SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2001
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___ TO
Commission File Number: 1-11859
PEGASYSTEMS INC.
(Exact name of Registrant as specified in its charter)
Massachusetts 04-2787865
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization )
101 Main Street
Cambridge, MA 02142-1590
(Address of principal executive offices) (zip code)
(617) 374-9600
(Registrant's telephone number including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
There were 32,676,988 shares of the Registrant's common stock, $.01 par value
per share, outstanding on July 27, 2001.
PEGASYSTEMS INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at June 30, 2001
and December 31, 2000 3
Condensed Consolidated Statements of Operations for the three
and six months ended June 30, 2001 and 2000 4
Condensed Consolidated Statements of Cash Flows for the six
months ended June 30, 2001 and 2000 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 2. Changes in Securities and Use of Proceeds 16
Item 3. Defaults upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES 18
PEGASYSTEMS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE-RELATED AMOUNTS)
JUNE 30, December 31,
2001 2000
-------------------- -------------------
Assets
Current assets:
Cash and cash equivalents $ 24,589 $ 17,339
Trade and installment accounts receivable, net of allowance for
doubtful accounts of $1,031 in 2001 and $1,037 in 2000 43,454 41,416
Prepaid expenses and other current assets 1,929 2,297
-------------------- -------------------
Total current assets 69,972 61,052
Long-term license installments, net 38,929 37,401
Equipment and improvements, net 4,398 6,568
Purchased software and other assets, net 4,100 5,472
-------------------- -------------------
Total assets $117,399 $110,493
==================== ===================
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 13,258 $ 11,917
Deferred revenue 6,954 5,065
Current portion of capital lease obligations 237 312
-------------------- -------------------
Total current liabilities 20,449 17,294
Commitments and contingencies (Note E)
Deferred income taxes 1,000 1,000
Capital lease obligations, net of current portion -- 84
Other long-term liabilities 34 52
-------------------- -------------------
Total liabilities 21,483 18,430
Stockholders' Equity:
Preferred stock, $.01 par value, 1,000,000 shares authorized; no
shares issued and outstanding -- --
Common stock, $.01 par value, 45,000,000 shares authorized; 327 326
32,676,988 shares and 32,570,094 shares issued and outstanding in
2001 and 2000, respectively
Additional paid-in capital 101,099 100,886
Stock warrant 2,897 2,897
Retained deficit (8,031) (11,777)
Accumulated other comprehensive loss (376) (269)
-------------------- -------------------
Total stockholders' equity 95,916 92,063
-------------------- -------------------
Total liabilities and stockholders' equity $117,399 $110,493
==================== ===================
See notes to condensed consolidated financial statements.
Page 3 of 18
PEGASYSTEMS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2001 2000 2001 2000
---------------- ------------------- --------------- -----------------
Revenue:
Software license $ 8,653 $ 9,168 $19,534 $ 15,264
Services 14,203 12,112 26,138 24,022
---------------- ------------------- --------------- -----------------
Total revenue 22,856 21,280 45,672 39,286
---------------- ------------------- --------------- -----------------
COST OF REVENUE:
Cost of software license 1,231 586 1,878 1,171
Cost of services 9,241 8,356 18,697 16,937
---------------- ------------------- --------------- -----------------
Total cost of revenue 10,472 8,942 20,575 18,108
---------------- ------------------- --------------- -----------------
GROSS PROFIT 12,384 12,338 25,097 21,178
OPERATING EXPENSES:
Research and development 4,995 3,933 9,986 7,868
Selling and marketing 4,231 6,559 9,140 11,596
General and administrative 2,106 2,608 5,096 5,205
Litigation settlement -- 14,088 -- 14,088
---------------- ------------------- --------------- -----------------
Total operating expenses 11,332 27,188 24,222 38,757
---------------- ------------------- --------------- -----------------
INCOME (LOSS) FROM OPERATIONS 1,052 (14,850) 875 (17,579)
Installment receivable interest income 1,450 900 2,900 1,843
Other interest income,net 234 485 448 888
Other income (expense),net 141 (206) (2) (178)
---------------- ------------------- --------------- -----------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME 2,877 (13,671) 4,221 (15,026)
TAXES
Provision for income taxes 225 28 475 50
---------------- ------------------- --------------- -----------------
NET INCOME (LOSS) $ 2,652 ($13,699) $ 3,746 ($15,076)
================ =================== =============== =================
EARNINGS (LOSS) PER SHARE:
Basic $0.08 ($0.47) $0.11 ($0.52)
================ =================== =============== =================
Diluted $0.08 ($0.47) $0.11 ($0.52)
================ =================== =============== =================
WEIGHTED AVERAGE NUMBER OF COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING:
Basic 32,655 29,152 32,625 29,144
================ =================== =============== =================
Diluted 33,379 29,152 33,371 29,144
================ =================== =============== =================
See notes to condensed consolidated financial statements.
Page 4 of 18
PEGASYSTEMS INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
SIX MONTHS ENDED
JUNE 30,
2001 2000
---------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 3,746 ($15,076)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization 3,539 3,217
Provision for doubtful accounts -- 190
Changes in operating assets and liabilities:
Trade and installment accounts receivable (3,575) 4,053
Prepaid expenses and other current assets 337 (208)
Accounts payable and accrued expenses 1,531 (722)
Accrued litigation settlement -- 17,700
Deferred revenue 1,889 (5,317)
---------------- ----------------
Net cash provided by operating activities 7,467 3,837
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment and improvements (252) (783)
Other long term assets and liabilities 173 55
---------------- ----------------
Net cash used in investing activities (79) (728)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of capital lease obligations (159) (97)
Exercise of stock options 49 725
Sale of stock under employee stock purchase plan 164 400
---------------- ----------------
Net cash provided by financing activities 54 1,028
---------------- ----------------
Effect of exchange rate changes on cash and cash equivalents (192) (76)
---------------- ----------------
NET INCREASE IN CASH AND CASH
EQUIVALENTS 7,250 4,061
---------------- ----------------
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD $17,339 $ 30,004
---------------- ----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $24,589 $ 34,065
================ ================
See notes to condensed consolidated financial statements.
Page 5 of 18
PEGASYSTEMS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2001
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Pegasystems Inc. (the "Company") presented herein have been prepared in
accordance with accounting principles generally accepted in the United States of
America and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three and six month periods ended June 30, 2001 are
not necessarily indicative of the results that may be expected for the full year
ending December 31, 2001. The Company suggests that these condensed
consolidated financial statements be read in conjunction with the consolidated
financial statements and notes thereto for the year ended December 31, 2000,
included in the Company's 2000 Annual Report on Form 10-K filed with the
Securities and Exchange Commission ("SEC").
NOTE B - REVENUE RECOGNITION
The Company's revenue is derived from two principal sources: software license
fees and services fees. Software license fees are generally payable on a monthly
basis under license agreements, which generally have a five-year term and may be
renewed for additional years at the customer's option. The present value of
future license payments is generally recognized as revenue upon customer
acceptance. A portion of the fee from each arrangement is deferred and
recognized as installment receivable interest income over the license term. In
the case of software license agreement renewals, license fee revenue is
recognized upon the commencement of the new license terms.
The Company's services revenue is comprised of fees for implementation,
consulting, maintenance, and training services. Software license customers are
offered the option to enter into an annual maintenance contract requiring the
customer to pay a monthly maintenance fee renewable on a year-to-year basis.
Prepaid maintenance fees are deferred based on their estimated fair value and
are recognized ratably over the term of the maintenance agreement. The Company's
software implementation agreements typically require the Company to provide a
specified level of implementation services for a specified fee, typically with
additional implementation services available at an hourly rate. Implementation
fees for time and material projects are recognized as incurred. Implementation
fees for fixed price projects are recognized once the fair value of services and
any other elements to be delivered under the arrangement can be determined.
Costs associated with fixed price contracts are expensed as incurred. Prior to
the point at which the fair value of the elements of a contract can be
determined, revenue recognition is limited to amounts equal to costs incurred
during the reporting period, resulting in no gross profit. Once the fair values
of the elements of a contract are apparent, profit associated with the services
elements will begin to be recognized. Training and consulting fees are generally
recognized as the services are provided.
Page 6 of 18
NOTE C - EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is computed based on the weighted average number
of common shares outstanding during the period. Diluted earnings (loss) per
share includes, to the extent inclusion of such shares would be dilutive to
earnings per share, the effect of outstanding options and warrants, computed
using the treasury stock method.
(in thousands, except per share data) Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
------------- --------------- -------------- --------------
Basic
Net income (loss) $ 2,652 ($13,699) $ 3,746 ($15,076)
============= =============== ============== ==============
Weighted average common shares outstanding 32,655 29,152 32,625 29,144
============= =============== ============== ==============
Basic earnings (loss) per share $ 0.08 ($0.47) $ 0.11 ($0.52)
============= =============== ============== ==============
Diluted
Net income (loss) $ 2,652 ($13,699) $ 3,746 ($15,076)
============= =============== ============== ==============
Weighted average common shares outstanding 32,655 29,152 32,625 29,144
Effect of assumed exercise of stock options 724 -- 746 --
------------- --------------- -------------- --------------
Weighted average common shares
outstanding, assuming dilution 33,379 29,152 33,371 29,144
============= =============== ============== ==============
Diluted earnings (loss) per share $ 0.08 ($0.47) $ 0.11 ($0.52)
============= =============== ============== ==============
Outstanding options and warrant excluded as
impact would be anti-dilutive 8,007 4,683 7,530 4,992
============= =============== ============== ==============
NOTE D - COMPREHENSIVE INCOME
The components of the Company's comprehensive income (loss) are as follows:
(in thousands) Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
------------- --------------- -------------- --------------
Net income (loss) $ 2,652 ($13,699) $ 3,746 ($15,076)
Foreign currency translation adjustments, net (15) (59) (107) (76)
of income taxes
------------- ------------- -------------- --------------
Comprehensive income (loss) $ 2,637 ($13,758) $ 3,639 ($15,152)
============= ============= ============== ==============
Page 7 of 18
NOTE E - COMMITMENTS AND CONTINGENCIES
Company Litigation
Ernst & Young Case. On June 9, 2000, the Company, Alan Trefler, the Company's
Chief Executive Officer, and Ira Vishner (a former chief financial officer of
the Company) filed a complaint against Ernst & Young LLP ("Ernst & Young") and
Alan B. Levine (a former partner of Ernst & Young) in Massachusetts state court
("the Complaint"). The Complaint alleged that the defendants committed
professional malpractice, breached contractual and fiduciary duties owed to the
Company, and issued false and misleading public statements, in connection with
advice that Ernst & Young rendered to the Company to record $5 million in
revenue in its financial statements for the second fiscal quarter ended June 30,
1997 pursuant to a series of contracts between the Company and First Data
Resources, Inc. (the "FDR Contracts"). The Complaint sought compensatory
damages, including contribution for losses and other costs incurred in
connection with certain class action securities litigation, now settled, arising
out of the Company's accounting for the FDR Contracts. On April 5, 2001, the
court dismissed the Complaint, finding that it was subject to the dispute
resolution procedures set forth in an engagement letter between the Company and
Ernst & Young. Pursuant to those dispute resolution procedures, on April 19,
2001, the Company and Messrs. Trefler and Vishner, through counsel, notified
Ernst & Young and Mr. Levine of their intention to submit the dispute that was
the subject of the court action to mediation. If mediation is unsuccessful, the
dispute resolution procedures provide that the dispute be submitted to
arbitration. The parties are scheduled to mediate this dispute in the fall of
2001. In the event mediation proves unsuccessful, the parties will move to
arbitration.
SEC INVESTIGATION. In May 1999, the Boston office of the SEC issued a Formal
Order of Private Investigation of the Company and unidentified individuals,
currently or formerly associated with the Company, concerning past accounting
matters, financial reports, and other public disclosures and trading activity in
the Company's securities during 1997 and 1998. The Company has cooperated fully
with the investigation.
NOTE F - RESTRUCTURING
During the three months ended December 31, 2000, the Company recorded a one-time
restructuring charge of $1.0 million for the severance of 75 employees in
various locations and certain costs associated with leased facilities. As of
June 30, 2001, all terminations have been completed, all severance has been
paid, and no restructuring accruals remain.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Historically, the timing of the Company's revenue has been unpredictable. The
timing of license revenue recognition is related to the completion of
implementation services and acceptance of the licensed software by the customer,
the timing of which has proven difficult to predict accurately. The Company is
more focused on closing larger but fewer license transactions than in the past.
This may increase the volatility of the Company's quarterly operating results.
THREE AND SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE AND SIX MONTHS ENDED
JUNE 30, 2000
Total revenue for the three months ended June 30, 2001 ("second quarter of
2001") increased 7% to $22.9 million from $21.3 million in the three months
ended June 30, 2000 ("second quarter of 2000"). The increase in total revenue
was due to an increase in services revenue. Total revenue for the six months
ended June 30, 2001 ("first half of 2001") increased 16% to $45.7 million from
$39.3 million in the six months ended June 30, 2000 ("first half of 2000"). The
increase in total revenue was due to an increase in software license and
services revenue.
Page 8 of 18
Software license revenue for the second quarter of 2001 decreased 6% to $8.7
million from $9.2 million in the second quarter of 2000. Decreases in license
revenue from new customers were partially offset by increased software license
renewals and $0.6 million due to improved accounting estimates relating to the
revenue attributable to the inflation adjustment provisions contained in the
Company's long-term software license agreements ($1.2 million for the first half
of 2001.). These improved accounting estimates will continue to benefit the
remaining quarters of 2001. Software license revenue for the first half of 2001
increased 28% to $19.5 million from $15.3 million in the first half of 2000. The
increase in software license revenue was due primarily to increased software
license renewals. A significant portion of the Company's software license
revenue is from existing customers.
Services revenue for the second quarter of 2001 increased 17% to $14.2 million
from $12.1 million in the second quarter of 2000. The increase was primarily due
to revenue from service projects performed in prior periods but not recognized
until the second quarter of 2001 when the terms of the Company's engagements
with respect to such projects were finalized. Services revenue for the first
half of 2001 increased 9% to $26.1 million from $24.0 million in the first half
of 2000. The increase was primarily due to revenue from service projects
performed in prior periods but not recognized until the first half of 2001 when
the terms of the Company's engagements with respect to such projects were
finalized.
Deferred revenue balances increased to $7.0 million as of June 30, 2001 from
$5.1 million as of December 31, 2000, due primarily to billings for software
licenses in advance of customer acceptance and revenue recognition, and annual
maintenance billings in the first half of 2001 that are recognized as revenue
ratably during the year.
COST OF REVENUE
Cost of software license revenue for the second quarter of 2001 increased 110%
to $1.2 million from $0.6 million in the second quarter of 2000. Cost of
software license includes the amortization associated with a stock purchase
warrant issued by the Company in June 1997, and the Company's acquisition of
software for resale. The increase was due to additional software acquired by
the Company in the fourth quarter of 2000 which, after initially being
amortized, was expensed in full in the second quarter of 2001 because the
productive use of this software is no longer anticipated. Cost of software
license as a percentage of license revenue increased to 14% from 6% in the
second quarter of 2000 primarily due to the increase in the cost of software
license. Cost of software license revenue for the first half of 2001 increased
60% to $1.9 million from $1.2 million in the first half of 2000, for the same
reason as noted above. Cost of software license as a percentage of license
revenue increased to 10% from 8% in the first half of 2000 due to the increase
in the cost of software license.
Cost of services consists primarily of the costs of providing implementation,
consulting, maintenance, and training services. Cost of services for the second
quarter of 2001 increased 11% to $9.2 million from $8.4 million for the second
quarter of 2000. The increase was due primarily to higher third party contracted
consultants billed to customers. Cost of services for the first half of 2001
increased 10% to $18.7 million from $16.9 million for the first half of 2000.
Cost of services as a percentage of services revenue increased to 72% for the
first half of 2001 from 71% for the first half of 2000. The increases were due
to third party contracted consultants billed to customers, and incentive
compensation and benefits accruals, partially offset by the impact of the
reduction in headcount implemented in the first half of 2001. Incentive
compensation increased due to a combination of enhanced incentive opportunities
and better performance versus goals.
OPERATING EXPENSES
Research and development expenses for the second quarter of 2001 increased 27%
to $5.0 million from $3.9 million for the second quarter of 2000. As a
percentage of total revenue, research and development expenses
Page 9 of 18
increased to 22% for the second quarter of 2001 from 18% for the second quarter
of 2000. The increase was due to higher incentive compensation and benefits
accruals, contracted resources, and the redeployment of internal resources.
Research and development expenses for the first half of 2001 increased 27% to
$10.0 million from $7.9 million for the first half of 2000. As a percentage of
total revenue, research and development expenses increased to 22% for the first
half of 2001 from 20% for the first half of 2000. The increase was due to higher
incentive compensation and benefits accruals, contracted resources, and the
redeployment of internal resources.
Selling and marketing expenses for the second quarter of 2001 decreased 35% to
$4.2 million from $6.6 million for the second quarter of 2000. As a percentage
of total revenue, selling and marketing expenses decreased to 19% for the second
quarter of 2001 from 31% for the second quarter of 2000. The decreases were due
to reduced marketing program and infrastructure costs and contracted services.
Selling and marketing expenses for the first half of 2001 decreased 21% to $9.1
million from $11.6 million for the first half of 2000. As a percentage of total
revenue, selling and marketing expenses decreased to 20% for the first half of
2001 from 30% for the first half of 2000. The decreases were due to reduced
discretionary spending such as travel and infrastructure costs and lower
marketing program and contracted services expense, partially offset by higher
incentive compensation accruals.
General and administrative expenses for the second quarter of 2001 decreased 19%
to $2.1 million from $2.6 million for the second quarter of 2000. As a
percentage of total revenue, general and administrative expenses decreased to 9%
for the second quarter of 2001 from 12% for the second quarter of 2000. The
decrease was due primarily to lower discretionary spending on infrastructure and
third party consulting expense. General and administrative expenses for the
first half of 2001 decreased 2% to $5.1 million from $5.2 million for the first
half of 2000. As a percentage of total revenue, general and administrative
expenses decreased to 11% for the first half of 2001 from 13% for the first half
of 2000. The decrease was due primarily to lower discretionary spending on
infrastructure and third party consulting expense offset by higher incentive
compensation and benefit accruals.
Installment Receivable Interest Income
Installment receivable interest income, which consists of the portion of all
license fees under long-term software license lease agreements that is
attributable to the time value of money, increased to $1.5 million for the
second quarter of 2001 from $0.9 million for the second quarter of 2000.
Installment receivable interest income for the first half of 2001 increased to
$2.9 million from $1.8 million for the first half of 2000. These increases were
due to improved accounting estimates regarding the amount of interest income
earned and higher average discount rates. A portion of the fee from each
license lease arrangement is initially deferred and recognized as installment
receivable interest income over the rest of the license term. For purposes of
the present value calculations, the discount rate used has varied between 5.375%
and 8.00% for the past few years.
OTHER INTEREST INCOME, NET
Other interest income, net, decreased to $0.2 million for the second quarter of
2001 from $0.5 million for the second quarter of 2000. Other interest income,
net, decreased to $0.4 million for the first half of 2001 from $0.9 million for
the first half of 2000. These decreases were due to lower average balances of
cash and cash equivalents.
OTHER INCOME (EXPENSE), NET
Other income (expense), net, which consists primarily of currency exchange gains
or losses and reseller development funds received from third-party vendors of
computer hardware products, was a $0.1 million gain for the second quarter of
2001 compared to a $0.2 million loss for the second quarter of 2000. This
increase was due primarily to a smaller currency exchange loss, offset by
increased reseller development funds received. Other income (expense), net was
a two thousand dollar loss for the first half of 2001 compared to a $0.2 million
loss for the first half of 2000. This increase was due primarily to increased
reseller development funds received, partially offset by a larger currency
exchange losses.
Page 10 of 18
PROVISION FOR INCOME TAXES
The tax provision for the second quarter of 2001 was $0.2 million compared to
$28 thousand for the second quarter of 2000. The tax provision for the first
half of 2001 was $0.5 million compared to $50 thousand for the first half of
2000. These increases are related to foreign subsidiary income tax and
profitable operations in the United States. No significant provision for U.S.
taxes have been made in 2001, due to the availability of tax loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has funded its operations primarily through
cash flow from operations, bank borrowings, and proceeds from the Company's
public stock offerings. At June 30, 2001, the Company had cash and cash
equivalents of $24.6 million and working capital of $49.5 million.
Net cash provided by operations for the first half of 2001 was $7.5 million
compared with $3.8 million for the first half of 2000. The increase was due
primarily to improved profitability from on-going operations. In the first half
of 2000, cash provided by operations included a one-time $4.3 million insurance
reimbursement received by the Company related to the shareholder lawsuits.
Net cash used in investing activities was $79 thousand for the first half of
2001, compared to $0.7 million during the first half of 2000. The change was
due primarily to reduced purchases of equipment and leasehold improvements.
Net cash provided by financing activities was $54 thousand for the first half of
2001, compared to $1.0 million during the first half of 2000. This change was
mostly due to lower proceeds from exercises of stock options and the employee
stock purchase plan.
The Company believes that current cash and cash equivalents will be sufficient
to fund the Company's operations for the near term. There can be no assurance,
however, that changes in the Company's plans or other events affecting the
Company's operations will not result in materially accelerated or unexpected
expenditures. In addition, there can be no assurance that additional capital,
if needed, will be available on reasonable terms, if at all, at such time as
required by the Company.
INFLATION
Inflation has not had a significant impact on the Company's operating results to
date, and the Company does not expect it to have a significant impact in the
future. The Company's license and maintenance fees are typically subject to
annual increases based on recognized inflation indexes.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Form 10-Q may be construed as "forward-
looking statements" as defined in the Private Securities Litigation Reform Act
of 1995. These statements involve various risks and uncertainties which could
cause the Company's actual results to differ from those expressed in such
forward-looking statements. These risks and uncertainties include the
fluctuation in the Company's quarterly results, reliance on third-party
relationships, risk of non-renewal by current customers, delays in product
development and implementation, rapid technological change involving the
Company's products and those of competitors, the Company's dependence on
customers in the finance services market, intense competition in the markets for
the Company's products, liquidity issues and regulatory proceedings, and other
risks and uncertainties. Further information regarding those factors which could
cause the Company's actual results to differ materially from any forward-looking
statements contained herein is provided below.
Page 11 of 18
THE TIMING OF LICENSE REVENUES IS RELATED TO THE COMPLETION OF IMPLEMENTATION
SERVICES AND PRODUCT ACCEPTANCE BY THE CUSTOMER, THE TIMING OF WHICH HAS BEEN
DIFFICULT TO PREDICT ACCURATELY. There can be no assurance that the Company
will be profitable on an annual or quarterly basis or that earnings or revenues
will meet analysts' expectations. Fluctuations may be particularly pronounced
because a significant portion of revenues in any quarter is attributable to
product acceptance or license renewal by a relatively small number of customers.
Fluctuations also reflect a policy of recognizing revenue upon product
acceptance or license renewal in an amount equal to the present value of the
total committed payments due during the term. Customers generally do not accept
products until the end of a lengthy sales cycle and an implementation period,
typically ranging from one to six months but in some cases significantly longer.
In addition, the Company is more focused on closing larger but fewer license
transactions than in the past. This may increase the volatility in the Company's
quarterly operating results. Risks over which the Company has little or no
control, including customers' budgets, staffing allocation, and internal
authorization reviews, can significantly affect the sales and acceptance cycles.
Changes dictated by customers may delay product implementation and revenue
recognition.
THE COMPANY RELIES ON CERTAIN THIRD-PARTY RELATIONSHIPS. The Company has a
number of relationships with third parties that are significant to sales,
marketing and support activities and product development efforts. The Company
relies on relational database management system applications and development
tool vendors, software and hardware vendors, and consultants to provide
marketing and sales opportunities for the direct sales force and to strengthen
the Company's products through the use of industry-standard tools and utilities.
The Company also has relationships with third parties that distribute its
products. In particular, the Company relies on its relationship with First Data
Corporation for the distribution of products to the credit card market, with
PFPC Inc. for distribution of products to the mutual fund market and on Carreker
Inc for the distribution of its products to the banking industry. There can be
no assurance that these companies, most of which have significantly greater
financial and marketing resources, will not develop or market products that
compete with those of the Company in the future or will not otherwise end their
relationships with or support of the Company.
IF EXISTING CUSTOMERS DO NOT RENEW THEIR LICENSES, THE COMPANY'S FINANCIAL
RESULTS MAY SUFFER. A significant portion of total revenue has been
attributable to license renewals. While historically a substantial majority of
customers have renewed their licenses, there can be no assurance that a
substantial majority of customers will continue to renew expiring licenses. A
decrease in license renewals absent offsetting revenue from other sources would
have a material adverse effect on future financial performance. In addition,
possible transition to a perpetual or prepaid extended term license may have a
material adverse impact on the amount of license renewal revenues in future
periods.
THE COMPANY WILL NEED TO DEVELOP NEW PRODUCTS, EVOLVE EXISTING ONES, AND ADAPT
TO TECHNOLOGY CHANGE. Technical developments, customer requirements,
programming languages and industry standards change frequently in the Company's
markets. As a result, success in current markets and new markets will depend
upon the Company's ability to enhance current products, to develop and introduce
new products that meet customer needs, keep pace with technology changes,
respond to competitive products, and achieve market acceptance. Product
development requires substantial investments for research, refinement and
testing. There can be no assurance that the Company will have sufficient
resources to make necessary product development investments. Pegasystems may
experience difficulties that will delay or prevent the successful development,
introduction or implementation of new or enhanced products. Inability to
introduce or implement new or enhanced products in a timely manner would
adversely affect future financial performance. The Company's products are
complex and may contain errors. Errors in products will require the Company to
ship corrected products to customers. Errors in products could cause the loss of
or delay in market acceptance or sales and revenue, the diversion of development
resources, injury to the Company's reputation, or increased service and warranty
costs which would have an adverse effect on financial performance.
Page 12 of 18
THE COMPANY HAS HISTORICALLY SOLD TO THE FINANCIAL SERVICES MARKET. This market
is consolidating rapidly, and faces uncertainty due to many other factors. The
Company has historically derived a significant portion of its revenue from
customers in the financial services market, and its future growth depends, in
part, upon increased sales to this market. Competitive pressures, industry
consolidation, decreasing operating margins within this industry, currency
fluctuations, geographic expansion and deregulation affect the financial
condition of the Company's customers and their willingness to pay. In addition,
customers' purchasing patterns are somewhat discretionary. As a result, some or
all of the factors listed above may adversely affect the demand by customers.
The financial services market is undergoing intense domestic and international
consolidation. In recent years, several customers have been merged or
consolidated. Future mergers or consolidations may cause a decline in revenues
and adversely affect the Company's future financial performance.
THE MARKET FOR THE COMPANY'S OFFERINGS IS INCREASINGLY AND INTENSELY
COMPETITIVE, RAPIDLY CHANGING, AND HIGHLY FRAGMENTED. The market for customer
relationship management software and related implementation, consulting and
training services is intensely competitive and highly fragmented. The Company
currently encounters significant competition from internal information systems
departments of potential or existing customers that develop custom software. It
also competes with companies that target the customer interaction and workflow
markets and professional services organizations that develop custom software in
conjunction with rendering consulting services. Competition for market share and
pressure to reduce prices and make sales concessions are likely to increase.
Many competitors have far greater resources and may be able to respond more
quickly and efficiently to new or emerging technologies, programming languages
or standards or to changes in customer requirements or preferences. Competitors
may also be able to devote greater managerial and financial resources to
develop, promote and distribute products and provide related consulting and
training services. There can be no assurance that the Company will be able to
compete successfully against current or future competitors or that the
competitive pressures faced by the Company will not materially adversely affect
its business, operating results, and financial condition.
THE COMPANY DEPENDS ON CERTAIN KEY PERSONNEL, AND MUST BE ABLE TO ATTRACT AND
RETAIN QUALIFIED PERSONNEL IN THE FUTURE. The business is dependent on a number
of key, highly skilled technical, managerial, consulting, sales, and marketing
personnel, including Mr. Trefler, the Company's Chief Executive Officer. The
loss of key personnel could adversely affect financial performance. The Company
does not have any key-man life insurance on any officers or employees and does
not plan to put any in place. The Company's success will depend in large part on
its ability to hire and retain qualified personnel. The number of potential
employees who have the extensive knowledge of computer hardware and operating
systems needed to develop, sell and maintain its products is limited, and
competition for their services is intense, and there can be no assurance that
the Company will be able to attract and retain such personnel. If the Company is
unable to do so, the Company's business, operating results, and financial
condition could be materially adversely affected.
THE COMPANY IS BEING INVESTIGATED BY THE SECURITIES AND EXCHANGE COMMISSION. In
May of 1999, the Boston office of the SEC issued a Formal Order of Private
Investigation of the Company and certain individuals, currently or formerly
associated with the Company, concerning past accounting matters, financial
reports and other public disclosures and trading activity in the Company's
securities during 1997 and 1998. Such investigation may result in the SEC
imposing fines on the Company or taking other measures that may have a material
adverse impact on the Company's financial position or results of operations. In
addition, regardless of the outcome of the investigation, it is likely that the
Company will incur substantial defense costs and that such investigation will
cause a diversion of management time and attention. Finally, the negative
publicity resulting from the investigation has made and may continue to make it
more difficult for the Company to close sales, which in turn could have a
material adverse impact on the Company's financial position or results of
operations.
Page 13 of 18
THE COMPANY HAD MATERIAL WEAKNESSES IN ITS INTERNAL CONTROL ENVIRONMENT. The
Company's independent public accountants identified material weaknesses in the
Company's internal control environment in connection with their audits of the
Company's 1997, 1998 and 1999 financial statements. This has had, and may
continue to have, a material adverse impact on the Company's reputation, which
in turn could have a material adverse impact on the Company's financial position
or results of operations. The Company has added resources to its finance
function and is working diligently with the suggestions of the auditors to
improve internal control. In connection with the audit of the Company's 2000
financial statements the independent auditors did not issue a material weakness
letter.
THE COMPANY'S STOCK PRICE HAS BEEN VOLATILE. Quarterly results have fluctuated
and are likely to continue to fluctuate significantly. The market price of the
Company's common stock has been and may continue to be highly volatile. Factors
that are difficult to predict, such as quarterly revenues and operating results,
statements and ratings by financial analysts, overall market performance and the
outcome of litigation, will have a significant effect on the price for shares of
the Company's common stock. Revenues and operating results have varied
considerably in the past from period to period and are likely to vary
considerably in the future. The Company plans product development and other
expenses based on anticipated future revenue. If revenue falls below
expectations, financial performance is likely to be adversely affected because
only small portions of expenses vary with revenue. As a result, period-to-period
comparisons of operating results are not necessarily meaningful and should not
be relied upon to predict future performance.
THE COMPANY MAY FACE PRODUCT LIABILITY AND WARRANTY CLAIMS. The Company's
license agreements typically contain provisions intended to limit the nature and
extent of the Company's risk of product liability and warranty claims. There is
a risk that a court might interpret these terms in a limited way or could hold
part or all of these terms to be unenforceable. Also, there is a risk that these
contract terms might not bind a party other than the direct customer.
Furthermore, some of the Company's licenses with its customers are governed by
non-U.S. law, and there is a risk that foreign law might give the Company less
or different protection. Although the Company has not experienced any material
product liability claims to date, a product liability suit or action claiming a
breach of warranty, whether or not meritorious, could result in substantial
costs and a diversion of management's attention and the Company's resources.
THE EURO'S ADOPTION IMPOSES PRODUCT AND MARKET RISKS. A new currency, the
"Euro", was introduced in certain Economic and Monetary Union ("EMU") countries
in early 1999. It is expected that by 2002, all participating EMU countries will
use the Euro as their single currency. As a result, software used by many
companies headquartered or maintaining a subsidiary in a participating EMU
country is expected to be Euro-enabled. All companies headquartered or
maintaining a subsidiary in an EMU country will need to be Euro-enabled. These
changes will change budgetary, accounting and fiscal systems in companies and
public administration, and require the simultaneous handling of parallel
currencies and conversion of legacy data. These requirements may curb market
demand for the Company's products because the budgets and priorities of its
customers and prospective customers may change. The Company is monitoring the
rules and regulations as they become known in order to make any changes to its
software products that the Company deems necessary to comply with such rules and
regulations. Although the Company believes that its most recent products address
these requirements, there can be no assurance that the rules and regulations
will not change and that the Company's software will contain all of the
necessary changes or meet all Euro requirements. Any inability to comply with
the Euro requirements could have an adverse effect on the Company's business,
operating results and financial condition.
THE COMPANY FACES RISKS FROM OPERATIONS AND CUSTOMERS BASED OUTSIDE OF THE U.S.
Sales to customers headquartered outside of the United States represented
approximately 26%, 21% and 23% of the Company's total revenue in 2000, 1999 and
1998, respectively. The Company, in part through its wholly owned subsidiaries
based in the United Kingdom, Singapore, and Australia, markets products and
renders
Page 14 of 18
consulting and training services to customers based in Canada, the United
Kingdom, France, Germany, the Netherlands, Switzerland, Ireland, Mexico, Sweden,
Australia, Austria, Hong Kong, and Singapore. The Company has established
offices in continental Europe and in Australia. The Company believes that its
continued growth will necessitate expanded international operations requiring a
diversion of managerial attention and financial resources. The Company
anticipates hiring additional personnel to accommodate international growth, and
the Company may also enter into agreements with local distributors,
representatives, or resellers. If the Company is unable to do one or more of
these things in a timely manner, the Company's growth, if any, in its foreign
operations will be restricted, and the Company's business, operating results,
and financial condition could be materially and adversely affected.
In addition, there can be no assurance that the Company will be able to maintain
or increase international market demand for its products. Most of the Company's
international sales are denominated in U.S. dollars. Accordingly, any
appreciation of the value of the U.S. dollar relative to the currencies of those
countries in which the Company distributes its products may place the Company at
a competitive disadvantage by effectively making its products more expensive as
compared to those of its competitors. Additional risks inherent in the Company's
international business activities generally include unexpected changes in
regulatory requirements, increased tariffs and other trade barriers, the costs
of localizing products for local markets and complying with local business
customs, longer accounts receivable patterns and difficulties in collecting
foreign accounts receivable, difficulties in enforcing contractual and
intellectual property rights, heightened risks of political and economic
instability, the possibility of nationalization or expropriation of industries
or properties, difficulties in managing international operations, potentially
adverse tax consequences (including restrictions on repatriating earnings and
the threat of "double taxation"), enhanced accounting and internal control
expenses, and the burden of complying with a wide variety of foreign laws. There
can be no assurance that one or more of these factors will not have a material
adverse effect on the Company's foreign operations, and, consequentially, the
Company's business, operating results, and financial condition.
THE COMPANY FACES RISKS RELATED TO INTELLECTUAL PROPERTY CLAIMS OR APPROPRIATION
OF ITS INTELLECTUAL PROPERTY RIGHTS. The Company relies primarily on a
combination of copyright, trademark and trade secrets laws, as well as
confidentiality agreements to protect its proprietary rights. In October 1998,
the Company was granted a patent by the United States Patent and Trademark
Office relating to the architecture of the Company's systems. There can be no
assurance that such patent will not be invalidated or circumvented or that
rights granted thereunder or the description contained therein will provide
competitive advantages to the Company's competitors or others. Moreover, despite
the Company's efforts to protect its proprietary rights, unauthorized parties
may attempt to copy aspects of the Company's products or to obtain the use of
information that the Company regards as proprietary. In addition, the laws of
some foreign countries do not protect the Company's proprietary rights to as
great an extent as do the laws of the United States. There can be no assurance
that the Company's means of protecting its proprietary rights will be adequate
or that the Company's competitors will not independently develop similar
technology.
The Company is not aware that any of its products infringe the proprietary
rights of third parties. There can be no assurance, however, that third parties
will not claim infringement by the Company with respect to current or future
products. The Company expects that software product developers will increasingly
be subject to infringement claims as the number of products and competitors in
the Company's industry segment grows and the functionality of products in
different industry segments overlaps. Any such claims, with or without merit,
could be time-consuming, result in costly litigation, cause product shipment
delays, or require the Company to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, may not be available on terms
acceptable to the Company or at all, which could have a material adverse effect
upon the Company's business, operating results, and financial condition.
Page 15 of 18
PEGASYSTEMS INC.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Reference is made to Part II, Item 7A, "Quantitative and Qualitative Disclosures
about Market Risk," in the Company's Annual Report on Form 10-K for the year
ended December 31, 2000.
Part II - Other Information:
Item 1. Legal Proceedings
ERNST & YOUNG CASE. On June 9, 2000, the Company, Alan Trefler, the Company's
Chief Executive Officer, and Ira Vishner (a former chief financial officer of
the Company) filed a complaint against Ernst & Young LLP ("Ernst & Young") and
Alan B. Levine (a former partner of Ernst & Young) in Massachusetts state court
("the Complaint"). The Complaint alleged that the defendants committed
professional malpractice, breached contractual and fiduciary duties owed to the
Company, and issued false and misleading public statements, in connection with
advice that Ernst & Young rendered to the Company to record $5 million in
revenue in its financial statements for the second fiscal quarter ended June 30,
1997 pursuant to a series of contracts between the Company and First Data
Resources, Inc. (the "FDR Contracts"). The Complaint sought compensatory
damages, including contribution for losses and other costs incurred in
connection with certain class action securities litigation, now settled, arising
out of the Company's accounting for the FDR Contracts. On April 5, 2001, the
court dismissed the Complaint, finding that it was subject to the dispute
resolution procedures set forth in an engagement letter between the Company and
Ernst & Young. Pursuant to those dispute resolution procedures, on April 19,
2001, the Company and Messrs. Trefler and Vishner, through counsel, notified
Ernst & Young and Mr. Levine of their intention to submit the dispute that was
the subject of the court action to mediation. If mediation is unsuccessful, the
dispute resolution procedures provide that the dispute be submitted to
arbitration. The parties are scheduled to mediate this dispute in the fall of
2001. In the event mediation proves unsuccessful, the parties will move to
arbitration.
SEC INVESTIGATION. In May 1999, the Boston office of the SEC issued a Formal
Order of Private Investigation of the Company and unidentified individuals,
currently or formerly associated with the Company, concerning past accounting
matters, financial reports, and other public disclosures and trading activity in
the Company's securities during 1997 and 1998. The Company has cooperated fully
with the investigation.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of shareholders was held on June 5, 2001. The following
matters were voted upon:
1. Edward Maybury, William Keough, and Alexander D'Arbeloff were elected to
serve as Directors of the Company until the 2004 Annual Meeting of
Stockholders and until their successors are duly elected and qualified. Mr.
Maybury was elected with 32,222,504 votes "FOR" and 13,040 votes
"ABSTAINING." Mr. Keough was elected with 32,225,504 votes "FOR" and 10,040
votes "ABSTAINING." Mr. D'Arbeloff was elected with 32,224,504 votes "FOR"
and 11,040 votes "ABSTAINING."
Page 16 of 18
2. The stockholders ratified the appointment by the Board of Directors of
Deloitte & Touche, LLP, independent public accountants, to audit the
financial statements of the Company for the fiscal year ending December 31,
2001 with 32,224,169 votes "FOR", 6,304 votes "AGAINST" and 5,071 votes
"ABSTAINING."
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
10.1 Employment Agreement dated May 10, 2001 between the Registrant and Joseph
Friscia
Page 17 of 18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PEGASYSTEMS INC.
Date: August 1, 2001 /s/ Alan Trefler
----------------
Chairman and Chief Executive Officer
/s/ James P. O'Halloran
------------------------
James P. O'Halloran
Treasurer and Chief Financial Officer
(principal financial officer and chief
accounting officer)
Page 18 of 18