UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

xQuarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended JuneSeptember 30, 2010

or

 

¨Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period fromto                

Commission File Number: 1-11859

 

 

PEGASYSTEMS INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Massachusetts 04-2787865

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

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 by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      Yes  ¨      No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ¨

  Accelerated filer  x  Non-accelerated filer  ¨  Smaller reporting company  ¨
  

(Do not check if smaller reporting company)

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨    No  x

There were approximately 37,120,06637,037,619 shares of the Registrant’s common stock, $.01 par value per share, outstanding on July 30,October 29, 2010.

 

 


PEGASYSTEMS INC.

Index to Form 10-Q

 

          Page  
Part I—I.  Financial Information  

Item 1.

    

Financial Statements:

  
    

Unaudited Condensed Consolidated Balance Sheets as of JuneSeptember 30, 2010 and December 31, 2009

 3
    

Unaudited Condensed Consolidated Statements of Operations for the three and sixnine months ended JuneSeptember 30, 2010 and 2009

 4
    

Unaudited Condensed Consolidated Statements of Cash Flows for the sixnine months ended JuneSeptember 30, 2010 and 2009

 5
    

Notes to Unaudited Condensed Consolidated Financial Statements

 6

Item 2.

    

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  1617

Item 3.

    

Quantitative and Qualitative Disclosures About Market Risk

  2832

Item 4.

    

Controls and Procedures

  2933

Part II—II.  Other Information

Item 1A.

    

Risk Factors

  2933

Item 2.

    

Unregistered Sales of Equity Securities and Use of Proceeds

  2933

Item 6.

    

Exhibits

  3034

SIGNATURE

  3135

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

  As of
June 30,
2010
  As of
December 31,
2009
  As of      
September 30,

2010      
   As of      
December 31,
2009      
 
ASSETSASSETSASSETS  

Current assets:

        

Cash and cash equivalents

      $63,033      $63,857      $52,777        $63,857  

Marketable securities

   11,008   138,796   16,076     138,796  
              

Total cash, cash equivalents, and marketable securities

   74,041   202,653   68,853     202,653  

Trade accounts receivable, net of allowance of $1,180 and $649

   65,910   39,396

Trade accounts receivable, net of allowance of $1,188 and $649

   75,952     39,396  

Short-term license installments

   2,638   2,829   2,447     2,829  

Deferred income taxes

   4,514   2,523   6,516     2,523  

Income taxes receivable and other current assets

   16,000   8,840   17,010     8,840  
              

Total current assets

   163,103   256,241   170,778     256,241  

Long-term license installments, net

   2,394   2,976   1,383     2,976  

Property and equipment, net

   11,265   8,931   10,769     8,931  

Long-term deferred income taxes and other assets

   2,129   8,710

Long-term deferred income taxes

   30,521     7,515  

Other assets

   2,489     1,195  

Intangible assets, net

   88,728   336   83,554     336  

Goodwill

   50,976   2,391   21,613     2,391  
              

Total assets

      $318,595      $279,585      $321,107        $279,585  
              
LIABILITIES AND STOCKHOLDERS’ EQUITYLIABILITIES AND STOCKHOLDERS’ EQUITYLIABILITIES AND STOCKHOLDERS’ EQUITY  

Current liabilities:

        

Accounts payable

      $5,483      $4,791      $5,445        $4,791  

Accrued expenses

   23,338   6,748   26,417     6,748  

Accrued compensation and related expenses

   18,839   23,280   23,746     23,280  

Deferred revenue

   53,761   32,870   48,773     32,870  
              

Total current liabilities

   101,421   67,689   104,381     67,689  

Income taxes payable

   6,778   4,828   6,134     4,828  

Other long-term liabilities

   7,462   1,849   5,192     1,849  
              

Total liabilities

   115,661   74,366   115,707     74,366  
              

Commitments and contingencies (Note 9)

        

Stockholders’ equity:

        

Preferred stock, 1,000 shares authorized; no shares issued and outstanding

                

Common stock and additional paid-in capital, 70,000 shares authorized; 37,113 shares and 36,818 shares issued and outstanding

   128,022   121,757

Retained earnings and accumulated other comprehensive (loss) income of $(302) and $1,686

   74,912   83,462

Common stock and additional paid-in capital, 70,000 shares authorized; 37,048 shares and 36,818 shares issued and outstanding

   126,685     121,757  

Retained earnings and accumulated other comprehensive income of $1,473 and $1,686

   78,715     83,462  
              

Total stockholders’ equity

   202,934   205,219   205,400     205,219  
              

Total liabilities and stockholders’ equity

      $        318,595      $        279,585      $        321,107        $        279,585  
              

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

        
 Three Months Ended
June 30,
   Six Months Ended
June 30,
 

 

Three Months Ended

September 30,

     

 

Nine Months Ended

September 30,

         2010                   2009                   2010                   2009         

2010

     

2009

     

2010

     

2009

Revenue:

                            

Software license

 $ 28,200  $ 25,651  $ 58,543  $ 53,687 $ 33,889    $ 28,358    $ 92,432    $ 82,045

Maintenance

  20,388   12,171   35,474   24,119  23,418     12,489     58,892     36,608

Professional services

  33,658   26,056   63,313   48,439  32,709     23,974     96,022     72,413
                                    

Total revenue

  82,246   63,878   157,330   126,245  90,016     64,821     247,346     191,066
                                    

Cost of revenue:

                            

Cost of software license

  1,109   31   1,140   62  1,571     28     2,711     90

Cost of maintenance

  2,715   1,457   4,652   2,894  3,187     1,558     7,839     4,452

Cost of professional services

  27,436   20,104   51,904   39,167  30,232     22,474     82,136     61,641
                                    

Total cost of revenue

  31,260   21,592   57,696   42,123  34,990     24,060     92,686     66,183
                                    

Gross profit

  50,986   42,286   99,634   84,122  55,026     40,761     154,660             124,883
                                    

Operating expenses:

                            

Selling and marketing

  29,896   16,659   51,789   32,095  31,199     19,568     82,988     51,663

Research and development

  14,010   9,149   25,636   18,268  14,924     9,930     40,560     28,198

General and administrative

  6,745   4,648   11,804   9,594  6,442     3,798     18,246     13,392

Acquisition-related costs

  3,395   -   4,903   -  111     

-

     5,014     

Restructuring costs

  6,080   -   6,080   -  407     

-

     6,487     

                                    

Total operating expenses

  60,126   30,456   100,212   59,957  53,083     33,296             153,295     93,253
                                    

(Loss) income from operations

  (9,140)   11,830   (578)   24,165

Foreign currency transaction (loss) gain

  (2,542)   2,923   (5,616)   2,111

Income from operations

  1,943     7,465     1,365     31,630

Foreign currency transaction gain (loss)

  1,513     266     (4,103)     2,377

Interest income, net

  119   881   632   1,683  129     721     761     2,404

Installment receivable interest income

  52   75   104   150  51     74     155     224

Other income, net

  1   7   242   17  572     

     814     17
                                    

(Loss) income before (benefit) provision for income taxes

  (11,510)   15,716   (5,216)   28,126

(Benefit) provision for income taxes

  (3,322)   4,475   (879)   8,243

Income (loss) before provision for income taxes

  4,208     8,526     (1,008)     36,652

Provision for income taxes

  1,069     2,525     190     10,768
                                    

Net (loss) income

 $ (8,188)  $ 11,241  $ (4,337)  $ 19,883

Net income (loss)

 $ 3,139    $ 6,001    $ (1,198)    $ 25,884
                                    

Net (loss) earnings per share:

           

Net earnings (loss) per share:

                 

Basic

 $ (0.22)  $ 0.31  $ (0.12)  $ 0.56 $ 0.08    $ 0.16    $ (0.03)    $ 0.72
                                    

Diluted

 $ (0.22)  $ 0.30  $ (0.12)  $ 0.53 $ 0.08    $ 0.16    $ (0.03)    $ 0.68
                                    

Weighted-average number of common shares outstanding

                            

Basic

  37,054   35,965   36,966   35,818          36,996             36,462     37,008     36,035

Diluted

  37,054   37,995   36,966   37,708  38,534     38,441     37,008     37,955

Cash dividends declared per share

 $ 0.03  $ 0.03  $ 0.06  $ 0.06 $ 0.03    $ 0.03    $ 0.09    $ 0.09
                                    

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

   Six Months Ended
June 30,
 

Nine Months Ended

September 30,

               2010                             2009              

        2010        

   

        2009        

Operating activities:

            

Net (loss) income

  $ (4,337)   $ 19,883 $ (1,198)  $ 25,884

Adjustment to reconcile net (loss) income to cash (used in) provided by operating activities:

            

Excess tax benefits from exercise or vesting of equity awards

   (5,529)    (10,068)  (5,456)   (14,409)

Deferred income taxes

   (321)    (783)  (2,088)   (901)

Depreciation, amortization and other non-cash items

   3,727    1,259  7,013   2,021

Amortization of investments and realized gain on sale of investments

   666    1,918  671   2,963

Stock-based compensation expense

   3,632    2,558  5,213   3,523

Foreign currency transaction loss

   4,011    -  3,775   

Change in operating assets and liabilities:

            

Trade accounts receivable

   (12,529)    10,424  (22,052)   15,093

License installments

   773    3,188  1,976   4,586

Income taxes receivable and other current assets

   395    (283)  (2,022)   (801)

Accounts payable and accrued expenses

   2,970    (2,697)  4,971   5,738

Deferred revenue

   6,025    3,883  (281)   (4,413)

Other long-term assets and liabilities

   (5,801)    150  (28)   (445)
                

Cash (used in) provided by operating activities

   (6,318)    29,432  (9,506)   38,839
                

Investing activities:

            

Purchases of marketable securities

   (61,156)    (29,535)  (67,228)   (49,851)

Matured and called marketable securities

   26,280    18,535  27,280   35,925

Sale of marketable securities

   162,242    -  162,226   

Payments for 2010 acquisition, net of cash acquired

   (108,991)    -  (109,228)   

Payments for 2008 acquisition

   (250)    -  (250)   

Investment in property and equipment

   (3,497)    (1,789)  (4,075)   (3,724)
                

Cash provided by (used in) investing activities

   14,628    (12,789)  8,725   (17,650)
                

Financing activities:

            

Issuance of common stock for share-based compensation plans

   1,198    3,042

Proceeds from issuance of common stock for share-based compensation plans

  1,546   4,075

Excess tax benefits from exercise or vesting of equity awards

   5,529    10,068  5,456   14,409

Dividend payments to shareholders

   (2,216)    (2,155)

Dividend payments to stockholders

  (3,330)   (3,245)

Common stock repurchases for tax withholdings for net settlement of equity awards

   (4,212)    (5,606)  (4,493)   (7,417)

Repurchase of common stock

   (3,330)    (9,202)  (6,098)   (9,893)
                

Cash used in financing activities

   (3,031)    (3,853)  (6,919)   (2,071)
                

Effect of exchange rate on cash and cash equivalents

   (6,103)    919  (3,380)   1,214
                

Net (decrease) increase in cash and cash equivalents

   (824)    13,709  (11,080)   20,332

Cash and cash equivalents, beginning of period

   63,857    36,087  63,857   36,087
                

Cash and cash equivalents, end of period

  $ 63,033   $ 49,796 $             52,777  $             56,419
                

See notes to unaudited condensed consolidated financial statements.

PEGASYSTEMS INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1.ACCOUNTING POLICIES

Basis of Presentation

The Company has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“U.S.”) for complete financial statements and should be read in conjunction with the Company’s audited financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2009.

In the opinion of management, the Company has prepared the accompanying unaudited condensed consolidated financial statements on the same basis as its audited financial statements, and these financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year 2010.

Correction of Statement of Cash Flow

After the issuance of our March 31, 2010 interim financial statements, management identified an error in the presentation of currency transaction losses on foreign currency denominated cash and cash equivalents within the statement of cash flows. These losses should have been presented as a reconciling item within cash flows from operating activities and included within theEffect of exchange rate on cash and cash equivalents in the statement of cash flows. The impact of the applicable line items within the condensed consolidated statement of cash flows for the three months ended March 31, 2010 is as follows:

   

Three Months Ended

March 31, 2010

  (in thousands)          As Reported                 As Corrected        

 Foreign currency transaction loss

  $- $2,263              

 Cash provided by operations

  $4,824 $7,087              

 Effect of exchange rate on cash and cash equivalents

  $(487) $(2,750)              

The effect of the presentation error has no impact on the reported cash and cash equivalents, total changes in cash flows for the period, the condensed consolidated statement of operations or condensed consolidated balance sheet. This matter did not have a material impact on the 2009, 2008, or 2007 consolidated financial statements, or any interim period within those years.

As the Company has concluded that these adjustments are immaterial to the March 31, 2010 interim financial statements, these adjustments will be prospectively reflected in applicable condensed consolidated statement of cash flows reported in the Company’s Form 10-Q for the quarter ended March 31, 2011.

Acquisition-related costs

Acquisition-related costs are expensed as incurred and include costs to effect an impending or completed acquisition and direct and incremental costs associated with an acquisition. During the first sixnine months of 2010, the Company incurred $5.0 million of acquisition-related costs were primarilyassociated with its acquisition of Chordiant Software, Inc. (“Chordiant”). These costs consisted of approximately $3.1 million of due diligence costs and advisory and legal transaction fees, legal,approximately $0.7 million of valuation and tax consulting and valuation fees, $0.8 million of legal costs associated with the Company’s acquisitionassumed litigation, and $0.4 million of Chordiant.integration and other expenses. See Note 5 “Acquisition, Goodwill and Intangibles” for further discussion of the acquisition.

Restructuring costs

Restructuring costs include severance and related benefit costs for the reduction of personnel during the second and third quarter of 2010 related to the Chordiant acquisition. See Note 8 “Accrued Restructuring Costs” for further detail.

2.FAIR VALUE MEASUREMENTS

Fair value is an exit price, representing the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants based on assumptions that market participants would use in pricing an asset or liability. As a basis for classifying such assumptions, a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value, was established as follows: (Level 1) observable inputs such as quoted prices in active markets for identical assets or liabilities; (Level 2) inputs other than the quoted prices in active markets that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which requires the Company to develop its own assumptions. This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. On a recurring basis, the Company measures its marketable securities and cash equivalents at fair value and classifies them as follows:

 

     Fair Value Measurements at  Reporting
Date Using
          Fair Value Measurements at Reporting    
Date Using
 
(in thousands)    June 30, 2010    Quoted Prices
in Active
Markets for
        Identical Assets        
(Level 1)
  Significant
Other
         Observable        
Inputs

(Level 2)
    September 30,  
  2010  
   Quoted Prices
in Active
Markets for
      Identical Assets      

(Level 1)
   Significant
Other
    Observable    

Inputs
(Level 2)
 

Cash equivalents

  $7,564  $7,564  $  $1,861    $1,861    $  
                     

Marketable securities:

            

Government sponsored enterprise bonds

  $7,800    $5,798    $2,002  

Commercial paper

   3,991          3,991  

Corporate bonds

   2,149     2,149       

Municipal bonds

  $2,152  $2,152  $   2,136     2,136       

Government sponsored enterprise bonds

   7,793   7,793   

Corporate bonds

   1,063   1,063   
                     

Total marketable securities

  $11,008  $11,008  $  $16,076    $        10,083    $5,993  
                     
     Fair Value Measurements at  Reporting
Date Using
      Fair Value Measurements at Reporting
Date Using
 
(in thousands)  December 31,
2009
  Quoted Prices
in Active
Markets for
Identical Assets

(Level 1)
  Significant
Other
Observable
Inputs
(Level 2)
    December 31,  
  2009  
   Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
 

Cash equivalents

  $9,880  $9,880  $  $9,880    $9,880    $  
                     

Marketable securities:

            

Municipal bonds

  $112,723  $27,152  $85,571  $112,723    $27,152    $85,571  

Government sponsored enterprise bonds

   19,560      19,560   19,560          19,560  

Corporate bonds

   6,513   6,513   —     6,513     6,513       
                     

Total marketable securities

  $138,796  $33,665  $105,131  $    138,796    $33,665    $    105,131  
                     

The carrying values of accounts receivable, license installments, and accounts payable approximate their fair value.

3.TRADE ACCOUNTS RECEIVABLE, NET OF ALLOWANCESALLOWANCE

Unbilled trade accounts receivable relate to services earned under time and material arrangements, maintenance and license arrangements that had not been invoiced as of JuneSeptember 30, 2010 and December 31, 2009, respectively.

 

(in thousands)  As of
    June 30,    
2010
  As of
    December 31,    
2009
  As of
September 30,
2010
   As of
December 31,
2009
 

Trade accounts receivable

  $50,613  $32,042  $61,822    $32,042  

Unbilled accounts receivable

   16,477   8,003   15,318     8,003  
              

Total accounts receivable

   67,090   40,045   77,140     40,045  
              

Allowance for sales credit memos

   (998)   (541)   (1,021)     (541)  

Allowance for doubtful accounts

   (182)   (108)   (167)     (108)  
              

Total allowances

   (1,180)   (649)   (1,188)     (649)  
              
  $65,910  $39,396  $75,952    $39,396  
              

4. INCOME TAXES RECEIVABLE AND OTHER CURRENT ASSETS

    
(in thousands)  As of
June 30,
2010
  As of
December 31,
2009

Income tax receivable

  $11,697  $5,046

Interest receivable

   59   1,664

Prepaid expenses

   2,306   1,092

Reimbursable expenses

   791   424

Sales tax receivable

   1,147   614
      
  $    16,000  $        8,840
      

4.INCOME TAXES RECEIVABLE AND OTHER CURRENT ASSETS

(in thousands)  As of
September 30,
2010
   As of
December 31,

2009
 

Income tax receivable

  $11,818    $5,046  

Prepaid expenses

   1,631     1,092  

Sales tax receivable

   1,761     614  

Interest receivable

   46     1,664  

Other

   1,754     424  
          
  $17,010    $8,840  
          

 

5.ACQUISITION, GOODWILL, AND INTANGIBLES

Chordiant Acquisition

On April 21, 2010, the Company acquired all of the outstanding shares of common stock of Chordiant, a leading provider of customer relationship management (“CRM”) software and services with a focus on improving customer experiences through decision technology. The aggregate purchase price for Chordiant was approximately $160.3 million, consisting of $156.8 million in cash and stock options with a fair value of $3.5 million. The Company issued approximately 241,000 stock options as replacement of outstanding Chordiant stock options at the date of the closing.acquisition date. The majority of the fair value of these stock options was recorded as purchase price based on the portion of the awards related to pre-combination services. The compensation expense associated with the portion of the replacement awards related to post-combination services totaled $0.2 million and will be recognized as compensation expense over the remaining service period. AsThe Company has expensed all transaction costs, as described in Note 1 “Accounting Policies.” These costs have been included in acquisition-related costs in the accompanying condensed consolidated statement of June 30, 2010, the Company incurred direct incremental expenses associated with the transaction of $4.9 million.operations.

The Company believes the acquisition will expand its global customer base and provide complementary solutions. Chordiant clients will be able to incorporate Pegasystems process automation to enhance their experience in their existing call center and marketing solutions. Pegasystems’ clients will benefit from Chordiant’s decision management solutions and extensive CRM assets. In addition, the Company believes the combination of the two companies will expand the partner network and provide incremental business opportunity growth.

The operations of Chordiant are included in our operating results from the date of acquisition. For the three and six months ended June 30, 2010, $7.8 million of revenue was directly attributable to Chordiant operations. Due to the rapid integration of the sales force and operations of Chordiant, other than the maintenance revenue attributable to the amortization of the fair value of acquired deferred revenue, it will become increasingly difficultis no longer feasible for the Company to separately identify revenue from arrangements attributable to Chordiant.

The valuation of the acquired intangible assets and assumed liabilities is preliminary. The Company is currently in the process of investigating the facts and circumstances existing as of the acquisition date in order to finalize its valuation and establish the related tax basis. The Company has preliminarily determined that it may utilize approximately $146 million of acquired Chordiant net operating losses (“NOLs”), which are subject to annual limitations through 2029. As a result of this determination, the Company updated its purchase price allocation in the third quarter of 2010 and recorded a $31.5 million increase in net deferred tax assets, a $0.3 million increase in accrued federal income taxes, a decrease of $2.4 million in acquired intangible assets, and a $29.4 million decrease in goodwill. As of September 30, 2010, as a result of the updated preliminary purchase price allocation, the Company recognized approximately $48.6$19.2 million of goodwill, which is primarily due to the expected synergies of the combined entities and the workforce in place. The goodwill created by the transaction is nondeductible for tax purposes. A summary of the preliminary purchase price allocation for the acquisition of Chordiant is as follows:

 

(in thousands)          

Total purchase consideration:

      

Cash

  $            156,832     $                156,832  

Stock options

   3,519      3,519  
         

Total purchase consideration

  $160,351     $160,351  
         
      

Allocation of the purchase consideration:

      

Cash

  $47,604     $47,604  

Accounts receivable, net of allowances

   14,231   

Accounts receivable, net of allowance

   14,231  

Other assets

   2,661      2,661  

Property, plant, and equipment

   753   

Property and equipment

   753  

Deferred tax assets, net

   24,784  

Identifiable intangible assets

   90,400      88,049  

Goodwill

   48,585      19,222  

Accounts payable

   (5,303)     (5,303)  

Accrued liabilities

   (10,478)     (10,478)  

Deferred revenue

   (17,863)     (17,863)  

Deferred tax liabilities, net

   (6,665)  

Other long-term liabilities

   (3,574)  

Long-term liabilities

   (3,309)  
         

Net assets acquired

  $160,351    $160,351  
         
    

The valuation of the assumed deferred maintenance revenue liability was based on the Company’s contractual commitment to provide post-contract customer support to Chordiant customers. The fair value of this assumed liability was based on the cost plus a reasonable margin to fulfill these service obligations. The majority of the deferred revenue is expected to be recognized in the next 12 months.months following the acquisition. The valuation of the acquired intangible assets is inherently subjective and relies on significant unobservable inputs. The valuation assumptions take into consideration the Company’s estimates of contract renewal, technology attrition and revenue growth projections. The preliminary allocations of the purchase price consideration to tangible and intangible assets acquired were based on our estimates and assumptions that are still subject to change.

The preliminary values for specifically identifiable intangible assets, by major asset class, are as follows:

 

(in thousands)     

Weighted-average
amortization
period

(in years)

Customer related intangible assets

  $            45,729      9

Technology

   44,421      9

Trade name

   250      1
      
  $90,400      8.4
      

  (in thousands)      

Weighted-average
amortization
period

(in years)

Customer related intangible assets

  $            44,355          9

Technology

   43,446          8

Trade name

   248         1
       
  $88,049          8.4
       

Pro forma Information

The following unaudited pro forma financial information presents the combined results of operations of the Company and Chordiant as if the acquisition had occurred on January 1, 2010 and 2009, respectively, after giving effect to certain pro forma adjustments. The pro forma adjustments reflected herein include only those adjustments that are directly attributable to the Chordiant acquisition, factually determinable, and expected to have a continuing impact on the Company. These pro forma adjustments include a reduction of historical Chordiant revenue for fair value adjustments related to acquired deferred revenue and deferred costs, a net increase in amortization expense to eliminate historical amortization of Chordiant intangible assets and to record amortization expense for the $90.4$88 million of acquired identifiable intangibles, and a decrease in interest income as a result of the cash paid for the acquisition. The unaudited pro forma financial information does not reflect any adjustments for anticipated synergies resulting from the acquisition and is not necessarily indicative of the operating results that would have actually occurred had the transaction been consummated as of January 1, 2010 and 2009, respectively. The preliminary allocations of the purchase price consideration to tangible and intangible assets acquired and liabilities assumed herein were based upon preliminary valuations and our estimates and assumptions are still subject to change.

 

   Pro Forma
Three Months Ended
June 30,
  Pro Forma
Six Months Ended
June 30,
   

 

2010

  2009  2010  2009

Revenue

  $85,524  $    80,545  $  234,087  $  156,704

Net (loss) income

       (16,858)   7,184   (11,632)   8,256

Net (loss) income per basic share

  $(0.45)  $0.20  $(0.31)  $0.23
                

Net (loss) income per diluted share

  $(0.45)  $0.19  $(0.31)  $0.22
                
   Pro Forma
        Three Months Ended        
September 30,
   Pro Forma
        Nine Months Ended        
September 30,
 
   2010   2009   2010   2009 

Revenue

   $        90,016     $    75,814     $    262,170     $  232,518  

Net income (loss)

   3,139     (2,792)     (19,397)     5,021  

Net income (loss) per basic share

   $0.08     $(0.08)     $(0.52)     $0.14  
                    

Net income (loss) per diluted share

   $0.08     $(0.07)     $(0.52)     $0.13  
                    

Goodwill and Intangibles

The Company operates in one operating segment.segment and has one reporting unit. The following table presents the change in the carrying amount of goodwill:goodwill during the year:

 

(in thousands)  As of
June 30,
2010

Beginning balance as of January 1,

  $2,391

Goodwill acquired during the period

   48,585
    
  $    50,976
    

Amortized intangible assets consist of the following:

(in thousands)  Cost    Accumulated  
  Amortization  
      Net Book    
Value

As of June 30, 2010

     

Customer relationships

  $    45,729  $(847 $    44,882

Technology

   44,421   (1,048  43,373

Trade name

   250   (42  208

Technology designs

   490   (279  211

Non-compete agreements

   100   (46  54

Intellectual property

   1,400   (1,400  —  
            

Total

  $92,390  $(3,662 $88,728
            

As of December 31, 2009

     

Technology designs

  $490  $(218 $272

Non-compete agreements

   100   (36  64

Intellectual property

   1,400   (1,400  —  
            

Total

  $1,990  $    (1,654 $336
            

(in thousands)           

Balance as of January 1, 2010

    $2,391   

Goodwill acquired during the period

     19,222   
        

Balance as of September 30, 2010

    $21,613   
        
Intangible assets consist of the following:     
(in thousands)      Cost       Accumulated
   Amortization  
      Net Book    
Value
 

As of September 30, 2010

     

Customer related intangibles

  $44,355    $(2,053 $42,302  

Technology

   43,446     (2,568  40,878  

Trade name

   248     (103  145  

Technology designs

   490     (310  180  

Non-compete agreements

   100     (51  49  

Intellectual property

   1,400     (1,400  —    
              

Total

  $    90,039    $(6,485 $83,554  
              

As of December 31, 2009

     

Technology designs

  $490    $(218 $272  

Non-compete agreements

   100     (36  64  

Intellectual property

   1,400     (1,400  —    
              

Total

  $1,990    $(1,654 $336  
              

Amortization expense for all of the acquired intangibles was approximately $2.0$2.8 million during both the secondthird quarter and first six months of 2010, of which approximately $1.1$1.6 million was included in cost of software licenses and approximately $0.9$1.2 million was included in operating expenses.

Amortization expense for acquired intangibles was $4.8 million during the first nine months of 2010, of which $2.7 million was included in cost of software licenses and $2.1 million was included in operating expenses. Amortization expense was de minimis in 2009.

 

  

(in thousands)

As of June 30,            

  Future estimated
amortization
expense
 

    Remainder of 2010

  $5,810
 

    2011

   11,453
 

    2012

   11,370
 

    2013

   11,370
 

    2014

   9,746
 

    2015 and thereafter

   38,714
     
   $        88,463
     

(in thousands)

As of September 30,              

  Future estimated
amortization
expense
 

        Remainder of 2010

  $2,870  

        2011

   11,315  

        2012

   11,137  

        2013

   11,095  

        2014

   9,489  

        2015

   8,688  

        2016 and thereafter

   28,960  
     
  $83,554  
     

 

6.ACCRUED EXPENSES

 

(in thousands)  As of
    June 30,    
2010
  As of
December 31,
2009
  As of
September 30,
2010
   As of
    December 31,    
2009
 

Accrued income taxes

  $3,780    $-  

Accrued restructuring

  $3,904  $-   3,245     -  

Accrued professional services partners fees

   2,491   1,055

Accrued professional services partner fees

   2,890     1,055  

Accrued other taxes

   2,080   1,289   2,494     1,289  

Accrued employee reimbursable expenses

   2,220     799  

Accrued professional fees

   1,438     389  

Accrued litigation judgment

   1,426     -  

Accrued self-insurance health and dental claims

   1,243     -  

Accrued short-term deferred rent

   1,681     422  

Dividends payable

   1,114   1,105   1,111     1,105  

Accrued employee reimbursable expenses

   1,849   799

Accrued acquisition-related costs

   451   -   307     -  

Accrued self-insurance health and dental claims

   1,549   -

Accrued litigation judgment

   1,426   -

Accrued professional fees

   1,308   389

Accrued short-term deferred rent

   1,027   422

Repurchases of common stock unsettled

   100   136   24     136  

Accrued other

   6,039   1,553   4,558     1,553  
              
  $23,338  $6,748  $26,417    $6,748  
              

7. DEFERRED REVENUE

    
(in thousands)  As of
    June 30,    
2010
  As of
December 31,
2009

Software license

  $5,442  $4,413

Maintenance

   44,324   22,039

Professional services and other

   3,995   6,418
      
  $      53,761  $      32,870
      

The increase in deferred

7.DEFERRED REVENUE

(in thousands)  As of
September 30,
2010
   As of
    December 31,    
2009
 

Software license

  $4,175    $4,413  

Maintenance

   40,053     22,039  

Professional services and other

   4,545     6,418  
          

Current deferred revenue

   48,773     32,870  

Long-term deferred revenue, included in other long-term liabilities

   1,806     -  
          
  $50,579    $32,870  
          

Deferred maintenance revenue is primarily due toincludes the fair value of maintenance obligations assumed in our acquisition of Chordiant. See Note 5 “Acquisition, Goodwill, and Intangibles” for further discussion of the acquired assets and assumed liabilities from the acquisition.

8.ACCRUED RESTRUCTURING COSTS

During the second quarter of 2010, in connection with the Company’s integration plan of Chordiant, the Company recorded $6.1 million of severance and related benefit costs for the reduction of approximately 50 personnel in redundant roles, primarily in general and administrative functions. These restructuring costs are all cash obligationsDuring the third quarter of which approximately $3.92010, the Company recorded the remaining $0.4 million is expectedof severance related to be paidthe reduction of those personnel whose employment ended in the next 12 monthsthird quarter of 2010. The severance and the remaining $1.1 millionrelated benefit costs will be paid by the end of the second quarter of 2012. The Company expects to incur an additional $0.4 million in severance costs during the third quarter of 2010.

In connection with the Company’s evaluation of its combined facilities, the Company approved a plan to eliminate one redundant facility. As a result,During the third quarter of 2010, the Company incurred moving costs associated with the elimination of this facility. The Company expects to incur approximately $1.3$1.2 million in additional restructuring expenses by the end of 2010,related to this facility, representing future lease payments and demising costs, net of estimated sublease income and costs for this identified facility. These exit costs will be recognized when the Company ceases to use the leased facility, which is expected to occur by the end of 2010.

A summary of the restructuring activity during the second quarter ofnine months ended September 30, 2010 is as follows:

 

  (in thousands)    Personnel   
 

Balance as of April 1, 2010

  $-  
 

    Restructuring costs

   6,080  
 

    Cash payments

   (1,118
      
 

Balance as of June 30, 2010

  $  4,962  
      
 (in thousands)  

 

As of
June 30,
2010

 
 

Reported as:

  
 

Accrued expenses

  $3,904  
 

Other long-term liabilities

   1,058  
      
   $4,962  
      
(in thousands)      Personnel          Facilities          Total     

Balance as of April 21, 2010

  $-   $-   $-  

Restructuring costs

   6,456    31    6,487  

Cash payments

   (2,584  (31  (2,615)  
             

Balance as of September 30, 2010

  $3,872   $-   $3,872  
             

(in thousands)  As of
    September 30,    
2010
 

Reported as:

  

Accrued expenses

  $3,245  

Other long-term liabilities

   627  
     
  $3,872  
     

 

9.COMMITMENTS AND CONTINGENCIES

The Company’s principal administrative, sales, marketing, support, and research and development operations are located in a leased facility in Cambridge, Massachusetts. The lease for this facility expires in 2013, subject to the Company’s option to extend for two additional five-year periods. The Company also leases space for its other offices under non-cancelable operating leases that expire on various dates through 2014.

As of JuneSeptember 30, 2010, the Company’s future minimum rental payments required under operating leases with non-cancelable terms in excess of one year were as follows:

 

(in thousands)

As of June 30,

  Net
  Operating  
Leases

(in thousands)

As of September 30,

  Net
    Operating    

Leases
 

Remainder of 2010

  $3,962  $2,517  

2011

   7,856   8,496  

2012

   7,691   7,886  

2013

   3,979   4,052  

2014

   265   275  
       
  $    23,753  $23,226  
       

As of June 30, 2010, the Company did not have any additional unconditional purchase obligations.

In connection with the acquisition of Chordiant, the Company assumed an agreement with Ness Technologies Inc., Ness USA, Inc. and Ness Technologies India, Ltd. (collectively, “Ness”) that expires December 31, 2011. Pursuant to this agreement, Ness provides technical product support, sustaining engineering, function, product testing services, product development services and other identified technical and consulting services to customers acquired from Chordiant. If the Company terminates the Ness agreement for convenience, it may be required to pay a termination fee of approximately $0.4 million.

Yue vs. Chordiant Software, Inc.

On January 2, 2008, Chordiant and certain of its officers and one other employee were named in a complaint filed in the United States District Court for the Northern District of California (the “Court”) by Dongxiao Yue under the caption Dongxiao Yue (“Plaintiff”) v. Chordiant Software, Inc. et al. Case No. CV 08-0019 (N.D. Cal.). The complaint alleged that the Company’s Marketing Director (“CMD”) software product infringed copyrights in certain software marketed by Netbula LLC. On May 14, 2010, a jury awarded the Plaintiff approximately $1.4 million, which was accrued in the assumed Chordiant liabilities and included in accrued expenses in the consolidated balance sheet as of JuneSeptember 30, 2010. This judgment was approved by the Court on August 3, 2010, following the conclusion of various post-trial motions filed by the parties. The Company has not yet determined whether it will file an appeal in this matter.

10.  COMPREHENSIVE (LOSS) INCOMEOn August 17, 2010, the Plaintiff filed an additional complaint with the Court against a number of Chordiant customers and partners, alleging that their use of CMD infringed the same copyrights at issue in the complaint filed against Chordiant. In accordance with the terms of Chordiant’s contracts with these customers and partners, the Company has agreed to indemnify and defend these customers and partners in this matter. On November 1, 2010, the Company filed motions with the Court seeking to dismiss the claims in this complaint. The Company does not expect a material unfavorable outcome from the resolution of this complaint is probable.

10.COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) income includes the Company’s net income (loss) income plus the results of certain stockholders’ equity changes not reflected in the unaudited condensed consolidated statements of operations. The components of comprehensive income (loss) income are as follows:

 

(in thousands)      Three Months Ended    
June 30,
     Six Months Ended    
June  30,
  Three Months Ended
September 30,
 Nine Months Ended
September 30,
 
  

 

    2010    

     2009         2010         2009    

Net (loss) income

   $    (8,188  $    11,241    $    (4,337  $    19,883

Other comprehensive (loss) income:

     
  2010   2009 2010 2009 

Net income (loss)

   $    3,139     $    6,001     $    (1,198  $    25,884  

Other comprehensive income (loss):

      

Unrealized gain (loss) on securities, net of tax

   (3)  (401  (541  20   26     (206  (515  (186)  

Foreign currency translation adjustments

   (1,114  1,011    (1,447  901   1,749     206    302    1,107  
                          

Comprehensive (loss) income

   $    (9,305  $    11,851    $    (6,325  $    20,804

Comprehensive income (loss)

   $    4,914     $    6,001     $    (1,411  $    26,805  
                          

11.  STOCK-BASED COMPENSATION

11.STOCK-BASED COMPENSATION

For the secondthird quarter and first sixnine months of 2010 and 2009, stock-based compensation expense was reflected in the Company’s unaudited condensed consolidated statements of operations as follows:

 

      Three Months Ended    
June 30,
       Six Months Ended    
June 30,
  Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
(in thousands)      2010     2009       2010             2009      2010   2009   2010   2009 
            

Cost of services

  $483  $ 128   $881    $634  $447    $250    $1,328    $884  

Operating expenses

   1,703   732    2,751     1,924   1,134     715     3,885     2,639  
                                

Total stock-based compensation before tax

   $    2,186  $   860   $      3,632    $    2,558  $1,581    $965    $5,213    $3,523  

Income tax benefit

   (578)   (155)    (1,091)     (739)     $(555)       $(527)       $(1,646)       $(1,266)  

During the first sixnine months of 2010, the Company issued approximately 395,000430,000 shares to its employees under the Company’s share-based compensation plans.plans and approximately 15,000 shares to its non-employee Directors under their annual award. Additional options to purchase approximately 241,000 shares were issued as replacement awards in connection with the acquisition of Chordiant. The compensation expense associated with the portion of the replacement awards related to post-combination services totaled $0.2 million and will be recognized as compensation expense, in accordance with the accelerated recognition model over the remaining service period.

As of JuneSeptember 30, 2010, the Company had approximately $7.1$5.9 million of unrecognized stock-based compensation expense related to all unvested RSUs and unvested stock options that is expected to be recognized over a weighted-average period of 2 years.

12.  NET (LOSS) EARNINGS PER SHARE

12.NET EARNINGS (LOSS) PER SHARE

Basic earnings (loss) earnings per share is computed using the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted-average number of common shares outstanding during the period, plus the dilutive effect of outstanding options, RSUs, and warrants, using the treasury stock method and the average market price of our common stock during the applicable period.period using the treasury stock method. Certain shares related to some of our outstanding stock options and RSUs were excluded from the computation of diluted earnings per share because they were antidilutive in the periods presented, but could be dilutive in the future.

 

      Three Months Ended    
June 30,
      Six Months Ended    
June  30,
  Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
(in thousands, except per share amounts)      2010          2009          2010          2009      2010   2009   2010   2009 

Basic

                

Net (loss) income

  $     (8,188)  $      11,241  $     (4,337)  $      19,883

Net income (loss)

  $    3,139    $    6,001    $    (1,198)    $    25,884  
                            

Weighted-average common shares outstanding

   37,054   35,965   36,966   35,818   36,996     36,462     37,008     36,035  
                            

Net (loss) earnings per share, basic

  $(0.22)  $0.31  $(0.12)  $0.56

Net earnings loss per share, basic

  $0.08    $0.16    $(0.03)    $0.72  
                            
        

Diluted

                

Net (loss) income

  $(8,188)  $11,241  $(4,337)  $19,883

Net income (loss)

  $3,139    $6,001    $(1,198)    $25,884  
                            

Weighted-average common shares outstanding, basic

   37,054   35,965   36,966   35,818   36,996     36,462     37,008     36,035  

Weighted-average effect of dilutive securities:

                

Stock options

   -   1,851   -   1,721   1,343     1,777     -     1,740  

RSUs

   -   169   -   159   192     199     -     172  

Warrants

   -   10   -   10   3     3     -     8  
                            

Effect of assumed exercise of stock options, warrants and RSUs

   -   2,030   -   1,890   1,538     1,979     -     1,920  
                            

Weighted-average common shares outstanding, diluted

   37,054   37,995   36,966   37,708   38,534     38,441     37,008     37,955  
                            

Net (loss) earnings per share, diluted

  $(0.22)  $0.30  $(0.12)  $0.53

Net earnings (loss) per share, diluted

  $0.08    $0.16    $(0.03)    $0.68  
                            

Outstanding options and RSUs excluded as impact would be antidilutive

   2,960   51   3,041   617   102     88     2,752     441  

13.  INCOME TAXES

13.INCOME TAXES

The Company accounts for income taxes at each interim period using its estimated annual effective tax rate. The provision for income taxes represents current and future amounts owed for federal, state, and foreign taxes.

During the second quarter and first six months of 2010, the Company recorded a benefit of $3.3 million and $0.9 million, respectively, on a pre-tax loss of $11.5 million and $5.2 million, respectively, which resulted in an effective tax rate of 28.9% and 16.9%, respectively. The Company recorded a discrete item related to the nondeductible portion of acquisition-related costs incurred in the second quarter and first sixnine months of 2010 associated with the Chordiant acquisition, which reduced the tax benefit for the second quarter and first sixnine months of 2010 by 2.9% and 13.5%, respectively.resulted in a provision of $0.2 million on a pre-tax loss of $1 million. During the third quarter of 2010, the Company recorded a $1.1 million provision on pre-tax income of $4.2 million, which resulted in an effective tax rate of 25.4%.

The Company is in the process of evaluating its tax position related to the assets acquired and liabilities assumed from the Chordiant acquisition. The valuationCompany has preliminarily determined that it may utilize approximately $146 million of the assets acquired and liabilities assumed, including the measurement of the acquiredChordiant net operating losses (“NOLs”), is preliminary and iswhich are subject to change untilannual limitations through 2029. As a result of this determination, the Company has gathered allrecorded deferred tax assets of approximately $51.1 million as of September 30, 2010 related to these acquired NOLs. See Note 5 “Acquisition, Goodwill and Intangibles” for further discussion of the relevant factors that existed at the acquisition date. We arepurchase price allocation. The Company is finalizing the determination of the acquired tax basis and measurement of valuation allowances and uncertain tax positions. There were no significant changes in ourthe Company’s uncertain tax positions since December 31, 2009 other than what may arise fromrelate to the Chordiant acquisition since December 31, 2009.

acquisition.

14.GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS

Our effective tax rate duringThe Company develops and licenses its SmartBPM software that provides business process solutions in the second quarter and first six months of 2009 was below the statutory federal income tax rate primarily due to the investment in tax-exempt municipal bonds and the benefit from the SEZ India tax holiday.

14.  GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS

enterprise applications market. The Company operates in one operating segment—rules-based Business Process Management (“BPM”) software. business process solutions. The Company derives substantially all of its revenue from the sale and support of one group of similar products and services. Substantially all of the Company’s assets are located within the U.S. The Company derived its revenue from the following geographic areas (sales outside the U.S. are principally through export from the U.S.):

 

              Three Months Ended            
June 30,
                Six Months Ended            
June 30,
  Three Months Ended
September 30,
    Nine Months Ended
September 30,
(Dollars in thousands)      2010            2009            2010            2009      2010    2009    2010    2009

U.S.

   $      49,254    60      $      41,709    65      $97,279    62      $81,476    65    $    54,338    61 

     $    39,011    60      $  150,620    61      $    120,486    63 

United Kingdom

   12,156    15      10,944    17      22,862    14      20,807    16    18,413    20 

     15,939    25      41,224    17      36,746    19 

Europe, other

   8,345    10      8,020    13      21,389    14      18,191    14    9,926    11 

     3,556    5      32,215    13      21,748    12 

Other

   12,491    15      3,205    5      15,800    10      5,771    5    7,339    8 

     6,315    10      23,287    9      12,086    6 
                                                                                
   $82,246        100      $63,878        100      $  157,330        100      $  126,245        100    $90,016        100 

     $    64,821        100      $  247,346      100      $    191,066      100 
                                                                                

There were no customers accounting for more than 10% of the Company’s total revenue.revenue or trade receivables, net. The following table summarizes the Company’s concentration of credit risk associated with customers accounting for 10% or more of the Company’s total outstanding trade receivables, and short and long-term license installments:

 

 As of
    June 30,    
 As of
      December 31,  
  As of
September 30, 
 As of
        December 31,  
 
(Dollars in thousands)     2010         2009      2010 2009 

Trade receivables

 $ 65,910     $39,396  

Long and short-term license installments

 $              3,830    $5,805  

Customer A

  14.4     44.5  42.7

Long and short-term license installments

 $ 5,032     $5,805  

Customer B

  49.1  42.7   20.3  20.5

Customer C

  17.9  20.5   18.3  16.8

Customer D

  15.5  16.8   -    12.7

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains or incorporates forward-looking statements within the meaning of section 27A of the Securities Act of 1933 and section 21E of the Securities Exchange Act of 1934. These forward-looking statements are based on current expectations, estimates, forecasts and projections about the industry and markets in which we operate and management’s beliefs and assumptions. In addition, other written or oral statements that constitute forward-looking statements may be made by us or on our behalf. Words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “could,” “estimate,” “may,” “target,” “project,” or variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict.

We encourage you to carefully review the risk factors we have identified in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2009. We believe these risk factors could cause our actual results to differ materially from the forward-looking statements we make. We do not intend to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

Our products and services

We develop and license rules-based BPMour SmartBPM software that provides business process solutions in the enterprise applications market. Our software is used to build business process solutions including customer on-boarding and account opening in new business, customer relationship management (“CRM”), servicing backbone and risk/fraud and compliance management. We also provide professional services, maintenance, and training related to our software. We focus our sales efforts on target accounts, which are companies or divisions within companies, and are typically large organizations that are among the leaders in their industry. Our strategy is to sell initial licenses to these target accounts that are focused on a specific purpose or area of operations, rather than selling large enterprise licenses. This strategy allows our customers to quickly realize business value from our software and limits their initial investment. Once a customer has realized this initial value, we work with the customer to identify opportunities for follow-on sales.

Our license revenue is primarily derived from sales of our PegaRULES Process Commander (“PRPC”) software and related solution frameworks. PRPC is a comprehensive platform for building and managing BPM applications that unifies business rules and business processes. Our solution frameworks are built on the capabilities of PRPC and are purpose- or industry-specific collections of best practice functionality to allow organizations to quickly implement new customer-facing practices and processes, bring new offerings to market, and provide customized or specialized processing. These products often require lessresult in shorter implementation assistanceperiods than prior generations of ourcompetitive enterprise software products. In many cases this has resulted in a shorter sales process and implementation period. PRPC and related solution frameworks can be used by a broad range of customers within financial services, insurance and healthcare markets, as well as other markets, such as life sciences and government.

As a result of our acquisition of Chordiant Software, Inc. (“Chordiant”) in April 2010, we have expanded our ability to develop and its customer experience management solutions, welicense CRM software. We acquired additional products (Chordiant Decision Management, Chordiant Foundation Server, and Chordiant Marketing Director solutions) that enable customers to maximize customer lifetime value through a suite of industry-leading technologies (Chordiant Decision Management, Chordiant Foundation Server, and Chordiant Marketing Director solutions).technologies. We expect to provide new releases of these products that include functional enhancements and improvements. We intend to remain a leader in the use of decision management to improve multi-channel customer experiences, provide better cross-sell/up-sell and aid customer retention. Our intent in this area is to make definition and deployment of decision strategies even easier by leveraging our thin-client design environment and our flexible, Build for Change® configuration capabilities.

We also offer SmartPaaS, which is our platform-as-a service offering that allows customers to create PRPC applications using an internet-based infrastructure.infrastructure (“cloud”). This offering enables our customers to immediately build their applications in a secure cloud environment while minimizing their infrastructure and hardware costs.

Our customers typically request professional services and training to assist them in implementing our products. Almost all of our customers also purchase maintenance on our products, which includes rights to upgrades and new releases, incident resolution and technical assistance. Professional services are provided directly by us and through our network of partners. By developing alliances with these partners, we have increased the supply of multi-skilled service consultants that can assist our customers.

Business overview

Our total revenue increased 29%39% and 25%29%, respectively, during the secondthird quarter and first sixnine months of 2010 compared to the same periods in 2009, primarily because of the increase in maintenance and professional services revenues associated with a higher number of license arrangements executed in 2009 and $7.8 million ofmaintenance revenue directly attributable to the Chordiant operations.amortization of the fair value of deferred revenue acquired from Chordiant. Due to the rapid integration of the sales force and operations of Chordiant it will become increasingly difficultis no longer feasible to separately identify revenue from arrangements attributable to Chordiant in future periods.Chordiant. We used $6.3$9.5 million in cash from operations during the first sixnine months of 2010 and generated $29.4$38.8 million in cash from operations in the first sixnine months of 2009. The primary componentscomponent of cash used in operations during the first sixnine months of 2010 were a $4.3 million net loss, andwas an increase in working capital requirements due to a $12.5$22 million increase in accounts receivable influenced by the timing of customer billings.

Through the first half of 2010, theThe aggregate value of new license arrangements executed in Europe and Asiathe third quarter of 2010 was significantly higher than in the first halfsecond quarter of 2009. During the same period the value of2010. However, due to a large new license arrangementsarrangement executed in the financial services, insurance and government industries was higher than in the first halfthird quarter of 2009. The value of new license arrangements in the first half of 2010 in the healthcare industry was less than the same period in 2009. Overall,2009, the aggregate value of new license arrangements inexecuted through the first halfthree quarters of 2010 was slightly lower than in 2009. Historically, new license arrangements executed in the second half of the year are significantly higher thanthrough the first half.three quarters of 2009.

We believe theseour results reflect our ability to quickly and successfully deliver our versatile Build for Change ® technology to Fortune ® 500 customers across industries and international borders, allowing these customers to reduce operating costs and increase revenues after a short implementation period. These operational efficiencies experienced by our customers are part of the strong value proposition our technology provides to our customers.

We believe the ongoing challenges for our business include our ability to continue to drive revenue growth, continue to expand our expertise in new and existing industries, remain a leader in the decision management market, and maintain our leadership position in the BPM market.

To address these challenges, during the first six months of 2010, we:we continue to invest in our research and development efforts and sales and marketing by significantly increasing headcount and we continue to expand our partner alliances.

Completed the acquisition of Chordiant;

Invested in our research and development efforts and sales and marketing by significantly increasing headcount.

Chordiant Acquisition

On April 21, 2010, we acquired all of the outstanding shares of common stock of Chordiant a leading provider of customer relationship management (“CRM”) software and services with a focus on improving customer experiences through decision technology. Thefor an aggregate purchase price for Chordiant wasof approximately $160.3 million, consisting of $156.8 million in cash and stock options with a fair value of $3.5 million.

We believe thethis acquisition will expandexpands our global customer base and provideprovides complementary solutions. Chordiant clients will beare able to incorporate Pegasystems process automation to enhance the functionality of their existing call center and marketing solutions. Pegasystems’ clients will benefit from Chordiant’s decision management solutions and extensive CRM experience. In addition, we believe the combination of the two companies will expandexpands the partner network and provideprovides incremental growth.growth opportunities. Both organizations share a vision of transforming multi-channel CRM through decisioning and process automation. The combination of Pegasystems and Chordiant will be able to deliver next-generation CRM that provides end-to-end customer experience functionality across organizations. We will focus our research and development efforts to deliver on this vision. We have gained significant expertise and knowledge via the Chordiant personnel who have been integrated with our existing resources.

The valuation of the acquired intangible assets and assumed liabilities is preliminary. The Company is currently in the process of investigating the facts and circumstances existing as of the acquisition date in order to finalize its valuation and establish the related tax basis.

During the second quarter of 2010, in connection with our integration plan, we recorded $6.1 million of severance and related benefit costs for the reduction of approximately 50fifty personnel in redundant roles across multiple functions, primarily general and administrative functions. During the third quarter of 2010, we recorded the remaining $0.4 million of severance and benefit costs related to the reduction of these personnel whose employment ended in the third quarter of 2010. These restructuring costs are all cash costs and are expected to be paid by the end of the second quarter of 2012. We expect to incur an additional $0.4 million in severance costs during the third quarter of 2010. In connection with our evaluation of our combined facilities, we approved a plan to eliminate one redundant facility. As a result, we expect to incur approximately $1.3$1.2 million in additional restructuring expenses, during the third quarter of 2010, representing future lease payments and demising costs, net of estimated sublease income for the identified facility. These exit costs will be recognized when we cease to use the leased facility, which is expected to occur by the end of 2010. In addition to these restructuring costs, during the secondthird quarter and first nine months of 2010, we recorded $0.2 million and $1.1 million, respectively, in compensation and related benefits relating tofor Chordiant employees who are

were in transitional rolls and officesroles that we expect to close. We expect these operating expenses to be approximately $0.4 million inended by the end of the third quarter of 2010 and zero in the fourth quarter of 2010 as the transitional rolls end and the offices will be closed.2010.

Critical accounting policies

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon the condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and the rules and regulations of the SEC for interim financial reporting. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, knowledge of current conditions and beliefs of what could occur in the future given available information.

There have been no changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009, other than as follows:

Goodwill and Intangible Assets Impairment

Goodwill represents the residual purchase price paid in a business combination after all identified assets and liabilities have been recorded. Goodwill is not amortized, but is tested annually for impairment by the use of a fair value model at a reporting unit level. If the fair value of the reporting unit is less than its carrying amount, we would determine the implied fair value of the goodwill and evaluate if it is impaired.

We evaluate our intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. In evaluating potential impairment of these assets, we specifically consider whether any indicators of impairment are present, including, but not limited to:

 

whether there has been a significant adverse change in the business climate that affects the value of an asset;

whether there has been a significant adverse change in the business climate that affects the value of an asset;

 

whether there has been a significant change in the extent or manner in which an asset is used; and

whether there has been a significant change in the extent or manner in which an asset is used; and

 

whether there is an expectation that the asset will be sold or disposed of before the end of its originally estimated useful life.

whether there is an expectation that the asset will be sold or disposed of before the end of its originally estimated useful life.

If indicators of impairment are present, we compare the estimated undiscounted cash flows that the specific asset is expected to generate to its carrying value. These estimates involve significant subjectivity. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value.

Valuation of Goodwill and Acquired Intangible Assets

In connection with our acquisition of Chordiant and as a result of theour preliminary purchase price allocation, we recorded $90.4$88 million of intangible assets, relating principally to customer related intangible assets and acquired technology, and $48.6 million of goodwill.technology. The valuation of the acquired intangible assets and assumed liabilities is preliminary. The valuation process used to calculate the values assigned to these acquired intangible assets is complex and involves significant estimation relative to our financial projections. The principal component of the valuation process is the determination of discounted future cash flows, which are based on a number of estimates and assumptions. There is inherent uncertainty involved with this estimation process. The estimates and assumptions that are most sensitive include, but are not limited to:

 

the selection of an appropriate discount rate;

the selection of an appropriate discount rate;

 

the required return on all assets employed by the valued asset to generate future income;

the required return on all assets employed by the valued asset to generate future income;

 

our projected overall revenue growth and mix of revenue from a market participant’s perspective;

our projected overall revenue growth and mix of revenue from a market participant’s perspective;

 

our gross margin estimates (which are highly dependent on our mix of revenue);

our gross margin estimates (which are highly dependent on our mix of revenue);

 

our technology life cycles;

our technology life cycles;

 

the attrition rate of our customers;

the attrition rate of our customers;

 

our planned level of operating expenses.

Accounting for Income Taxes

We recognize deferred tax assets and liabilities due to temporary differences between the book and tax bases of recorded assets and liabilities. Future realization of our deferred tax assets ultimately depends on the existence of sufficient taxable income within the available carryback or carryforward periods. Sources of taxable income include future reversals of existing taxable temporary differences, future taxable income, taxable income in prior carryback years, and tax planning strategies. We record a valuation allowance to reduce our deferred tax assets to an amount we believe is more likely than not to be realized. Changes in our valuation allowance impact income tax expense in the period of adjustment.

Our deferred tax valuation allowances require significant judgment and uncertainties, including assumptions about future taxable income that are based on historical and projected information.

We have preliminarily determined that we may utilize approximately $146 million of acquired Chordiant net operating losses (“NOLs”), which are subject to annual limitations through 2029. As a result of the preliminary purchase price allocation, we recorded deferred tax assets of approximately $51.1 million related to these acquired NOLs. If our taxable income is not consistent with our expectations or the timing of income is not within the applicable carryforward period, we may be required to establish a valuation allowance on all or a portion of these deferred tax assets.

As a global company, we use significant judgment to calculate and provide for income taxes in each of the tax jurisdictions in which we operate. In the ordinary course of our business, there are transactions and calculations undertaken whose ultimate tax outcome cannot be certain. Some of these uncertainties arise as a consequence of transfer pricing for transactions with our subsidiaries and nexus and credit estimates. In addition, the calculation of acquired tax attributes and the associated limitations are complex. We estimate our exposure to unfavorable outcomes related to these uncertainties and estimate the probability for such outcomes.

Although we believe our estimates are reasonable, no assurance can be given that the final tax outcome will not be different from what is reflected in our historical income tax provisions, returns, and accruals. Such differences, or changes in estimates relating to potential differences, could have a material impact on our income tax provision and operating results in the period in which such a determination is made.

For more information regarding our critical accounting policies, we encourage you to read the discussion contained in Item 7 under the heading “Critical Accounting Policies and Estimates” and Note 2. “Significant Accounting Policies” included in the notes to the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2009.

Results of Operations

 

      Three Months Ended    
June 30,
        Increase (Decrease)    

 

        Six Months Ended    
June 30,
        Increase (Decrease)    

 

 Three Months Ended
September 30,
 Increase (Decrease)

 

 Nine Months Ended
September 30,
 Increase (Decrease)

 

 
(Dollars in thousands)  

 

2010

 

    

 

2009

 

            

 

2010

 

    

 

2009

 

         2010 2009     2010 2009     
                                      

Total revenue

  $82,246    $63,878      $ 18,368  29%        $ 157,330        $126,245      $ 31,085  25%          $ 90,016    $ 64,821            $ 25,195    39%           $ 247,346    $ 191,066      $ 56,280    29%    

Gross profit

  50,986    42,286      8,700  21%      99,634      84,122      15,512  18%    55,026    40,761      14,265    35%       154,660    124,883      29,777    24%    

Acquisition-related expenses

  3,395    -      3,395  n/m      4,903      -      4,903  n/m  

Restructuring expenses

  6,080    -      6,080  n/m      6,080      -      6,080  n/m  

Acquisition-related costs

  111    -      111    n/m       5,014    -      5,014    n/m    

Restructuring costs

  407    -      407    n/m       6,487    -      6,487    n/m    

Other operating expenses

  50,651    30,456      20,195  66%      89,229      59,957      29,272  49%    52,565    33,296      19,269    58%       141,794    93,253      48,541    52%    

Total operating expenses

  60,126    30,456      29,670  97 %      100,212      59,957      40,255  67%    53,083    33,296      19,787    59%       153,295    93,253      60,042    64%    

(Loss) income before (benefit) provision for income taxes

      $(11,510)    $15,716          $ (27,226)  (173)%      $ (5,216)      $28,126          $(33,342)  (119)%  

Income (loss) before provision for income taxes

  $4,208    $8,526      $ (4,318)    (51)%    $ (1,008)    $36,652      $(37,660)    (103)   

n/m – not meaningful

We continue to experience demand for our software productssolutions and related services, which we believe is due to the strong value proposition, short implementation period, and variety of licensing termsmodels we offer our customers. Our success is also due to the growth in the overall BPM sector and our position as the leader in this market space.

The increases in gross profit during the secondthird quarter and first sixnine months of 2010 compared to the same periods in 2009 were primarily due to the increases in maintenance and license revenue.

The increase in operating expenses during the third quarter and first nine months of 2010 was primarily due to costs associated with the continued expansion of our sales force and our research and development operations and incremental expenses related to the Chordiant acquisition and the resulting restructuring costs.

The decreases in income before provision for income taxes during the secondthird quarter and first sixnine months of 2010 compared to the same periods in 2009 were primarily due to the higher growth rate of ourthe operating expenses incremental expenses relatedand lower total gross margin due to the Chordiant acquisition and the resulting restructuring costs, lower software license revenue as a percentage of total revenue and foreign currency transaction lossesrevenue. The decrease in 2010 as opposed to foreign currency gains in 2009.

The increase in operating expensesincome before provision for income taxes during the second quarter and first sixnine months of 2010 included $6.5 million of incremental Chordiant operating expenses.

Our loss before benefit for income taxes was primarily attributablecompared to the $5.5 million and $7.7same period in 2009 was also due to the $6.5 million increase in foreign currency transaction losses during the second quarter and first six months of 2010, respectively, compared to the same periods in 2009.losses.

A change in the number or size of high value license arrangements, or a change in the mix between perpetual and term licenses, can cause our revenues to fluctuate materially from quarter to quarter. The revenue growth rate achieved in any historical period is not necessarily indicative of the results expected for future periods.

Revenue

 

           Three Months Ended         
June 30,
    Increase (Decrease)  

 

  Six Months Ended
June 30,
  Increase (Decrease)

 

(Dollars in thousands)  2010

 

  2009

 

     2010

 

  2009

 

   

License revenue

                            

Perpetual licenses

  $16,104  57 %  $16,130  63 %     $ (26)  n/m      $33,108  56 %    $33,618  63 %    $ (510)    (2)%

Term licenses

   7,641  27 %   8,455  33 %      (814)  (10)%   18,561  32 %     17,788  33 %        773      4%

Subscription

   4,455  16 %   1,066  4 %     3,389  318%   6,874  12 %     2,281  4 %     4,593  201%
                                          

Total license revenue

  $28,200  100 %  $25,651  100 %  $ 2,549    10%  $58,543  100 %    $53,687  100 %  $ 4,856      9%
                                          

n/m = not meaningful

  Three Months Ended
September 30,
 Increase (Decrease)

 

  Nine Months Ended
September 30,
 Increase (Decrease)

 

 
(Dollars in thousands) 2010 2009       2010 2009      

Software license revenue

                

Perpetual licenses

  $ 25,430   75 %  $13,666   48 %  $ 11,764    86%    $ 58,538   63 %  $47,284   58 %  $ 11,254    24%  

Term licenses

  6,909   20 %  12,006   42 %  (5,097)    (42)%    25,470   28 %  29,794   36 %  (4,324)    (15)%  

Subscription

  1,550   5 %  2,686   10 %  (1,136)    (42)%    8,424   9 %  4,967   6 %  3,457    70%  
                                      

Total software license revenue

  $ 33,889   100 %  $28,358   100 %  $ 5,531    20%    $ 92,432   100 %  $82,045   100 %  $ 10,387    13%  
                                      

The mix between perpetual and term license revenue is driven by the type of license arrangements fluctuatesexecuted, which vary based on customer needs. The increase in perpetual license revenue during the third quarter and first nine months of 2010 compared to the same periods in 2009 was primarily due to a significant increase in the number of arrangements.

Many of our perpetual license arrangements include extended payment terms and/or additional rights of use that delay the recognition of revenue to future periods. The aggregate value of payments due under these perpetual and certain subscription licenses was $41.2$36.2 million as of JuneSeptember 30, 2010 compared to $28.2$45.8 million as of JuneSeptember 30, 2009. See the table of future cash receipts by year from these perpetual licenses and certain subscription licenses on page 26.29.

We recognize revenue for our term license arrangements over the term of the agreement as payments become due or earlier if prepaid.paid. The decreasedecreases in term license revenue during the secondthird quarter of 2010 and first nine months of 2010 compared to the same periodperiods in 2009 waswere primarily due to fewer arrangements and more prepayments of term licenses by a few customers during the secondthird quarter of 2009.

The aggregate value of payments due under term licenses was $66.1$71.6 million as of JuneSeptember 30, 2010 compared to $78.0$70.2 million as of JuneSeptember 30, 2009. A portion of the revenue related to the aggregate value of payments for term licenses signed during 2010, 2009, 2008, and 20072008 was recognized during the secondthird quarter and first sixnine months of 2010. The remainder of the revenue under these agreements will be recognized in future periods. The aggregate value of future payments due under non-cancellable term licenses as of JuneSeptember 30, 2010 includes $11.8$5.3 million of term license payments that we expect to recognize as revenue during the remainder of 2010. However, we expect our actual term license revenue for the remainder of 2010 could be higher than $11.8$5.3 million as we complete new term license agreements in 2010 or if we receive prepayments from existing term license agreements. See the table of future cash receipts by year from these term licenses on page 26.29.

Subscription revenue primarily relates to our arrangements that include a right to unspecified future products and is recognized ratably over the term of the arrangement. The increasesdecrease in subscription revenue during the secondthird quarter of 2010 compared to the same period in 2009 was primarily due to a change in a customer’s selection of a renewal option and the timing of scheduled payments under another customer’s arrangement. Changes of this nature can cause our subscription revenue to vary quarter to quarter. The increase in subscription revenue during the first sixnine months of 2010 compared to the same periodsperiod in 2009 werewas primarily due to a new customer arrangement that began in the third quarter of 2009.

 

  

    Three Months Ended    

September 30,

 

   

Increase

 

   

Nine Months Ended

September 30,

   

Increase

 

 
          Three Months Ended         
June 30,
          Increase        

 

         Six Months Ended         
June 30,
          Increase        

 

                    
(Dollars in thousands)  2010  2009    2010  2009     2010   2009           2010   2009         

Maintenance revenue

                               

Maintenance

  $ 20,388  $12,171      $ 8,217  68%   $ 35,474  $24,119  $ 11,355  47%       $ 23,418       $12,489       $  10,929     88 %       $ 58,892     $36,608     $ 22,284     61%    

The increases in maintenance revenue during the secondthird quarter and first sixnine months of 2010 compared to the same periods in 2009 were primarily due to the $4.1 million and $8 million in maintenance revenue attributable to the amortization of the fair value of deferred revenue acquired from Chordiant, respectively, and the continued increase in the aggregate value of the installed base of our software and $3.9 million revenue contribution from Chordiant.

software.

  Three Months Ended
June  30,
  Increase  Six Months Ended
June 30,
  Increase

 

 Three Months Ended
September 30,
 Increase Nine Months Ended
September 30,
 Increase

 

 
(Dollars in thousands)  2010

 

  2009

 

     2010

 

  2009

 

    2010 2009     2010 2009     

Professional services revenue

                                            

Consulting Services

  $ 32,000  95   $25,108  96   $ 6,892  27%  $ 59,719  94   $46,281  96   $ 13,438  29%    $ 31,349   96 %  $23,371   97 %  $ 7,978    34%    $ 91,068   95 %  $69,652   96 %  $ 21,416    31%  

Training

   1,658  5    948  4    710  75%   3,594  6    2,158  4    1,436  67%    1,360   4 %  603   3 %  757    126%    4,954   5 %  2,761   4 %  2,193    79%  
                                                                      

Total Professional services

  $ 33,658  100   $26,056  100 

 

  $ 7,602  29%  $ 63,313  100   $48,439  100   $ 14,874  31%    $ 32,709   100 %  $23,974   100 %  $ 8,735    36%    $ 96,022   100 %  $72,413   100 %  $ 23,609    33%  
                                                                      

Professional services are primarily consulting services related to new license implementations. During the secondthird quarter and first sixnine months of 2010, the increases in consulting services and training were primarily due to a higher demand for these services in North America associated with new license arrangements executed in 2009 and $3.9 million revenue contribution from Chordiant.2009.

Gross profit

 

  

    Three Months Ended    

September 30,

 

   

Increase

 

   

Nine Months Ended

September 30,

 

   

Increase

 

 
          Three Months Ended         
June 30,
          Increase        

 

          Six Months Ended         
June 30,
          Increase        

 

                    
(Dollars in thousands)  2010

 

  2009

 

     2010

 

  2009

 

     2010   2009           2010   2009         

Gross Profit

                                

Software license

  $27,091  $25,620      $1,471  6%      $ 57,403  $53,625        $ 3,778  7%         $ 32,318           $28,330       $ 3,988       14%       $ 89,721       $81,955       $ 7,766       9%    

Maintenance

    17,673    10,714        6,959  65%        30,822    21,225          9,597  45%     20,231       10,931       9,300       85%       51,053       32,156       18,897       59%    

Professional services

      6,222      5,952      270  5%        11,409      9,272          2,137  23%     2,477       1,500       977       65%       13,886       10,772       3,114       29%    
                                                  

Total gross profit

  $ 50,986  $42,286      $8,700  21%      $99,634  $84,122      $ 15,512  18%     $ 55,026       $40,761             $14,265       35%       $154,660       $124,883           $ 29,777       24%    
                                                  

Software gross profit percent

   95%       100%           97%       100%        

Maintenance gross profit percent

           87%             88%                 87%             88%         86%       88%           87%       88%        

Professional services gross profit percent

           18%             23%                 18%             19%         8%       6%           14%       15%        

Gross profit percentage of professional services can vary quarter to quarter due to the timing of project completion, however, gross profit percent for each of software license, maintenance and professional services for the third quarter and first sixnine months of 2010 waswere relatively unchanged fromcompared to the same periodperiods in 2009. The decreases in software license gross profit percent during the third quarter and first nine months of 2010 were due to the amortization expense of acquired technology intangibles related to Chordiant.

 

           Three Months Ended         
June 30,
          Increase        

 

          Six Months Ended         
June 30,
          Increase        

 

(Dollars in thousands)  2010

 

  2009

 

     2010

 

  2009

 

   

Amortization of intangibles:

                

Cost of software license

  $ 1,079      $31      $  1,048  n/m  $ 1,110      $62      $ 1,048  n/m  

Selling and marketing

      $847        $-           $847  n/m       $847        $-          $847  n/m  

General and Administrative

        $47        $5             $42  n/m         $52      $10             $42  n/m  
                      

Total amortization expense

  $1,973      $36        $1,937  n/m    $2,009      $72        $1,937  
                      

       Three Months Ended    
September 30,
   Increase

 

       Nine Months Ended    
September 30,
   Increase

 

 
(Dollars in thousands)  2010   2009           2010   2009         

Amortization of intangibles:

                

Cost of software license

   $ 1,550           $28           $  1,522       n/m           $ 2,660       $90       $ 2,570       n/m      

Selling and marketing

   1,206       -       1,206       n/m       2,053       -       2,053       n/m      

General and Administrative

   67       5       62       n/m       118       15       103.       n/m      
                                  

Total amortization expense of intangibles

   $2,823       $33       $2,790       n/m       $4,831           $105           $4,726      
                                  

The increases in amortization expense during the secondthird quarter and first sixnine months of 2010 compared to the same periods in 2009 were due to the amortization associated with the $90.4$88.0 million of identifiableacquired intangible assets recognized as a result of the preliminary purchase price allocation of Chordiant. The identifiable intangible assets are expected to be amortized over a weighted-average period of 8.4 years on a straight-line basis.

Operating expenses

 

          Three Months Ended         
June 30,
          Increase        

 

          Six Months Ended         
June 30,
          Increase        

 

      Three Months Ended    
September 30,
   Increase

 

   Nine Months Ended
September 30,
   Increase

 

 
(Dollars in thousands)  2010

 

  2009

 

     2010

 

  2009

 

     2010   2009           2010   2009         

Selling and marketing

                                

Selling and marketing

  $ 29,896  $16,659      $ 13,237  79%    $ 51,789  $32,095      $ 19,694  61%         $ 31,199         $19,568         $ 11,631     59%         $ 82,988         $51,663         $ 31,325     61%    

As a percent of total revenue

          36%            26%                  33%            25%         35%       30%           34%       27%        

Selling and marketing headcount at June 30

                  365        215              150  70%  

Headcount at September 30

           376       230       146     63%    

Selling and marketing expenses include compensation, benefits, and other headcount-related expenses associated with our selling and marketing personnel as well as advertising, promotions, trade shows, seminars, and other programs. Selling and marketing expenses also include the amortization of customer related intangibles.

The increase in selling and marketing expenses during the secondthird quarter of 2010 compared to the same period in 2009 was primarily due to a $4.6$5.7 million increase in compensation and benefit expenses associated with higher headcount, a $1.3$1.2 million increase in amortization related to the acquired Chordiant customer related intangibles, a $1.1 million increase in travel expenses, $2.7 million of incremental expenses related to Chordiant and $1.9$0.7 million higher expenses related to marketing programs including PegaWorld, our annual user conference heldand $0.4 million increase in April 2010.contractor services expenses. The increase in selling and marketing expenses during the first sixnine months of 2010 compared to the same period in 2009 was primarily due to a $8.4$15.9 million increase in compensation and benefit expenses associated with higher headcount, a $2.1 million increase in amortization related to the acquired Chordiant customer related intangibles, a $3.2 million increase in travel expenses, $2.7$1.0 million of incrementalincrease in contractor services expenses, related to Chordiant and $2.1$2.8 million of higher expenses related to marketing programs, including PegaWorld.our PegaWorld user conference. To provide coverage oftarget new accounts across expanded geographies and to create additional accounts and geographiessales capacity for future periods, we significantly increased sales hiring in the first half of 2010. Sales hiring in the third quarter of 2010 was at a lower rate compared to create additional sales capacity for future periods.the second quarter of 2010. We plan to hire additional sales personnel in the second halffourth quarter of 2010 but at a lowersimilar rate as compared toin the first halfthird quarter of 2010.

 

          Three Months Ended         
June 30,
  Increase

 

          Six Months Ended         
June 30,
  Increase

 

      Three Months Ended    
September 30,
   Increase

 

       Nine Months Ended    
September 30,
   Increase

 

 
(Dollars in thousands)  2010

 

  2009

 

     2010

 

  2009

 

     2010   2009           2010   2009         

Research and development

                                

Research and development

  $ 14,010  $9,149      $ 4,861  53%    $ 25,636  $18,268      $ 7,368  40%     $ 14,924     $9,930     $ 4,994     50%     $ 40,560     $28,198     $ 12,362     44%  

As a percent of total revenue

           17%          14%                 16%            14%         17 %     15%         16%     15%      

Research and development headcount at June 30

                   347          201           146  73%  

Headcount at September 30

           368     219     149     68%  

Research and development expenses include compensation, benefits, contracted services, and other headcount-related expenses associated with research and development. The increase in headcount reflects organic growth, primarily in our Indian research facility, as well as new employees from the Chordiant acquisition. The second quarter research and development expenses include only two months of compensation related to Chordiant employees. Other than the Chordiant acquisition, our increase in offshore headcount was primarily in our Indian research facility thereby loweringlowered our average compensation expense per employee.

The increase in research and development expenses during the secondthird quarter of 2010 compared to the same period in 2009 was due to a $1.4$3.1 million increase in compensation and benefit expenses associated with higher headcount primarily in our research and development facility in India, a $0.5$0.4 million increase in engineering contractor expenses and $2.7a $0.2 million increase in travel expenses associated with the expansion of expenses related to Chordiant.our India operations. The increase in research and development expenses during the first sixnine months of 2010 compared to the same period in 2009 was due to a $2.7$7.2 million increase in compensation and benefit expenses associated with higher headcount, a $1.1$1.4 million increase in engineering contractor expenses, and $2.7a $0.3 million of incremental expenses related to Chordiant.increase in travel expenses.

   

Three Months Ended    
June 30,

 

       

Increase

 

     

Six Months Ended

June 30,

 

  

Increase

 

(Dollars in thousands)  

 

2010  

 

     

 

2009  

 

          

 

2010  

 

     

 

2009  

 

   

 

General and administrative

                           

 

General and administrative

  $ 6,745      $4,648         $ 2,097    45 %      $ 11,804      $9,594    $ 2,210  23%  

As a percent of total revenue

  8%      7%               8%      8%      

General and administrative headcount at June 30

                   184      141    43  30%  

       Three Months Ended    
September 30,
   Increase

 

       Nine Months Ended    
September 30,
   Increase

 

 
(Dollars in thousands)  2010   2009           2010   2009         

General and administrative

                

General and administrative

   $ 6,442     $3,798     $2,644     70 %     $18,246     $13,392     $ 4,854     36%  

As a percent of total revenue

   7%     6%         7%     7%      

Headcount at September 30

           176     138     38     28%  

General and administrative expenses include compensation, benefits, and other headcount-related expenses associated with the finance, legal, corporate governance, and other administrative headcount. It also includes accounting, legal, and other professional consulting administrative fees.

The general and administrative headcount includes employees in human resources, information technology and corporate services departments whose costs are allocated to the rest of the Company’sour functional departments. The general and administrative headcount at June 30,expenses during the third quarter and first nine months of 2010 also includes approximately 20include $0.2 million and $1.1 million, respectively, of compensation and benefit expenses for Chordiant employees who were in transitional roles that are part of the restructuring related to the Chordiant acquisition and whose employment with the Company will endended by the end of the third quarter of 2010.

The increase in general and administrative expenses during the secondthird quarter of 2010 compared to the same period in 2009 was due to a $0.2$0.4 million increase in compensation and benefit expenses associated with higher headcount, a $0.3 million increase in contractor services expenses,expense, and a $0.3$0.8 million increase in professional fees, and $1.1 million of expenses related to Chordiant.fees. The increase in general and administrative expenses during the first sixnine months of 2010 compared to the same period in 2009 was primarily due to a $0.5$1.5 million increase in compensation and benefit expenses associated with higher headcount, a $0.3$0.7 million increase in contractingcontractor services expense, and $1.1a $0.7 million increase in professional fees. The increases in general and administrative expenses during the third quarter and first nine months of expenses related2010 compared to Chordiant.the same periods in 2009 was also due to a $0.5 million reduction in our non-income tax reserve recorded during the third quarter of 2009.

Acquisition-related costs

Acquisition-related costs are expensed as incurred and include costs to effect an impending or completed acquisition and direct and incremental costs associated with an acquisition. During the second quarterfirst nine months of 2010, the $3.4we incurred $5.0 million of acquisition-related costs were primarily advisory fees, legal, tax consulting and valuation fees associated with our acquisition of Chordiant. During the first quarter of 2010, the $1.5 million of acquisition related costs were primarily legal and advisory fees and due diligence costs associated with the Chordiant acquisition. These costs consisted of approximately $3.1 million of due diligence costs and advisory and legal transaction fees, approximately $0.7 million of valuation and tax consulting fees, approximately $0.8 million of legal costs associated with acquired litigation, and approximately $0.4 million of integration and other expenses.

Restructuring costs

The $6.1 million of restructuringRestructuring costs are primarily severance and related benefit costs recognized during the second and third quarter of 2010 for the reduction of approximately 50fifty personnel in redundant roles, primarily in general and administrative functions. We expect to incur an additional $0.4 million in severance costs during the third quarter of 2010. In connection with our evaluation of our combined facilities, we approved a plan to eliminate one redundant facility. As a result, we expect to incur approximately $1.3$1.2 million in additional restructuring expenses, during the end of 2010, representing future lease payments and demising costs, net of estimated sublease income for this identified facility. These exit costs will be recognized when we cease to use the leased facility, which is expected to occur by the end of 2010.

Stock-based compensation

The following table summarizes stock-based compensation expense included in our condensed consolidated statements of operations:

 

      Three Months Ended    
June 30,
  Increase

 

      Six Months Ended    
June 30,
  Increase

 

      Three Months Ended    
September 30,
   Increase

 

       Nine Months Ended    
September 30,
   Increase

 

 
(Dollars in thousands)  

 

2010

 

  2009

 

     2010

 

  2009

 

     2010   2009           2010   2009         

Stock-based compensation expense:

                                

Cost of services

  $483    $128    $355    277%    $881    $634      $ 247    39%     $447       $250       $ 197       79%     $ 1,328       $884       $444       50%  

Operating expenses

  1,703  

 

  732  

 

  971  

 

  133%  

 

  2,751  

 

  1,924  

 

  827  

 

  43%  

 

           1,134               715               419       59%             3,885               2,639               1,246       47%  
                                                  

Total stock-based compensation before tax

  $2,186    $860      $1,326    154%    $3,632    $2,558    1,074    42%     $1,581       $965       $616       64%     $5,213       $3,523       $1,690       48%  

Income tax benefit

  (578)    (155)        (1,091)    (739)         $(555)       $(527)           $(1,646)       $(1,266)        

The increases in stock-based compensation during the secondthird quarter and first sixnine months of 2010 compared to the same periods in 2009 were primarily due to our periodic stock option grants and new hire stock option grants.

       Three Months Ended    
June 30,
  Change

 

      Six Months Ended    
June 30,
  Change

 

(Dollars in thousands)  

 

2010

 

  

 

2009

 

     

 

2010

 

  

 

2009

 

   

Non-operating (loss) income and expenses, net

                

Foreign currency transaction (loss) gain

  $(2,542)   $2,923   $(5,465)   (187)%   $(5,616)   $2,111     $(7,727)   (366)% 

Interest income, net

  119   881   (762)   (86)%   632   1,683   (1,051)   (62)% 

Installment receivable interest income

  52   75   (23)   (31)%   104   150   (46)   (31) % 

Other income, net

  

 

  

 

  (6) 

 

  (86)% 

 

  242 

 

  17 

 

  225 

 

  n/m 

 

                      

Non-operating (loss) income and expenses, net

  $(2,370) 

 

  $3,886 

 

    $(6,256) 

 

  (161)% 

 

  $(4,638) 

 

  $3,961 

 

  $(8,599) 

 

  217 % 

 

                      

n/m = not meaningful

Non-operating (loss) income and expenses, net

      Three Months Ended    
September 30,
  Change      Nine Months Ended    
September 30,
  Change 
(Dollars in thousands) 2010  2009     2010  2009    
                        

Foreign currency transaction gain (loss)

  $ 1,513      $266      $ 1,247      469%      $ (4,103)      $2,377      $ (6,480)      (273)%    

Interest income, net

  129      721      (592)      (82)%      761      2,404      (1,643)      (68)%    

Installment receivable interest income

  51      74      (23)      (31)%      155      224      (69)      (31)%    

Other income, net

      572          —          572      n/m          814          17          797          n/m    
                          

Non-operating income (loss) and expenses, net

      $2,265          $1,061          $1,204      113%          $(2,373)          $5,022          $(7,395)      (147)%    
                          

n/m = not meaningful

The increase in foreign currency transaction gains during the third quarter of 2010 compared to the same period in 2009 was due to the increase in the value of the British pound and Euro relative to the U.S. dollar during the three-month comparative periods.

The increase in foreign currency transaction losses during the first nine months of 2010 was due to the significant decrease in the value of the British pound and the Euro relative to the U.S. dollar during the nine-month comparative periods and the higher total amount of foreign currency denominated net assets held in the U.S., during 2010, consisting primarily of cash receivables, license installments and accounts payable.receivables.

As a result of our acquisition of Chordiant, we have expanded our international operations. We hold U.S. dollars in these foreign operations whose functional currency is the Euro in order to partially offset our exposure to foreign currency transaction losses related to non-functionalforeign currencies held by our U.S. operating company.

Other income for the third quarter and first nine months of 2010 includes a $0.6 million unrealized gain related to the fair value adjustment of warrants we own for shares of a closely-held private company. On November 1, 2010, the sale of this private company was completed and we received $0.6 million cash proceeds for the shares underlying these warrants.

The decreases in interest income and the increases in the realized gains for the secondthird quarter and first sixnine months of 2010 compared to the same periods in 2009 were due to the liquidation of our marketable securities used to pay for the Chordiant acquisition.

(Benefit) provisionProvision for income taxes

We account for income taxes at each interim period using our estimated annual effective tax rate. The provision for income taxes represents current and future amounts owed for federal, state, and foreign taxes.

During the second quarter and first six months of 2010, we recorded a benefit of $3.3 million and $0.9 million, respectively, on a pre-tax loss of $11.5 million and $5.2 million, respectively, which resulted in an effective tax rate of 28.9% and 16.9%, respectively. We recorded a discrete item related to the nondeductible portion of acquisition-related costs incurred in the second quarter and first sixnine months of 2010 associated with the Chordiant acquisition, which reduced the tax benefit for the second quarter and first sixnine months of 2010 by 2.9% and 13.5%, respectively.resulted in a provision of $0.2 million on a pre-tax loss of $1 million. During the third quarter of 2010, we recorded a $1.1 million provision on pre-tax income of $4.2 million, which resulted in an effective tax rate of 25.4%.

We are infinalizing the process of evaluating our tax position related to the assets acquired and liabilities assumed from the Chordiant acquisition. The valuation of the assets acquired and liabilities assumed, including the valuationdetermination of the acquired net operating losses is preliminarytax basis and is subjectmeasurement of valuation allowances and uncertain tax positions. There were no significant changes in our uncertain tax positions since December 31, 2009 other than what may relate to change until we have gathered all of the relevant facts that existed at the acquisition date.Chordiant acquisition.

Our effective tax rate during the secondthird quarter and first sixnine months of 2009 was below the statutory federal income tax rate primarily due to the investment in tax-exempt municipal bonds and the benefit from the SEZ India tax holiday.

Liquidity and capital resources

After the issuance of our March 31, 2010 interim financial statements, management identified an error in the presentation of currency transaction losses on foreign currency denominated cash and cash equivalents within the statement of cash flows. Please see Note 1 “Accounting Policies” in the accompanying notes to the unaudited condensed consolidated financial statements.

  

Six Months Ended

June 30,

  

Nine Months Ended

September 30,

 
(in thousands)  2010  2009  2010   2009 

Cash (used in) provided by:

        

Operating activities

    $(6,318)    $29,432   $(9,506)      $38,839  

Investing activities

   14,628   (12,789)   8,725     (17,650)  

Financing activities

   (3,031)   (3,853)   (6,919)     (2,071)  

Effect of exchange rate on cash

   (6,103)   919   (3,380)     1,214  
              

Net (decrease) increase in cash and cash equivalents

    $(824)    $13,709   $(11,080)     $20,332  
              
  As of
June 30, 2010
    As of  
  December 31, 2009  
  As of
    September 30, 2010    
   As of
    December 31, 2009      
 

Total cash, cash equivalents, and marketable securities

    $            74,041    $202,653   $68,853     $202,653  
              

We have funded our operations primarily from cash provided by operations. Working capital was $61.7$66.4 million as of JuneSeptember 30, 2010 compared to $188.6 million as of December 31, 2009.

In April 2010, we acquired Chordiant for $109.2 million in cash, net of approximately $47.6 million of cash acquired.

In connection with the Company’sour integration plan of Chordiant and the reduction of approximately 50fifty employees, the Companywe paid approximately $1.1$2.6 million in severance and related benefit costs during the second quarterfirst nine months of 2010. The Company expectsWe expect to pay an additional $5$3.9 million in severance and related benefit costs, of which $3.9$3.3 million will be paid over the next 12 months and $1.1$0.6 million by the second half of 2012.

We believe that our current cash, cash equivalents, and cash flow from operations will be sufficient to fund our operations and our share repurchase program for at least the next 12 months.

Cash (used in) provided by operating activities

The primary components of cash used in operations during the first sixnine months of 2010 were a $4.3$1.2 million net loss and a $12.5$22 million increase in accounts receivable and $5.5 million of excess tax benefits from exercise or vesting of equity awards.receivable.

The primary driver of cash provided by operations during the first sixnine months of 2009 was net income of $19.9$25.9 million.

Future Cash Receipts from License Arrangements

The following table summarizes the cash receipts due in connection with our existing license agreements as of June 30, 2010.agreements:

 

As of June 30,(in thousands)

     

Installment

payments for

    licenses recorded on    

the balance sheet (1)

       

Installment

      payments for term      

licenses not recorded

on the balance sheet (2)

       

Other license payments not    

recorded on the balance    

sheet (3)    

As of September 30,(in thousands)

 Installment
payments for
licenses recorded on
    the  balance sheet (1)    
 

Installment

payments for term
licenses not recorded
 on the balance sheet (2) 

 Other license payments not
recorded on the balance
sheet (3)
 
                 

Remainder of 2010

  $   1,828      $11,840              $15,921 $466   $5,341           $7,280  

2011

    2,232       26,129       17,608  2,260    28,792    19,408  

2012

    1,292       18,031       7,704  1,316    20,166    8,429  

2013

    -       7,543       -  -    9,812    405  

2014

    -       2,389       -

Thereafter

    -       206       -

2014 and thereafter

  -    7,508    640  
                            

Total

    5,352      $66,138              $41,233  4,042   $71,619           $36,162  
                         

Unearned installment interest income

    (320)              (212)    
                     

Total license installments receivable, net

  $   5,032             $3,830    
                     

 

(1)These license installment payments have already been recognized as license revenue and are included in short- and long-term license installments in the accompanying unaudited condensed consolidated balance sheet as of JuneSeptember 30, 2010.

(2)These amounts will be recognized as revenue in the future over the term of the agreement as payments become due or earlier if prepaid.

(3)These amounts willare expected to be recognized as revenue in future periods and relate to perpetual and subscription licenses with extended payment terms and/or additional rights of use.

Cash provided by (used) investing activities

During the first quarter of 2010, we liquidated our marketable securities to pay for the Chordiant acquisition. During the second quarter of 2010, we paid $109.0$109.2 million, net of cash acquired to complete the Chordiant acquisition.

During the first sixnine months of 2009, cash used in investing activities was primarily for purchases of marketable debt securities of $29.5$50 million, partially offset by the proceeds received from the sales, maturities and called marketable debt securities of $18.5$35.9 million.

Cash used in financing activities

Cash used in financing activities during the first sixnine months of 2010 and 2009 was primarily for repurchases of our common stock and the payment of our quarterly dividend. Since 2004, our Board of Directors has approved annual stock repurchase programs that have authorizedauthorizing the repurchase in the aggregate of up to $75.0$80.8 million of our common stock. Purchases under these programs have been made on the open market.

Share repurchases

The following table is a summary of our repurchase activity under all of our repurchase programs during the first sixnine months of 2010 and 2009:

 

   2010     2009
(Dollars in thousands)  

 

        Shares        

     Amount               Shares             Amount  

Prior year authorization as of January 1,

     $  15,779     $  12,862

Authorizations

          

Repurchases paid

     96,579  (3,195)     570,954  (8,824)

Repurchases unsettled

  3,024  (100)      
            

Authorization remaining as of June 30,

     $  12,484     $  4,038
            

   2010     2009
(Dollars in thousands)          Shares            

  Amount  

             Shares            

  Amount  

Prior year authorization as of January 1,

     $ 15,779    $ 12,862

Authorizations

         

Repurchases paid

      214,414    (5,962)     605,256    (9,859)

Repurchases unsettled

   799    (24)    975    (34)
           

Authorization remaining as of September 30,

     $ 9,793    $ 2,969
         

In addition to the share repurchases made under our repurchase programs, we net settled the majority of our employee equity awards, which resulted in the withholding of shares to cover the stock option exercise price and the minimum statutory tax withholding obligations.

During the first sixnine months of 2010 and 2009, our employees net settled equity awards representing the right to purchase a total of 623,000571,000 shares and 1,704,0002,161,000 shares, respectively, of which only 289,000299,000 shares and 777,0001,049,000 shares were issued to the employees and the balance of the shares were surrendered to us to pay for the exercise price and the applicable taxes. During the first sixnine months of 2010 and 2009, instead of receiving cash from the equity holders, we withheld shares with a value of $4.2$4.5 million and $5.6$7.0 million, respectively, for withholding taxes, and $4.7$5.0 million and $15.1$19.7 million, respectively, for the exercise price. The value of share repurchases and shares withheld for net settlement of our employee equity awards more than offset the proceeds received under our various share-based compensation plans during the first sixnine months of 2010 and 2009.

Dividends

The CompanyWe declared a cash dividend of $0.03 per share for each quarter during the first sixnine months of 2010 and 2009, and paid cash dividends of $2.2$3.3 million and $3.2 million in both the first sixnine months of 2010 and 2009.2009, respectively. It is our current intention to pay a quarterly cash dividend of $0.03 per share to shareholders of record as of the first trading day of each quarter, however, the Board of Directors may terminate or modify this dividend program at any time without notice.

Contractual obligations

As of JuneSeptember 30, 2010, we had material purchase obligations for customer support and consulting services and payments under operating leases. Our principal administrative, sales, marketing, support, and research and development operations are located in approximately 105,000 square foot leased facility in Cambridge, Massachusetts. The lease for this facility expires in 2013, subject to our option to extend for two additional five-year periods. We also lease space for our other offices under non-cancelable operating leases that expire on various dates through 2014.

As of JuneSeptember 30, 2010 our known contractual obligations, including future minimum rental payments required under operating leases with non-cancelable terms in excess of one year were as follows:

 

  Total  Payment due by period      Payment due by period 

Contractual obligations:

(in thousands)

   Remainder 
 of 2010 
  2011 &
2012
  2013 &
2014
  2015 and
after
  Other  Total    Remainder 
 of 2010 
   2011 &
2012
   2013 &
2014
   2015 and
after
   Other 

Purchase obligations (1)

  $1,894  $1,894  $—    $—    $  $—    $1,588    $839    $749    $—      $         —    $         —    

Liability for uncertain tax positions (2)

   881   881   —     —     —       881     881     —       —       —        

Operating lease obligations (3)

   23,753   3,962   15,547   4,244      —     23,226     2,517     16,382     4,327          —    
                                          

Total

  $  26,528  $6,737  $  15,547  $    4,244  $         —  $         —  $  25,695    $    4,237    $  17,131    $  4,327            
                                          

 

(1)Represents the fixed or minimum amounts due under purchase obligations for customer support and consulting services.

(2)We expect that the changes in the unrecognized benefits within the next twelve months will be approximately $0.9 million related to tax positions for which the ultimate settlement is highly certain but for which there is uncertainty about the timing of such recognition. We are finalizing the determination of the acquired tax basis and measurement of valuation allowances and uncertain tax positions from Chordiant.

(3)Includes deferred rent of approximately $1.1$0.9 million included in accrued expenses and approximately $1.8$2.3 million in other long-term liabilities in the accompanying consolidated balance sheet as of JuneSeptember 30, 2010. Excludes a total commitment of approximately $6.2 million, net of incentives, under a ten-year lease that is expected to be signed in the fourth quarter of 2010.

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Market risk represents the risk of loss that may affect us due to adverse changes in financial market prices and rates. Our market risk exposure is primarily related to fluctuations in foreign exchange rates and interest rates. We have not entered into derivative or hedging transactions to manage risk in connection with such fluctuations.

Foreign currency exposure

We derived approximately 38%39% and 35%37% of our total revenue from sales to customers based outside of the United States (“U.S.”) during the first sixnine months of 2010 and 2009, respectively. Our international license and professional services have increasingly become denominated in foreign currencies. However, the operating expenses of our foreign operations are also primarily denominated in foreign currencies, which partially offset our foreign currency exposure. A decrease in the value of foreign currencies, particularly the British pound and the Euro relative to the U.S. dollar, could adversely impact our revenues and operating results.

MostOur U.S. operating company invoices most of our transactions withforeign customers are invoiced from our offices in the U.S. For those transactions that are denominated inforeign currencies, other than the U.S. dollar, we haveso it holds certain cash, receivables and license installments that are valued in these foreign currencies. Our U.S. operating company holds cash in foreign currencies in order to support our foreign operations. Ourcompany’s functional currency is primarily the U.S. dollar, therefore,dollar. Therefore, when there are changes in the foreign currency exchange rates versus the U.S. dollar, we recognize a foreign currency transaction gain or (loss) in our condensed consolidated statements of operations. In addition, our foreign subsidiarieswe have intercompany accounts that are eliminated in consolidation, but that expose us to foreign currency exchange rate fluctuation. Foreign currency exchange rate fluctuations on our short-term intercompany accountsfluctuation, which are recorded as foreign currency transaction gains or (losses) in our condensed consolidated statements of operations.

As a result of our acquisition of Chordiant, we have expanded our international operations. We hold U.S. dollars in these foreign operations whose functional currency is the Euro in order to partially offset our exposure to foreign currency transaction losses related to non-functionalforeign currencies held by our U.S. operating company. As of JuneSeptember 30, 2010, we held cash and receivables subject to foreign currency transaction gains or (losses)losses with a net carrying value of approximately $20.2$18.9 million. TheA ten percent change in the foreign currency exchange rates as of September 30, 2010 would have changed the net carrying value of theseour net monetary assets includes the nettingby approximately $1.9 million as of U.S. dollar denominated monetary assets heldthat date with a corresponding currency gain (loss) recognized in certain foreign operations whose functional currency is the Euro with the foreign currency monetary assets held by our U.S.condensed consolidated statement of operations.

During the first sixnine months of 2010, we recorded a $5.6$4.1 million foreign currency transaction loss due to the decrease in the value of foreign currencies, primarily the Euro and British pound, relative to the U.S. dollar. As of June 30, 2010, a ten percent change in foreign currency exchange rates would have changed the carrying value of our net monetary assets by approximately $2.0 million as of that date with a corresponding currency gain (loss) recognized in our consolidated statement of operations.

Interest rate exposure

In March 2010, we liquidated our marketable securities and invested the proceeds primarily in money market funds in preparation to pay for the Chordiant acquisition. In April 2010, we acquired Chordiant for a cash purchase price of approximately $109.2 million, net of approximately $47.6 million of cash acquired. WeAs of September 30, 2010, our cash was invested the cash primarily in money market funds, commercial paper, and government sponsored enterprises and foreign currencies.enterprise bonds. As a result, we are not subject to significant interest rate risk.

Item 4.  Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures.

Our management, with the participation of our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of JuneSeptember 30, 2010. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of JuneSeptember 30, 2010.

(b) Changes in Internal Control over Financial Reporting.

There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act) during the quarter ended JuneSeptember 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II—Other Information:

Item 1A.    Risk Factors

We encourage you to carefully consider the risk factors identified in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009. These risk factors could materially affect our business, financial condition and future results and could cause our actual business and financial results to differ materially from those contained in forward-looking statements made in this Quarterly Report on Form 10-Q or elsewhere by management from time to time. There have been no material changes during the first sixnine months of 2010 to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December  31, 2009.

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds

The following table sets forth information regarding our repurchases of our common stock during the secondthird quarter of 2010:

 

Period                    

  

    Total Number    
of Shares
Purchased

     

  Average Price  
Paid per

Share

   

Total Number

of Shares
    Purchased as Part    

of Publicly

Announced Share

Repurchase

Programs (1)

     

Approximate Dollar

Value of Shares That

    May Yet Be Purchased    

Under Publicly

Announced Share

Repurchase Programs

(in thousands) (1)

4/1/10-4/30/10

  15,070  $ 34.54  15,070  $ 13,698

5/1/10-5/31/10

  22,579   30.81  22,579   13,002

6/1/10-6/30/10

  17,655   29.34  17,655   12,484
           

Total

  55,304  $ 31.36     

Period                    

  

    Total Number    

of Shares

Purchased

      

  Average Price  

Paid per

Share

   

Total Number

of Shares

    Purchased as Part    

of Publicly

Announced Share

Repurchase

Programs (1)

   

Approximate Dollar

Value of Shares That

    May Yet Be Purchased    

Under Publicly

Announced Share

Repurchase Programs

(in thousands) (1)

7/1/10-7/31/10

  15,053   $   31.65  15,053     $ 12,008

8/1/10-8/31/10

  98,093   21.85  98,093  9,864

9/1/10-9/30/10

  2,464   29.01  2,464  9,793
          

Total

  115,610   $   23.28    

 

(1)Since 2004, our Board of Directors has approved annual stock repurchase programs that have authorized the repurchase, in the aggregate, up to $75.0$80.8 million of our common stock. The most recentOn November 24, 2009, we announced a $15 million repurchase program was publicly announced on November 24, 2009 andthat expires December 31, 2010.2010 (the “Current Program”). On November 8, 2010, we announced that our Board of Directors approved an increase in the remaining funds available under the Current Program, from $9.2 million to $15 million, and an extension of the expiration date to December 31, 2011. Under this program, purchases willmay be made from time to time on the open market or in privately negotiated transactions. Shares may be repurchased in such amounts as market conditions warrant, subject to regulatory and other considerations. The Company hasWe have established a pre-arranged stock repurchase plan, intended to comply with the requirements of Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, and of Rule 10b-18 of the Exchange Act (the “10b5-1 Plan”). All share repurchases under the FourthCurrent Program during closed trading window periods will be made pursuant to the 10b5-1 Plan.

Item 6.Exhibits

Item 6.  Exhibits

The exhibits listed in the Exhibit Index immediately preceding such exhibits are filed as part of this report and such Exhibit Index is incorporated herein by reference.

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: AugustNovember 9, 2010 By: 

/s/ CRAIG DYNES

  Craig Dynes
  Senior Vice President, Chief Financial Officer
  

(principal financial officer)

(duly authorized officer)

PEGASYSTEMS INC.

Exhibit Index

 

Exhibit No.

  

Description

31.1  Certification pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief Executive Officer.
31.2  Certification pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief Financial Officer.
32  Certification pursuant to 18 U.S.C. Section 1350 of the Chief Executive Officer and the Chief Financial Officer.

 

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