of implementation services for a specified fee, typically with
additional implementation services available at an hourly rate. Implementation
fees for time and material projects are recognized as incurred. Implementation
fees for fixed price projects are recognized once the fair value of services and
any other elements to be delivered under the arrangement can be determined.
Costs associated with fixed price contracts are expensed as incurred. Prior to
the point at which the fair value of the elements of a contract can be
determined, revenue recognition is limited to amounts equal to costs incurred
during the reporting period, resulting in no gross profit. Once the fair values
of the elements of a contract are apparent, profit associated with the services
elements will begin to be recognized. Training and consulting fees are generally
recognized as the services are provided.
The Company has adopted the provisions of the American Institute of Certified
Public Accountants Statement of Position 98-9, "Modification of SOP 97-2,
Software Revenue Recognition, With Respect to Certain Transactions." While such
adoption did not have a material impact on the financial statements of the
Company included in this report on Form 10-Q, it may in the future cause a
greater portion of contract revenue to be classified as services revenue rather
than license revenue.
<PAGE>
FORM 10-Q PAGE 7 OF 22
NOTE C - EARNINGS (LOSS) PER SHARE
<TABLE>
<CAPTION>
(in thousands, except per share data) Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
------- ------- -------- --------
<S> <C> <C> <C> <C>
Basic
Net (loss) income ($13,699) $ 1,025 ($15,076) ($5,685)
========= ======= ======== ========
Weighted average common shares outstanding 29,152 28,752 29,144 28,732
========= ======= ======== ========
Basic (loss) earnings per share ($ 0.47) $ 0.04 ($0.52) ($0.20)
========= ======= ======== ========
Diluted
Net (loss) income ($13,699) $ 1,025 ($15,076) ($5,685)
========= ======= ======== ========
Weighted average common shares outstanding 29,152 28,752 29,144 28,732
Effect of:
Assumed exercise of stock options -- 1,539 -- --
--------- ------- -------- --------
Weighted average common shares outstanding,
Assuming dilution 29,152 30,291 29,144 28,732
========= ======= ======== ========
Diluted (loss) earnings per share ($ 0.47) $ 0.03 ($0.52) ($0.20)
========= ======= ======== ========
</TABLE>
Basic earnings (loss) per share is computed based on the weighted average number
of common shares outstanding during the period. Diluted earnings (loss) per
share includes, to the extent inclusion of such shares would be dilutive to
earnings per share, the effect of outstanding options and warrants, computed
using the treasury stock method. For the three-month periods ended June 30, 2000
and 1999, 4,682,995 and 3,778,686 potential shares, respectively, have been
excluded from the calculation, as such effect would be anti-dilutive. For the
six-month periods ended June 30, 2000 and 1999, 4,992,457 and 4,141,343
potential shares, respectively, have been excluded from the calculation, as
their effect would be anti-dilutive.
NOTE D - COMPREHENSIVE INCOME (LOSS)
The components of the Company's comprehensive (loss) income are as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30
(IN THOUSANDS) 2000 1999 2000 1999
-------------- ------ ------ -------- --------
<S> <C> <C> <C> <C>
Net (loss) income ($13,699) $1,025 ($15,076) ($5,685)
--------- ------ --------- --------
Other comprehensive income -
foreign currency translation
adjustments, net of income
taxes (59) 200 (76) 264
--------- ------ --------- --------
Comprehensive (loss) income ($13,758) $1,225 ($15,152) ($5,421)
========= ====== ========= ========
</TABLE>
<PAGE>
FORM 10-Q PAGE 8 OF 22
NOTE E - NEW ACCOUNTING STANDARDS
On January 1, 2001, the Company will be adopting Statement of Financial Account
Standards No. 133 "Accounting for Derivative Instruments and Hedging
Activities." The Company does not believe adoption will have a material impact
on the Company's financial position, operations or cash flows.
The Securities and Exchange Commission has released Staff Accounting Bulletin
No. 101, "Revenue Recognition in Financial Statements," which sets forth its
views regarding how revenue should be recognized in financial statements. The
Company's revenue recognition practices are in conformity with accounting
standards generally accepted in the United States of America, and the Company
does not expect that this bulletin will have an effect on financial position
or results of operation.
NOTE F - COMMITMENTS AND CONTINGENCIES
LITIGATION SETTLEMENT
Class Action Litigation
The Company has been involved in two lawsuits involving litigation related to
restatements of its financial statements (the Chalverus Case and the Gelfer
Case). As described below, the Company has reached settlements-in-principle
with the plaintiffs in both cases and has recorded a charge of $14.1 million
(net of insurance reimbursements of $4.3 million) against operations in the
quarter ended June 30, 2000, reflecting the estimated cost of the settlements
and remaining legal costs.
Chalverus Case
As a result of complaints filed in 1997 and 1998 in the United States
District Court of Massachusetts, which were subsequently consolidated into a
single complaint (the "Amended Complaint" or the "Chalverus Case"), the
Company has been engaged in litigating matters related to a restatement of
its financial statements in 1997. The Amended Complaint alleged that the
Company and two officers caused the Company to issue false and misleading
financial statements for the fiscal quarter ended June 30, 1997 by
inappropriately including $5 million in revenue from a series of contracts
with First Data Resources, Inc. The Amended Complaint alleged that as a
result of the inclusion of such revenue in the Company's financial statements
for that quarter, the market price of the Company's common stock was
artificially inflated, causing damage to purchasers of the Company's common
stock.
The parties have agreed in writing to a settlement-in-principle of the
litigation, pursuant to which the Company will pay $5.25 million in shares of
its common stock or in cash, at the Company's option, for the benefit of a
stipulated class defined to include all purchasers of the Company's common
stock between July 29, 1997 and October 29, 1997, inclusive, and the action
will be dismissed with prejudice. The parties' settlement is subject to the
negotiation and execution of a definitive Stipulation of Settlement, which
will be subject to notice to class members and the further approval by the
United States District Court of Massachusetts (the "Court".).
Gelfer Case
In December 1998, a complaint also purporting to be a class action was filed
with the Court after the Company's announcement on November 23, 1998 that it
may be recording revenue adjustments to prior periods. In April 1999, the
plaintiffs filed their First Amended Class Action Complaint (the "Gelfer
Complaint") in that action following the January 20, 1999 restatement. The
Gelfer Complaint involves the Company and two officers and alleges violations
of the Exchange Act. The Complaint was filed on behalf of a purported class
of persons who purchased the Company's common stock between April 2, 1998
through November 23, 1998.
The parties have agreed in writing to a settlement-in-principle of this
litigation, pursuant to which the Company will pay a total of $12.25 million,
of which at least $4.5 million is a cash payment and the remaining
$7.75 million is a payment in shares of its common stock or in cash, at the
Company's option. The Settlement is for the benefit of stipulated class
defined to include all purchasers of the Company's common stock between
April 2, 1998 and November 23, 1998, inclusive, and the action will be
dismissed with prejudice. The parties' settlement is subject to the negotiation
and execution of a definitive Stipulation of Settlement, which will be subject
to notice to class members and further approval by the Court.
<PAGE>
FORM 10-Q PAGE 9 OF 22
Ernst & Young Case On June 9, 2000, the Company and two of its officers filed
a complaint against Ernst & Young, LLP and Alan B. Levine (a former partner
of Ernst & Young) in Massachusetts state court. The complaint alleges that
the defendants committed professional malpractice, breached contractual and
fiduciary duties owed to the Company, and issued false and misleading public
statements, in connection with accounting advice that Ernst & Young rendered
to the Company regarding the revenues in question in the Chalverus case
discussed above. The Company seeks compensatory damages, including
contribution, for losses and other costs incurred in connection with the
Chalverus litigation. The defendants have not yet served their response to
the complaint.
FORMAL ORDER OF PRIVATE INVESTIGATION
In May 1999, the Boston office of the SEC issued a Formal Order of Private
Investigation of the Company and unidentified individuals, currently or formerly
associated with the Company, concerning past accounting matters, financial
reports, and other public disclosures and trading activity in the Company's
securities during 1997 and 1998. The Company is cooperating fully with such
investigation.
<PAGE>
FORM 10-Q PAGE 10 OF 22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Company's business has historically experienced a lack of predictable
revenues. The timing of revenue recognition is related to the completion of
implementation services and acceptance of the licensed software by the customer,
the timing of which has proven to be difficult to predict accurately.
In 1999, there was a reduction in the size of the Company's sales force of
almost 50%. Given the intense competition for qualified sales personnel and the
significant amount of time required to train new sales personnel, this reduction
may adversely affect the Company's ability to meet its future sales goals. In
addition, because of the reduced size of the Company's sales force, the Company
is more focused on closing larger but fewer license transactions than in the
past. This may increase the volatility in the Company's quarterly operating
results.
The Company's independent public accountants have identified in connection with
their audits of the Company's 1997, 1998, and 1999 financial statements material
weaknesses in the Company's internal control environment. See Note 1 to the
Consolidated Financial Statements included in the Company's 1999 Annual Report
on Form 10-K/A.
RESULTS OF OPERATIONS
As of January 1, 1999, the Company refined its method of classifying costs and
expenses by directly charging costs to their appropriate functional
classification.
During the third quarter of 1999, the Company further refined its methodology of
classifying costs and expenses. Results for the first six months of 1999 have
been reclassified to conform with the current methodology.
THREE AND SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO THREE AND SIX MONTHS ENDED
JUNE 30, 1999
REVENUE
Total revenue for the three-month periods ended June 30, 2000 (the "2000 Three
Month Period") and June 30, 1999 (the "1999 Three Month Period") remained
constant at $21.3 million. Total revenue for the six-month period ended June 30,
2000 (the "2000 Six Month Period") increased 7.9% to $39.3 million from $36.4
million for the six-month period ended June 30, 1999 (the "1999 Six Month
Period"). The increase was due primarily to the recognition of service revenue
during the three months ended March 31, 2000 that had previously been deferred
and a slight increase in software license revenue.
Software license revenue for the 2000 Three Month Period increased 0.5% to $9.2
million from $9.1 million for the 1999 Three Month Period. Software license
revenue for the 2000 Six Month Period increased 0.8% to $15.3 million from $15.1
million for the 1999 Six Month Period. The increases were due primarily to an
increased number of software license acceptances by new and existing customers
partially offset by the allocation of a portion of license revenue to services
revenue as required by SOP 97-2.
Services revenue for the 2000 Three Month Period decreased 0.9% to $12.1 million
from $12.2 million for the 1999 Three Month Period. The decrease was due
primarily to the reduction of revenue recognized from previously deferred
projects, offset by the additional allocation of software license revenue to
services revenue as required by SOP 97-2. Services revenue for the 2000 Six
Month Period increased 13.0% to $24.0 million from $21.3 million for the 1999
Six Month Period. The increase in service revenue for the 2000 Six Month Period
was primarily attributable to the completion of projects during the three months
ended March 31, 2000 which had been previously deferred and the allocation of
software license revenue to services revenue as required by SOP 97-2.
<PAGE>
FORM 10-Q PAGE 11 OF 22
COST OF REVENUE
Cost of software license revenue for the 2000 Three and Six Month Periods and
the 1999 Three and Six Month Periods remained constant at $0.6 million and $1.2
million, respectively. Cost of software license relates to the amortization
associated with a stock purchase warrant issued by the Company in June 1997, and
the Company's acquisition of First Data Resources Corporation's ESP software
product. These costs are being amortized through December 31, 2002. Cost of
software license as a percentage of license revenue for the 2000 Three Month
Period and the 1999 Three Month Period remained constant at 6.4%. Cost of
software license as a percentage of license revenue for the 2000 Six Month
Period and the 1999 Six Month Period remained constant at 7.7%.
Cost of services consists primarily of the costs of providing implementation,
consulting, maintenance, and training services. Cost of services for the 2000
Three Month Period increased 6.6% to $8.4 million from $7.8 million for the 1999
Three Month Period. Cost of services for the 2000 Six Month Period increased
1.8% to $16.9 million from $16.6 million for the 1999 Six Month Period. Cost of
services as a percentage of services revenue increased to 69.0% for the 2000
Three Month Period from 64.2% for the 1999 Three Month Period. These increases
were primarily due to a lower recovery rate on hours worked, partially offset by
a reduction in travel related costs and equipment. Cost of services as a
percentage of services revenue decreased to 70.5% for the 2000 Six Month Period
from 78.2% for the 1999 Six Month Period. This decrease was primarily due to the
recognition of service revenue that had been previously deferred. The costs
associated with the deferred revenue were recognized in prior periods.
OPERATING EXPENSES
Research and development expenses for the 2000 Three Month Period decreased
21.7% to $3.9 million from $5.0 million for the 1999 Three Month Period.
Research and development expenses for the 2000 Six Month Period decreased
23.1% to $7.9 million from $10.2 million for the 1999 Six Month Period. As a
percentage of total revenue, research and development expenses decreased to
18.5% for the 2000 Three Month Period from 23.5% for the 1999 Three Month
Period. As a percentage of total revenue, research and development expenses
decreased to 20.0% for the 2000 Six Month Period from 28.1% for the 1999 Six
Month Period. These decreases were due to costs associated with decreased
staffing, such as compensation, facilities, and equipment-related costs.
These cost reductions are not indicative of management's commitment to
research and development projects. Management believes that the current level
of staffing will enable the Company to successfully innovate.
Selling and marketing expenses for the 2000 Three Month Period increased
21.6% to $6.6 million from $5.4 million for the 1999 Three Month Period.
Selling and marketing expenses for the 2000 Six Month Period increased 6.2%
to $11.6 million from $10.9 million for the 1999 Six Month Period. As a
percentage of total revenue, selling and marketing expenses increased to
30.8% for the 2000 Three Month Period from 25.3% for the 1999 Three Month
Period. These increases were due to an increase in marketing programs such as
trade shows and additional employee related costs, such as employee
compensation, partially offset by a reduction in travel related expenses. As
a percentage of total revenue, selling and marketing expenses decreased to
29.5% for the 2000 Six Month Period from 30.0% for the 1999 Six Month Period.
This decrease was primarily due to the recognition of revenue that had been
previously deferred.
General and administrative expenses for the 2000 Three Month Period decreased
3.3% to $2.6 million from $2.7 million for the 1999 Three Month Period.
General and administrative expenses for the 2000 Six Month Period decreased
1.1% to $5.2 million from $5.3 million for the 1999 Six Month Period. As a
percentage of total revenue, general and administrative expenses decreased to
12.3% for the 2000 Three Month Period from 12.6% for the 1999 Three Month
Period. These decreases were due to a lower level of bad debt costs and legal
fees, partially offset by increased staffing related expenses such as
<PAGE>
FORM 10-Q PAGE 12 OF 22
compensation and equipment related costs and additional fees relating to
professional services. As a percentage of total revenue, general and
administrative expenses decreased to 13.2% for the 2000 Six Month Period from
14.5% for the 1999 Six Month Period. This decrease was primarily due to the
recognition of service revenue that had been previously deferred.
LITIGATION SETTLEMENT
The Company has been involved in two lawsuits involving litigation related to
restatements of its financial statements (the Chalverus Case and the Gelfer
Case). As stated in Note F to the condensed consolidated financial
statements, the Company has reached settlements-in-principle with the
plaintiffs in both cases and has recorded a charge of $14.1 million (net of
insurance reimbursements of $4.3 million) against operations in the quarter
ended June 30, 2000, reflecting the estimated cost of the settlements and the
remaining legal costs. See Note F.
INSTALLMENT RECEIVABLE INTEREST INCOME
Installment receivable interest income, which consists of the portion of all
license fees under long-term software license agreements that is attributable to
the time value of money, increased 7.5% to $0.9 million for the 2000 Three Month
Period from $0.8 million for the 1999 Three Month Period. Installment receivable
interest income increased 10.7% to $1.8 million for the 2000 Six Month Period
from $1.7 million for the 1999 Six Month Period. These changes were primarily
due to the increase in the Company's installed customer base.
INTEREST INCOME, NET
Interest income, net, increased 199.4% to $0.5 million for the 2000 Three Month
Period from $0.2 million for the 1999 Three Month Period. Interest income, net
increased 171.6% to $0.9 million for the 2000 Six Month Period from $0.3 million
for the 2000 Six Month Period. The increase was due primarily to additional
interest income generated on cash and cash equivalents.
OTHER INCOME (EXPENSE), NET
Other income (expense), net, which consists primarily of reseller development
funds received from third-party resellers of computer hardware products and mark
to market gains or losses on foreign denominated accounts receivable, decreased
192.0% to $0.2 million of net expenses for the 2000 Three Month Period from $0.2
million of net income for the 1999 Three Month Period. Other income, net,
decreased 231.9% to $0.2 million net expenses for the 2000 Six Month Period from
$0.1 million net income for the 1999 Six Month Period. The decrease was due
primarily to a larger mark to market loss for foreign denominated accounts
receivable.
PROVISION FOR INCOME TAXES
The tax provision for the 2000 Three and Six Month Periods consisted of foreign
taxes in the amount of $28,000 and $50,000, respectively. There was no tax
provision for the 1999 Three and Six Month Periods. No benefit was recorded for
domestic losses incurred due to uncertainty regarding eventual utilization of
these losses.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has funded its operations primarily through
cash flow from operations, bank borrowings, and proceeds from the Company's
public stock offerings.
At June 30, 2000, the Company has cash and cash equivalents of approximately
$34.1 million and working capital of approximately $33.1 million. The Company's
approach of charging license fees payable in installments over the term of its
license has historically deferred the receipt of cash and limits the
availability of working capital in the short term while having a stabilizing
effect on cash and working capital for the longer term.
Net cash provided by operating activities for the 2000 Six Month Period was
$3.9 million, as compared to $6.4 million of net cash provided by the 1999
Six Month Period. This change was primarily due to the decrease in accounts
receivable, the decrease in accounts payable and accrued expenses, and a
decrease in bad debt expense, and a decrease in deferred revenue, partially
offset by the insurance settlement received (see Note F to condensed
consolidated financial statements) and the operating loss, net of non-cash
items.
<PAGE>
FORM 10-Q PAGE 13 OF 22
Net cash used in investing activities was approximately $0.8 million during the
2000 Six Month Period, as compared to $1.3 million for the 1999 Six Month
Period. This change was primarily due to fewer purchases of property and
equipment, consisting mainly of computer hardware and software, and furniture
and fixtures.
Net cash provided by financing activities was $1.0 million during the 2000 Six
Month Period, as compared, to $0.3 million used in the 1999 Six Month Period.
The increase in cash provided was due to additional stock option exercises and
the sale of stock under the Employee Stock Purchase Plan.
The Company believes that current cash and cash equivalents will be
sufficient to fund the Company's operations for the near term and the
settlement of the Chalverus Case and the Gelfer Case. There can be no
assurance that additional capital which may be required to support further
revenue growth 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.
EFFECT OF "YEAR 2000" ISSUES
As of the date of this filing, the Company has not incurred any significant
business disruptions nor has the Company encountered any significant issues with
respect to our software products as a result of year 2000 issues. However, while
no such significant occurrence has developed, year 2000 issues that may arise
related to key suppliers and service providers may not become apparent
immediately. The Company has received assurances from key suppliers and service
providers such as financial institutions, the Company's payroll service
provider, and the Company's retirement plan administrator as to their year 2000
readiness. The Company can provide no assurance that we will not be adversely
affected by these suppliers and service providers due to noncompliance in the
future. The Company has funded our Year 2000 costs from operating cash flows and
has not separately accounted for these costs. These costs have not been
material.
ADOPTION OF THE EURO
A new currency, "EURO", was introduced in certain Economic and Monetary Union
("EMU") countries. It is expected that by 2002 (at the latest) all participating
EMU countries will use the EURO as their single currency. As a result, software
used by many companies headquartered or maintaining a subsidiary in a
participating EMU country is expected to be EURO-enabled. In less than two
years, all companies headquartered or maintaining a subsidiary in an EMU country
will need to be EURO-enabled. These changes will change budgetary, accounting
and fiscal systems in companies and public administration, and require the
simultaneous handling of parallel currencies and conversion of legacy data.
These requirements (and the fact that the final rules and regulations are not
yet available) may curb market demand for the Company's products because the
budgets and priorities of our customers and prospective customers may change.
The Company is monitoring the rules and regulations as they become known in
order to make any changes to its software products that the Company deems
necessary to comply with such rules and regulations. Although the Company
believes that its most recent products address these requirements, there can be
no assurance that, once the final rules and regulations are completed, the
Company's software will contain all of the necessary changes or meet all of the
EURO requirements. Any inability to comply with the EURO requirements could have
an adverse effect on 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, and the Company does not expect it to have a significant impact in the
future. The Company's license and maintenance fees are typically subject to
annual increases based on recognized inflation indexes.
<PAGE>
FORM 10-Q PAGE 14 OF 22
FORWARD-LOOKING STATEMENTS
This report on Form 10-Q contains certain forward-looking statements. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
generality of the foregoing, the words "believes", "anticipates", "plans"
"expects", and similar expressions are intended to identify forward-looking
statements. There are a number of important factors that could cause the
Company's actual results to differ materially from those indicated by
forward-looking statements made in this report and presented elsewhere by
management from time to time. Some of the important risks and uncertainties that
may cause the Company's operating results to differ materially and adversely are
discussed below.
THE COMPANY IS PRESENTLY A DEFENDANT IN TWO PRIVATE SECURITIES LITIGATION
MATTERS. The Company has entered into a settlement-in-principle with the
plaintiffs' in each of these cases with respect to proposed settlements, the
financial impact of which are reflected in the Company's financial statements
contained in this report on Form 10-Q. The proposed settlements are
contingent, however, on the negotiation and execution of the
stipulation-of-settlement and final court approval. The failure to settle
either of these cases on the proposed terms could result in the Company being
required to pay substantial damages or higher settlement costs, incurring
substantial defense costs and suffering diversion of management time and
attention, any of which could have a material adverse effect on the Company's
financial position or results of operation.
THE COMPANY IS BEING INVESTIGATED BY THE SECURITIES AND EXCHANGE COMMISSION. In
May of 1999, the Boston office of the SEC issued a Formal Order of Private
Investigation of the Company and, as a result, the Company and certain
individuals, currently or formerly associated with the Company, are presently
being investigated by the SEC concerning past accounting matters, financial
reports and other public disclosures and trading activity in the Company's
securities during 1997 and 1998. Such investigation may result in the SEC
imposing fines on the Company or taking other measures that may have a material
adverse impact on the Company's financial position or results of operations. In
addition, regardless of the outcome of the investigation, it is likely that the
Company will incur substantial defense costs and that such investigation will
cause a diversion of management time and attention. Finally, the negative
publicity resulting from the investigation has made and may continue to make it
more difficult for the Company to close sales, which in turn could have a
material adverse impact on the Company's financial position or results of
operations.
THE COMPANY CONTINUED TO HAVE MATERIAL WEAKNESSES IN ITS FINANCIAL CONTROL
ENVIRONMENT. The Company's independent public accountants have identified in
connection with their audits of the Company's 1997, 1998, and 1999 financial
statements material weaknesses in the Company's internal control environment. In
connection with the completion of the 1999 audit, they informed the Company that
their management letter would include a recommendation to, among other things,
strengthen the resources of the Company's finance organization to improve
financial accounting and internal controls. Although the Company is actively
seeking to hire additional qualified personnel into such organization, these
efforts have proved to be difficult and there can be no assurance that the
Company will be successful in these efforts in the near term. The inability to
hire such personnel could have a material adverse impact on the Company's
reputation and on its financial condition and results of operations.
THE COMPANY'S STOCK PRICE HAS BEEN VOLATILE. Quarterly results have and are
likely to fluctuate significantly. The market price of Pegasystems' common stock
has been and may continue to be highly volatile. Factors that are difficult to
predict, such as quarterly revenues and operating results, statements and
ratings by financial analysts, overall market performance and the outcome of
litigation, will have a significant effect on the price for shares of
Pegasystems' common stock. Revenues and operating results have varied
considerably in the past from period to period and are likely to vary
considerably in the future. The Company plans product development and other
expenses based on anticipated future revenue. If revenue falls below
expectations, financial performance is likely to be adversely affected because
only a small portion of
<PAGE>
FORM 10-Q PAGE 15 OF 22
expenses vary with revenue. As a result, period-to-period comparisons of
operating results are not necessarily meaningful and should not be relied upon
to predict future performance.
THE TIMING OF LICENSE REVENUES IS RELATED TO THE COMPLETION OF IMPLEMENTATION
SERVICES AND PRODUCT ACCEPTANCE BY THE CUSTOMER, THE TIMING OF WHICH HAS BEEN
DIFFICULT TO PREDICT ACCURATELY. There can be no assurance that Pegasystems will
be profitable on an annual or quarterly basis or that earnings or revenues will
meet analysts' expectations. Fluctuations may be particularly pronounced because
a significant portion of revenues in any quarter is attributable to product
acceptance or license renewal by a relatively small number of customers.
Fluctuations also reflect a 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 payment due during the term. Customers generally do
not accept products until the end of a lengthy sales cycle and an implementation
period, typically ranging from one to six months but in some cases significantly
longer. Risks over which the Company has little or no control, including
customers' budgets, staffing allocation, and internal authorization reviews, can
significantly affect the sales and acceptance cycles. Changes dictated by
customers may delay product implementation and revenue recognition. The
Company's business and financial and operating results have experienced and may
continue to experience significant seasonality.
THE COMPANY WILL NEED TO DEVELOP NEW PRODUCTS, EVOLVE EXISTING ONES, AND ADAPT
TO TECHNOLOGICAL CHANGE. Technological developments, customer requirements,
programming languages and industry standards change frequently in the Company's
markets. As a result, success in current markets and new markets will depend
upon the Company's ability to enhance current products, to develop and introduce
new products that meet customer needs, keep pace with technological changes,
respond to competitive products, and achieve market acceptance. Product
development requires substantial investments for research, refinement and
testing. There can be no assurance that the Company will have sufficient
resources to make necessary product development investments. Pegasystems may
experience difficulties that will delay or prevent the successful development,
introduction or implementation of new or enhanced products. Inability to
introduce or implement new or enhanced products in a timely manner would
adversely affect future financial performance. The Company's products are
complex and may contain errors. Errors in products will require the Company to
ship corrected products to customers. Errors in products could cause the loss of
or delay in market acceptance or sales and revenue, the diversion of development
resources, injury to the Company's reputation, or increased service and warranty
costs which would have an adverse effect on financial performance.
THE COMPANY HAS HISTORICALLY SOLD TO THE FINANCIAL SERVICES MARKET. This market
is consolidating rapidly, and faces uncertainty due to many other factors. The
Company has historically derived a significant portion of its revenue from
customers in the financial services market, and its future growth depends, in
part, upon increased sales to this market. Competitive pressures, industry
consolidation, decreasing operating margins within this industry, currency
fluctuations, geographic expansion and deregulation affect the financial
condition of the Company's customers and their willingness to pay. In addition,
customers' purchasing patterns are somewhat discretionary. As a result, some or
all of the factors listed above may adversely affect the demand by customers.
The financial services market is undergoing intense domestic and international
consolidation. In recent years, several customers have been merged or
consolidated. Future mergers or consolidations may cause a decline in revenues
and adversely affect the Company's future financial performance.
THE COMPANY'S GROWTH STRATEGY REQUIRES EXPANSION INTO NEW VERTICAL MARKETS. The
results of this strategy are uncertain. A critical part of the Company's growth
strategy is to continue selling products to markets other than financial
services, such as insurance, telecommunications, and health care. The Company
will need to hire additional personnel with expertise in these other markets and
otherwise invest in people and technologies to facilitate this expansion.
Deterioration in economic or market
<PAGE>
FORM 10-Q PAGE 16 OF 22
conditions generally may also adversely affect the demand by customers in these
other markets. There can be no assurance that the Company will be successful in
selling products to these other markets or in continuing to attract and retain
personnel with the necessary industry expertise. Inability to effectively
penetrate these other markets could have an adverse effect on future financial
performance.
IF EXISTING CUSTOMERS DO NOT RENEW THEIR LICENSES, THE COMPANY'S FINANCIAL
RESULTS MAY SUFFER. A significant portion of total revenue has been attributable
to license renewals. While historically a significant number of customers have
renewed their licenses, there can be no assurance that a significant number of
customers will continue to renew expiring licenses. A decrease in license
renewals absent offsetting revenue from other sources would have a material
adverse effect on future financial performance. In addition, possible transition
to a prepaid extended term license may have a material adverse impact on the
amount of license renewal revenues in future periods.
THE COMPANY DEPENDS ON CERTAIN KEY PERSONNEL AND MUST BE ABLE TO ATTRACT AND
RETAIN QUALIFIED PERSONNEL IN THE FUTURE. The business is dependent on a number
of key, highly skilled technical, managerial, consulting, sales and marketing
personnel, including Mr. Trefler, the Company's Chief Executive Officer. The
loss of key personnel could adversely affect financial performance. The Company
does not have any significant key-man life insurance on any officers or
employees and does not plan to put any in place. The Company's success will
depend in large part on the ability to hire and retain qualified personnel. The
number of potential employees who have the extensive knowledge of computer
hardware and operating systems needed to develop, sell and maintain its products
is limited, and competition for their services is intense and there can be no
assurance that the Company will be able to attract and retain such personnel. If
the Company is unable to do so, the Company's business, operating results, and
financial condition could be materially adversely affected.
THE MARKET FOR THE COMPANY'S OFFERINGS IS INCREASINGLY AND INTENSELY
COMPETITIVE, RAPIDLY CHANGING, AND HIGHLY FRAGMENTED. The market for customer
relationship management software and related consulting and training services is
intensely competitive and highly fragmented. The Company currently encounters
significant competition from internal information systems departments of
potential or existing customers that develop custom software. It also competes
with companies that target the customer interaction and workflow markets and
professional services organizations that develop custom software in conjunction
with rendering consulting services. Competition for market share and pressure to
reduce prices and make sales concessions are likely to increase. Many
competitors have far greater resources 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. Competitors may
also be able to devote greater managerial and financial resources to develop,
promote and distribute products and provide related consulting and training
services. 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 adversely affect its
business, operating results, and financial condition.
THE COMPANY MUST MANAGE INCREASED BUSINESS COMPLEXITY AND GROWTH EFFECTIVELY.
The business has grown in size, geographic scope and complexity and product
offerings and the customer base have expanded. This growth and expansion have
placed, and are expected to continue to place, a significant strain on
management, operations and capital needs. Continued growth will require the
Company to hire, train and retrain many employees in the United States and
abroad, particularly additional sales and financial personnel. The Company will
also need to enhance its financial and managerial controls and reporting
systems. There can be no assurance that the Company will attract and retain the
personnel necessary to meet its business challenges. Failure to manage growth
effectively may adversely affect future financial performance.
THE COMPANY SUFFERED RECENT ATTRITION IN ITS SALES FORCE. In 1999, there was a
reduction in the size of the Company's sales force of almost 50%. Given the
intense competition for qualified
<PAGE>
FORM 10-Q PAGE 17 OF 22
sales personnel and significant amount of time required to train new sales
personnel, this reduction may adversely affect the Company's ability to meet its
future sales goals. In addition, because of the reduced size of the Company's
sales force, the Company is more focused on closing larger but fewer license
transactions than in the past. This may increase the volatility in the Company's
quarterly operating results.
THE COMPANY RELIES ON CERTAIN THIRD PARTY RELATIONSHIPS. The Company has a
number of relationships with third parties that are significant to sales,
marketing and support activities and product development efforts. The Company
relies on relational database management system applications and development
tool vendors, software and hardware vendors, and consultants to provide
marketing and sales opportunities for the direct sales force and to strengthen
the Company's products through the use of industry-standard tools and utilities.
The Company also has relationships with third parties that distribute its
products. In particular, the Company relies on its relationship with First Data
Corporation for the distribution of products to the credit card and mutual fund
markets. There can be no assurance that these companies, most of which have
significantly greater financial and marketing resources, will not develop or
market products that compete with those of the Company in the future or will not
otherwise end their relationships with or support of the Company.
THE COMPANY MAY FACE PRODUCT LIABILITY AND WARRANTY CLAIMS. The Company's
license agreements typically contain provisions intended to limit the nature and
extent of the Company's risk of product liability and warranty claims. There is
a risk that a court might interpret these terms in a limited way or could hold
part or all of these terms to be unenforceable. Also, there is a risk that these
contract terms might not bind a party other than the direct customer.
Furthermore, some of the Company's licenses with its customers are governed by
non-U.S. law, and there is a risk that foreign law might give the Company less
or different protection. Although the Company has not experienced any material
product liability claims to date, a product liability suit or action claiming a
breach of warranty, whether or not meritorious, could result in substantial
costs and a diversion of management's attention and the Company's resources.
THE COMPANY FACES RISKS FROM OPERATIONS AND CUSTOMERS BASED OUTSIDE OF THE U.S.
Sales to customers headquartered outside of the United States represented
approximately 21.4%, 22.6%, and 16.5% of the Company's total revenue in 1999,
1998, and 1997, respectively. The Company, in part through its wholly-owned
subsidiaries based in the United Kingdom, Singapore, Sweden and Australia,
markets products and renders consulting and training services to customers based
in Canada, the United Kingdom, France, Switzerland, Ireland, Luxembourg, Mexico,
Sweden, Australia, Austria, Hong Kong and Singapore. The Company has established
offices in continental Europe and in Australia. The Company believes that its
continued growth will necessitate expanded international operations requiring a
diversion of managerial attention and financial resources. The Company
anticipates hiring additional personnel to accommodate international growth, and
the Company may also enter into agreements with local distributors,
representatives, or resellers. If the Company is unable to do one or more of
these things in a timely manner, the Company's growth, if any, in its foreign
operations will be restricted, and the Company's business, operating results,
and financial condition could be materially and adversely affected.
In addition, there can be no assurance that the Company will be able to maintain
or increase international market demand for its products. Most of the Company's
international sales are denominated in U.S. dollars. Accordingly, any
appreciation of the value of the U.S. dollar relative to the currencies of those
countries in which the Company distributes its products may place the Company at
a competitive disadvantage by effectively making its products more expensive as
compared to those of its competitors.
Additional risks inherent in the Company's international business activities
generally include unexpected changes in regulatory requirements, increased
tariffs and other trade barriers, the costs of localizing products for local
markets and complying with local business customs, longer accounts receivable
patterns and difficulties in collecting foreign accounts receivable,
difficulties in enforcing contractual and intellectual
<PAGE>
FORM 10-Q PAGE 18 OF 22
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.
THE COMPANY FACES RISKS RELATED TO INTELLECTUAL PROPERTY CLAIMS OR
APPROPRIATION OF ITS INTELLECTUAL PROPERTY RIGHTS. The Company relies
primarily on a combination of copyright, trademark and trade secrets laws, as
well as confidentiality agreements to protect its proprietary rights. In
October 1998, the Company was granted a patent by the United States Patent
and Trademark Office relating to the architecture of the Company's systems.
There can be no assurance that such patent will not be invalidated or
circumvented or that rights granted thereunder or the description contained
therein will provide competitive advantages to the Company's competitors or
others. 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 infringe the proprietary
rights of third parties. There can be no assurance, however, that third parties
will not claim infringement by the Company with respect to current or future
products. The Company expects that software product developers will increasingly
be subject to infringement claims as the number of products and competitors in
the Company's industry segment grows and the functionality of products in
different industry segments overlaps. Any such claims, with or without merit,
could be time-consuming, result in costly litigation, cause product shipment
delays, or require the Company to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, may not be available on terms
acceptable to the Company or at all, which could have a material adverse effect
upon the Company's business, operating results, and financial condition.
<PAGE>
FORM 10-Q PAGE 19 OF 22
PEGASYSTEMS INC.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may affect the Company due to
adverse changes in financial market prices and rates. The Company's market risk
exposure is primarily the result of fluctuations in foreign exchange rates. The
Company has not entered into derivative or hedging transactions to manage risk
in connection with such fluctuations.
Certain of the Company's international sales are denominated in foreign
currencies. The price in dollars of products sold outside the United States in
foreign currencies will vary as the value of the dollar fluctuates against such
foreign currencies. Although the Company's sales denominated in foreign
currencies in 1999 and the six months ended June 30, 2000 were not material,
there can be no assurance that such sales will not be material in the future and
that there will not be increases in the value of the dollar against such
currencies that will reduce the dollar return to the Company on the sale of its
products in such foreign currencies.
PART II - OTHER INFORMATION:
ITEM 1. LEGAL PROCEEDINGS
LITIGATION SETTLEMENT
Class Action Litigation
The Company has been involved in two lawsuits involving litigation related to
restatements of its financial statements (the Chalverus Case and the Gelfer
Case). As described below, the Company has reached settlements-in-principle
with the plaintiffs in both cases and has recorded a charge of $14.1 million
(net of insurance reimbursements of $4.3 million) against operations in the
quarter ended June 30, 2000, reflecting the estimated cost of the settlements
and remaining legal costs.
Chalverus Case
As a result of complaints filed in 1997 and 1998 in the United States
District Court of Massachusetts, which were subsequently consolidated into a
single complaint (the "Amended Complaint" or the "Chalverus Case"), the
Company has been engaged in litigating matters related to a restatement of
its financial statements in 1997. The Amended Complaint alleged that the
Company and two officers caused the Company to issue false and misleading
financial statements for the fiscal quarter ended June 30, 1997 by
inappropriately including $5 million in revenue from a series of contracts
with First Data Resources, Inc. The Amended Complaint alleged that as a
result of the inclusion of such revenue in the Company's financial statements
for that quarter, the market price of the Company's common stock was
artificially inflated, causing damage to purchasers of the Company's common
stock.
The parties have agreed in writing to a settlement-in-principle of the
litigation, pursuant to which the Company will pay $5.25 million in shares of
its common stock or in cash, at the Company's option, for the benefit of a
stipulated class defined to include all purchasers of the Company's common
stock between July 29, 1997 and October 29, 1997, inclusive, and the action
will be dismissed with prejudice. The parties' settlement is subject to the
negotiation and execution of a definitive Stipulation of Settlement, which
will be subject to notice to class members and the further approval by the
United States District Court of Massachusetts (the "Court".).
<PAGE>
FORM 10-Q PAGE 20 OF 22
Gelfer Case
In December 1998, a complaint also purporting to be a class action was filed
with the Court after the Company's announcement on November 23, 1998 that it
may be recording revenue adjustments to prior periods. In April 1999, the
plaintiffs filed their First Amended Class Action Complaint (the "Gelfer
Complaint") in that action following the January 20, 1999 restatement. The
Gelfer Complaint involves the Company and two officers and alleges violations
of the Exchange Act. The Complaint was filed on behalf of a purported class
of persons who purchased the Company's common stock between April 2, 1998
through November 23, 1998.
The parties have agreed in writing to a settlement-in-principle of this
litigation, pursuant to which the company will pay a total of $12.25 million,
of which at least $4.5 million is a cash payment and the remaining
$7.75 million is a payment in shares of its common stock or in cash, at the
Company's option. The Settlement is for the benefit of stipulated class
defined to include all purchasers of the Company's common stock between
April 2, 1998 and November 23, 1998, inclusive, and the action will be
dismissed with prejudice. The parties' settlement is subject to the negotiation
and execution of a definitive Stipulation of Settlement, which will be subject
to notice to class members and further approval by the Court.
Ernst & Young Case
On June 9, 2000, the Company and two of its officers filed a complaint
against Ernst & Young, LLP and Alan B. Levine (a former partner of Ernst &
Young) in Massachusetts state court. The complaint alleges that the
defendants committed professional malpractice, breached contractual and
fiduciary duties owed to the Company, and issued false and misleading public
statements, in connection with accounting advice that Ernst & Young rendered
to the Company regarding the revenues in question in the Chalverus case
discussed above. The Company seeks compensatory damages, including
contribution, for losses and other costs incurred in connection with the
Chalverus litigation. The defendants have not yet served their response to
the complaint.
FORMAL ORDER OF PRIVATE INVESTIGATION
In May 1999, the Boston office of the SEC issued a Formal Order of Private
Investigation of the Company and unidentified individuals, currently or formerly
associated with the Company, concerning past accounting matters, financial
reports, and other public disclosures and trading activity in the Company's
securities during 1997 and 1998. The Company is cooperating fully with such
investigation.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of stockholders was held on June 29, 2000. The following
matters were voted upon:
1. Stephen F. Kaplan, Alan Trefler and William W. Wyman were elected
to serve as Directors of the Company until the 2003 Annual Meeting of
Stockholders and until their respective successors are duly elected and
qualified. The following Directors' terms of office continued after the
annual meeting: Edward A. Maybury, William H. Keough, Edward B. Roberts
and James P. O'Halloran. Mr. Kaplan was elected with 24,422,459 votes
"FOR" and 198,837 votes "WITHHELD". Alan Trefler was elected with
24,422,459 votes "FOR" and 198,837 votes "WITHHELD". Mr. Wyman was
elected with 24,422,459 votes "FOR" and 198,837 votes "WITHHELD".
2. The stockholders approved an amendment to the Amended and Restated
1994 Long-Term Incentive Plan increasing the number of shares reserved
for issuance thereunder from 9,500,000 to 11,500,000 with 22,920,591
votes "FOR", 1,652,205 votes "AGAINST", and 48,500 votes "ABSTAINING."
3. The stockholders approved an amendment to the Amended and Restated
Director Stock Option Plan to provide for the annual grant to each
non-employee director of the Company of a fully-vested option to
purchase 10,000 shares of the Company's common stock at fair market
value, in addition to a one-time grant of an option to purchase 30,000
shares of the Company's common stock on the date each non-employee
director first becomes a director of the Company. The vote on the
amendment was 23,163,385 votes "FOR", 1,408,301 votes "AGAINST", and
49,610 votes "ABSTAINING."
4. The stockholders ratified the appointment by the Board of Directors
of Deloitte & Touche, LLP, independent public accountants, to audit the
financial statements of the Company for the fiscal year ending December
31, 2000, with 24,619,196 votes "FOR", 1,000 votes "AGAINST", and 1,100
votes "ABSTAINING."
<PAGE>
FORM 10-Q PAGE 21 OF 22
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
27.1 Financial Data Schedule
<PAGE>
FORM 10-Q PAGE 22 OF 22
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: August 14, 2000 /s/ James P. O'Halloran
-------------------------------------
James P. O'Halloran
Treasurer and Chief Financial Officer
(principal financial officer and
chief accounting officer)
