SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15 (d) of the Securities Exchange
Act of 1934
For the quarterly period ended March 31, 2002
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
--- ____
There were 33,465,221 shares of the Registrant's common stock, $.01 par value
per share, outstanding on April 15, 2002.
1
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 March 31, 2002
and December 31, 2001 3
Condensed Consolidated Statements of Operations for the three
months ended March 31, 2002 and 2001 4
Condensed Consolidated Statements of Cash Flows for the three
months ended March 31, 2002 and 2001 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 21
Part II - Other Information
Item 1. Legal Proceedings 21
Item 2. Changes in Securities and Use of Proceeds 22
Item 3. Defaults upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 23
EXHIBIT INDEX 24
2
PEGASYSTEMS INC.
Condensed Consolidated Balance Sheets
(in thousands, except share-related amounts)
March 31, December 31,
2002 2001
------------ -----------
Assets
Current assets:
Cash and cash equivalents ................................................ $ 41,340 $ 33,017
Trade accounts receivable, net of allowance for
doubtful accounts of $1,035 in 2002 and $1,034
in 2001 ............................................................... 7,821 9,592
Short-term license installments, net ..................................... 35,512 31,359
Prepaid expenses and other current assets ................................ 954 2,286
------------ ------------
Total current assets ................................................. 85,627 76,254
Long-term license installments, net ...................................... 38,030 43,155
Equipment and improvements, net .......................................... 2,787 3,053
Acquired technology ...................................................... 1,342 --
Purchased software and other assets, net ................................. 2,019 2,610
Goodwill ................................................................. 3,167 --
------------ ------------
Total assets ....................................................... $ 132,972 $ 125,072
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses .................................... $ 10,547 $ 12,840
Deferred revenue ......................................................... 8,522 6,176
Current portion of capital lease obligations ............................. 27 81
------------ ------------
Total current liabilities ............................................ 19,096 19,097
Commitments and contingencies (Note 5)
Deferred income taxes ....................................................... 1,000 1,000
Other long-term liabilities ................................................. 204 17
------------ ------------
Total liabilities ................................................. 20,300 20,114
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;
33,448,743 shares and 32,754,648 shares issued and
outstanding in 2001 and 2000, respectively ............................. 335 328
Additional paid-in capital ............................................... 105,226 101,318
Stock warrants ........................................................... 3,271 2,897
Retained earnings ........................................................ 4,195 757
Accumulated other comprehensive loss ..................................... (355) (342)
------------ ------------
Total stockholders' equity ........................................... 112,672 104,958
------------ ------------
Total liabilities and stockholders' equity ......................... $ 132,972 $ 125,072
============ ============
See notes to condensed consolidated financial statements.
3
PEGASYSTEMS INC.
Condensed Consolidated Statements of Operations
(in thousands, except per share amounts)
Three Months Ended
March 31,
2002 2001
-------- --------
Revenue:
Software license .............................. $ 16,266 $ 10,882
Services ...................................... 7,945 12,723
-------- --------
Total revenue ............................... 24,211 23,605
-------- --------
Cost of revenue:
Cost of software license ...................... 643 648
Cost of services .............................. 7,292 10,244
-------- --------
Total cost of revenue ....................... 7,935 10,892
-------- --------
Gross Profit ..................................... 16,276 12,713
Operating expenses:
Research and development ...................... 5,750 4,991
Selling and marketing ......................... 5,729 4,909
General and administrative .................... 2,409 2,990
-------- --------
Total operating expenses .................... 13,888 12,890
-------- --------
Income (loss) from operations .................... 2,388 (177)
Installment receivable interest income ........... 1,258 1,450
Other interest income, net ....................... 143 214
Other expense, net ............................... (151) (143)
-------- --------
Income before provision for income taxes ......... 3,638 1,344
Provision for income taxes ....................... 200 250
-------- --------
Net income ....................................... $ 3,438 $ 1,094
======== ========
Earnings per share:
Basic .......................................... $ 0.10 $ 0.03
======== ========
Diluted ........................................ $ 0.10 $ 0.03
======== ========
Weighted average number of common and
common equivalent shares outstanding:
Basic .......................................... 32,799 32,595
======== ========
Diluted ........................................ 34,739 33,462
======== ========
See notes to condensed consolidated financial statements.
4
PEGASYSTEMS INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)
Three Months Ended
March 31,
2002 2001
-------- --------
Cash Flows from Operating Activities:
Net income .................................................... $ 3,438 $ 1,094
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ............................. 1,184 1,470
Changes in operating assets and liabilities:
Trade and installment accounts receivable ............... 3,044 93
Prepaid expenses and other current assets ............... 1,325 (684)
Accounts payable and accrued expenses ................... (2,825) (555)
Deferred revenue ........................................ 2,287 1,643
-------- --------
Net cash provided by operating activities ............ 8,453 3,061
-------- --------
Cash Flows from Investing Activities:
Acquisition of 1mind (See note 3) ............................. (573) --
Purchase of equipment and improvements ........................ (140) (188)
Other long term assets and liabilities ........................ 59 92
-------- --------
Net cash used in investing activities ................ (654) (96)
-------- --------
Cash Flows from Financing Activities:
Payments of capital lease obligations ......................... (54) (80)
Exercise of stock options ..................................... 620 53
-------- --------
Net cash provided by (used in) financing activities .. 566 (27)
-------- --------
Effect of exchange rate changes on cash and cash equivalents ....... (42) (141)
-------- --------
NET INCREASE IN CASH AND CASH
EQUIVALENTS .................................................. 8,323 2,797
-------- --------
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ..................... 33,017 17,339
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD ........................... $ 41,340 $ 20,136
======== ========
See notes to condensed consolidated financial statements.
5
PEGASYSTEMS INC.
Notes to Condensed Consolidated Financial Statements
March 31, 2002
Note 1 - Basis of presentation
Our unaudited condensed consolidated financial statements of Pegasystems
Inc. (the "Company") 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 months
ended March 31, 2002 are not necessarily indicative of the results that may be
expected for the full year ending December 31, 2002. We suggest that these
condensed consolidated financial statements be read in conjunction with the
consolidated financial statements and notes thereto for the year ended December
31, 2001, included in our 2001 Annual Report on Form 10-K filed with the
Securities and Exchange Commission ("SEC").
Certain amounts in the Company's 2001 condensed consolidated financial
statements were reclassified to be consistent with the current presentation.
Reimbursements received for out-of-pocket expenses have been reflected as
services revenue, in compliance with Financial Accounting Standards Board Staff
Announcement Topic No. D-103; in prior periods the reimbursements had been
reflected as reduction of cost of services.
(in thousands) Three months ended
March 31, 2001
--------------
Services revenue as reported previously ............... $ 11,935
Add: Reimbursements for out-of-pocket expenses ........ 788
-----------
Services revenue, reclassified ........................ $ 12,723
Cost of services as reported previously ............... $ 9,456
Add: Reimbursements for out-of-pocket expenses ........ 788
-----------
Cost of services, reclassified ........................ $ 10,244
Note 2 - Significant Accounting Policies
(a) Business
The Company and its subsidiaries develop, market, license and support
software that enables transaction intensive-organizations to manage a broad
array of customer interactions. We also offer consulting, training, and
maintenance and support services to facilitate the installation and use of our
products.
(b) Management Estimates and Reporting
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the periods presented. Actual results could differ from those
estimates. Significant assets and liabilities with reported amounts based on
estimates include trade and installment accounts receivable, long term license
installments and deferred revenue.
6
(c) Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries, Pegasystems Limited (a United Kingdom
company), Pegasystems Company (a Canadian company), Pegasystems Worldwide Inc.
(a United States corporation), and Pegasystems Pty Ltd. (an Australian company),
Pegasystems Investments Inc. (a United States corporation) and Pegasystems
Private Limited (a Singapore company). All intercompany accounts and
transactions have been eliminated in consolidation.
(d) Foreign Currency Translation
The translation of assets and liabilities of our foreign subsidiaries is
made at period-end exchange rates, while revenue and expense accounts are
translated at the average exchange rates during the period transactions
occurred. The resulting translation adjustments are reflected as a separate
component of accumulated other comprehensive loss. Realized and unrealized
exchange gains or losses from transactions and adjustments are reflected in
other income, net, in the accompanying consolidated statements of operations.
(e) Revenue Recognition
Our revenue is derived from two primary sources: software license fees and
service fees. We offer two types of software licenses: perpetual licenses and
term licenses. Perpetual license fees are generally payable at the time the
software is delivered, and are generally recognized as revenue upon customer
acceptance.
Term software license fees are generally payable on a monthly basis under
license agreements that 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 and
commitment to the contractual payment stream. A portion of the fee from each
arrangement is initially deferred and recognized as installment receivable
interest income over the license term. In addition, many of our license
agreements provide for license fee increases based on inflation. The net present
value of such increases is recognized as revenue when the values are
determinable. For purposes of the present value calculations, the discount rates
used are estimates of customers' borrowing rates, typically below prime rate,
and have varied between 3.5% and 8.0% for the past few years. As a result,
revenue that we recognize relative to these types of license arrangements may be
impacted by changes in market interest rates. For term license agreement
renewals, license revenue is recognized upon customer commitment to the new
license terms.
Our service revenue is comprised of fees for software implementation,
consulting, maintenance, and training services. Our software implementation and
consulting agreements typically require us to provide a specified level of
implementation services for a specified fee, with additional consulting services
available at an hourly rate. Revenues for time and material projects are
recognized as fees are billed. Revenues 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. Historically, we have had difficulty accurately estimating
the time and resources needed to complete fixed price projects. As a result,
determination of the fair value of the elements of the contract has generally
occurred later in the implementation process, typically when implementation is
complete and remaining services are no longer significant to the project. Prior
to the point at which the fair value of the elements of a contract can be
determined, revenue recognition for fixed price projects is limited to amounts
equal to costs incurred, resulting in no gross profit. Once the fair values of
the elements of a contract are apparent, profit
7
associated with the fixed price services elements will begin to be recognized.
Software license customers are offered the option to enter into a maintenance
contract, which requires the customer to pay a monthly maintenance fee over the
term of the maintenance agreement, typically renewable annually. Prepaid
maintenance fees are deferred and are recognized evenly over the term of the
maintenance agreement. We generally recognize training fees as the services are
provided.
We reduce revenue for estimates of the fair value of potential concessions
during the period in which revenue is initially recorded, which are in turn
recognized as revenue when the related elements are completed and provided to
the customer.
(f) Concentration of Credit Risk
Financial instruments that potentially subject us to a concentration of credit
risk consist of short term cash investments, trade accounts receivable and
long-term license installments receivable. We record long-term license
installments in accordance with its revenue recognition policy, which results in
receivables from customers (due in periods exceeding one year from the reporting
date, primarily from large organizations with strong credit ratings). We grant
credit to customers who are located throughout the world. We perform credit
evaluations of its customers and generally do not request collateral from its
customers. Amounts due under long-term license installments are expected to be
received as follows:
License Installments
Years ended December 31, in thousands)
2002 ........................... $ 25,345
2003 ........................... 23,028
2004 ........................... 18,161
2005 ........................... 12,508
2006 ........................... 6,352
2007 ........................... 259
--------
85,653
Deferred license interest income ........ (12,111)
--------
Total license installments receivable ... $ 73,542
========
(g) Cash and Cash Equivalents
We consider all highly liquid investments with remaining maturities of
three months or less at the date of purchase to be cash equivalents.
(h) Equipment and Improvements
Equipment and improvements are recorded at cost. Depreciation is computed
using the straight-line method over the estimated useful lives of the assets,
which are three years for equipment and five years for furniture and fixtures.
Leasehold improvements and equipment under capital lease are amortized over the
lesser of the life of the lease or the useful life of the asset. Repairs and
maintenance costs are expensed as incurred.
(i) Impairment of Long-Lived Assets
We evaluate our long-lived assets for impairment whenever events or changes
in circumstances indicate that the carrying amount of such assets may not be
recoverable. 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 the fair value of the asset.
8
(j) Research and Development and Software Costs
Research and development costs, other than certain software related costs,
are expensed as incurred. Capitalization of software costs begins upon the
establishment of technical feasibility, generally demonstrated by a working
model or an operative version of the computer software product that is completed
in the same language and is capable of running on all of the platforms as the
product to be ultimately marketed. Such costs have not been material to date,
and no internal costs were capitalized during the first quarter of 2002 and
2001.
Software costs are included in cost of software license revenue. No
amortization expense for internally developed capitalized software costs was
charged to cost of software license revenue during the first quarter of 2002 and
2001.
(k) Net Earnings Per Share
Basic earnings per share is computed based on the weighted average number
of common shares outstanding during the period. Diluted earnings 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
March 31,
2002 2001
--------- ---------
Basic
- -----
Net income ........................................................ $ 3,438 $ 1,094
========= =========
Weighted average common shares outstanding ........................ 32,799 32,595
========= =========
Basic earnings per share .......................................... $ 0.10 $ 0.03
========= =========
Diluted
- -------
Net income ........................................................ $ 3,438 $ 1,094
========= =========
Weighted average common shares outstanding ........................ 32,799 32,595
Effect of assumed exercise of stock options ...................... 1,940 867
--------- ---------
Weighted average common shares outstanding, assuming dilution ..... 34,739 33,462
========= =========
Diluted earnings per share ........................................ $ 0.10 $ 0.03
========= =========
Outstanding options and warrant excluded as impact would
be anti-dilutive ................................................ 4,362 6,259
========= =========
(l) Segment Reporting
We currently operate in one operating segment, customer service software.
We derive substantially all of our operating revenue from the sale and support
of one group of similar products and services. Substantially all of our assets
are located within the United States. For the three months ending March 31, 2002
and 2001, the Company derived its operating revenue from the following
countries, principally through export from the United States of America:
9
Three Months Ended
March 31,
---------
(in $ thousands) 2002 2001
------ ------
United States .... $19,358 80% $17,322 73%
United Kingdom ... 3,646 15% 3,339 14%
Europe ........... 898 4% 2,565 11%
Other ............ 309 1% 379 2%
------ --- ------- ---
$24,211 100% $23,605 100%
During the first quarter of 2002 and 2001, one customer accounted for
approximately 39.7% and 19% of the Company's total revenue, respectively. At
March 31, 2002, one customer represented 7% of outstanding accounts receivable
and one customer represented 15.3% of long and short-term license installments.
(m) Stock Options
We periodically grant stock options for a fixed number of shares to
employees and directors with an exercise price equal to the fair market value of
the shares at the date of the grant. We account for such stock option grants
using the intrinsic value method in accordance with APB Opinion No. 25,
"Accounting for Stock Issued to Employees", and intend to continue to do so.
Stock options granted to non-employee contractors are accounted for using the
fair value method in accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation". We have adopted the disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," relative to the impact of the fair
value method.
(n) Fair Value of Financial Instruments
The principal financial instruments held consist of cash and equivalents,
accounts receivable and payable, capital lease obligations, and license
installment receivables arising from license transactions. The carrying values
of cash and cash equivalents, accounts receivable, accounts payable, and capital
lease obligations approximates their fair value due to the short-term nature of
the accounts. Using current market rates, the fair value of license installment
receivables approximates carrying value at March 31, 2002 and 2001.
(o) Legal Costs
Costs incurred in connection with litigation in which we are involved are
expensed as incurred.
(p) New Accounting Standards
We have adopted the Financial Accounting Standards Board ("FASB") Statement
of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," and
SFAS No. 142, "Goodwill and Other Intangible Assets." These pronouncements
provide guidance on how to account for the acquisition of businesses and
intangible assets, including goodwill, which arise from such activities. SFAS
No.141 affirms that only one method of accounting may be applied to a business
combination, the purchase method. SFAS No. 141 also provides guidance on the
allocation of purchase price to the assets acquired. SFAS No. 142 provides that
goodwill resulting from business combinations no longer be amortized to expense,
but rather requires an annual assessment of impairment and, if necessary,
adjustments to the carrying value of goodwill.
We have adopted SFAS No. 143, "Accounting for Obligations Associated with
the Retirement of Long-Lived Assets" and SFAS No. 144 "Accounting for the
Impairment of Disposal of Long-Lived Assets." SFAS No.143 establishes accounting
standards for the recognition and measurement of an asset retirement obligation
10
and its associated asset retirement cost. It also provides guidance for legal
obligations associated with the retirement of tangible long-lived assets. SFAS
No. 144 establishes a single accounting model for the impairment or disposal of
long-lived assets, including discontinued operations. Adoption of these
pronouncements is not expected to have a significant effect on our consolidated
financial statements.
Note 3 - Acquisition
On February 6, 2002, we acquired substantially all of the assets of 1mind
Corporation (1mind) for initial consideration value of $3.7 million. Depending
upon the achievement of specified milestones by the acquired business in 2002
and validation of the negotiated value of 1mind, we may pay up to approximately
$6 million in additional consideration substantially in the form of shares of
our common stock. We believe that the acquisition will help increase our
penetration of the healthcare and insurance markets, strengthen our management
and delivery teams and deepen our product offerings. The acquisition of 1mind
has been accounted for as purchase and the operations of 1mind have been
included in our consolidated financial statements from the date of acquisition.
Results of operations would not have changed materially for 2001 or the current
year if 1mind had been acquired on January 1, 2001 and 2002, respectively. The
cash flow impact of $573 thousand from this acquisition was transaction costs of
$614 thousand less cash acquired of $41 thousand. We have not yet completed the
process of appraising the fair values of 1mind assets, and therefore, the
allocation of purchase price in the condensed consolidated financial statements
is based on estimates, and is subject to change.
(in thousands)
Shares issued (a) ................................... $ 3,295
Warrants issued (b) ................................. 374
------------
Total purchase price ................................. $ 3,669
============
Current assets, including cash of $41 $ 339
Equipment and improvements 143
Acquired existing technology (c) 1,400
Goodwill and other intangibles (d) 3,167
Current liabilities (571)
Long term liabilities (195)
Transaction costs (614)
------------
$ 3,669
============
(a) 569,949 common shares of Pegasystems Inc. valued at approximately $5.78
per share, the average of closing prices as reported by Nasdaq for the
three days before and after January 29, 2002, the date of agreement.
(b) Warrants to purchase, for nominal consideration, 83,092 common shares
of Pegasystems Inc., valued at approximately $4.50 per warrant using a
Black-Scholes model.
(c) Acquired existing technology results from a preliminary appraisal
report of 1mind intangible assets.
(d) Any additional consideration paid will be recorded as goodwill.
11
Note 4 - Comprehensive Income
The components of comprehensive income are as follows:
Three Months Ended
March 31,
(in thousands) 2002 2001
---------- ----------
Net income .................................................................. $ 3,438 $ 1,094
Foreign currency translation adjustments, net of income taxes ............... (13) (92)
---------- ----------
Comprehensive income ........................................................ $ 3,425 $ 1,002
========== ==========
Note 5 - Commitments and Contingencies
Company Litigation
- ------------------
In the Matter of the Arbitration Between Pegasystems Inc, et al., and Ernst &
Young, LLP, et al. On June 9, 2000, the Company and two of its officers filed a
complaint against Ernst & Young, LLP and Alan B. Levine (a former partner of
Ernst & Young) in Massachusetts state court. The Complaint alleges that the
defendants committed professional malpractice, breached contractual and
fiduciary duties owed to the Company, and issued false and misleading public
statements, in connection with 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 complaint sought compensatory
damages, including contribution for losses and other costs incurred in
connection with certain class action securities litigation, which has been
settled. 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. The parties have agreed to
arbitrate this dispute. An arbitration hearing has tentatively been scheduled
for June 2002.
SEC Investigation. The Company previously disclosed that in May 1999 the Boston
Office of the Securities and Exchange Commission's Division of Enforcement
("SEC") issued a Formal Order of Private Investigation of the Company and
certain individuals, currently or formerly associated with the Company, related
primarily to past accounting matters, financial reports, other public
disclosures and trading activity in the Company's securities during 1997 and
1998. On March 28, 2002, the Company was advised by the staff of the SEC that
the staff had terminated its investigation of the Company and such individuals,
with no enforcement action being recommended.
Qwest Arbitration. On January 17, 2002, the Company filed a demand for
arbitration with the American Arbitration Association in Denver, Colorado
against Qwest Corporation, successor in interest to US West Business Resources,
Inc. ("Qwest"). The Company is seeking monetary damages in the arbitration
relating to Qwest's termination of a software license and service agreement
between the parties. On February 8, 2002, Qwest filed a counterclaim against the
Company seeking monetary damages for alleged breach of that agreement by the
Company.
12
Acquisition
- -----------
Under the agreement for acquisition of 1mind, depending upon the
achievement of specified milestones by the acquired business in 2002 and
validation of the negotiated value of 1mind, the Company will pay up to
approximately $6 million in additional consideration, substantially in the form
of shares of the Company's common stock.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Our revenue is derived from two primary sources: software license fees and
service fees. We offer two types of software licenses: perpetual licenses and
term licenses. Perpetual license fees are generally payable at the time the
software is delivered, and are generally recognized as revenue upon customer
acceptance.
Term software license fees are generally payable on a monthly basis under
license agreements that 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 and
commitment to the contractual payment stream. A portion of the fee from each
arrangement is initially deferred and recognized as installment receivable
interest income over the license term. In addition, many of our license
agreements provide for license fee increases based on inflation. The net present
value of such increases is recognized as revenue when the values are
determinable. For purposes of the present value calculations, the discount rates
used are estimates of customers' borrowing rates, typically below prime rate,
and have varied between 3.5% and 8.0% for the past few years. As a result,
revenue that we recognize relative to these types of license arrangements can be
impacted by changes in market interest rates. For term license agreement
renewals, license revenue is recognized upon customer commitment to the new
license terms.
Our service revenue is comprised of fees for software implementation,
consulting, maintenance, and training services. Our software implementation and
consulting agreements typically require us to provide a specified level of
implementation services for a specified fee, with additional consulting services
available at an hourly rate. Revenues for time and material projects are
recognized as fees are billed. Revenues 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. Historically, we have had difficulty accurately estimating
the time and resources needed to complete fixed price projects. As a result,
determination of the fair value of the elements of the contract has generally
occurred later in the implementation process, typically when implementation is
complete and remaining services are no longer significant to the project. Prior
to the point at which the fair value of the elements of a contract can be
determined, revenue recognition for fixed price projects is limited to amounts
equal to costs incurred, resulting in no gross profit. Once the fair values of
the elements of a contract are apparent, profit associated with the fixed price
services elements will begin to be recognized. Software license customers are
offered the option to enter into a maintenance contract, which requires the
customer to pay a monthly maintenance fee over the term of the maintenance
agreement, typically renewable annually. Prepaid maintenance fees are deferred
and are recognized evenly over the term of the maintenance agreement. We
generally recognize training fees as the services are provided.
13
We reduce revenue for estimates of the fair value of potential concessions
during the period in which revenue is initially recorded, which are in turn
recognized as revenue when the related elements are completed and provided to
the customer.
Historically, it has been difficult for us to predict when we would be able
to recognize software license revenue because, as indicated above, our ability
to recognize software license revenue is generally related to the completion of
implementation services and the acceptance of the licensed software by the
customer. This, coupled with our focus on closing large but relatively few
license transactions in a given quarter may cause our quarterly operating
results to fluctuate significantly.
Three months ended March 31, 2002 Compared to Three Months Ended March 31, 2001
Revenue
Our total revenue for the three months ended March 31, 2002 ("the first
quarter of 2002") increased 3% to $24.2 million from $23.6 million for the three
months ended March 31, 2001 ("the first quarter of 2001"). The increase was due
to a $5.4 million increase in software license revenue partially offset by a
$4.8 million decrease in services revenue.
Software license revenue for the first quarter of 2002 increased 49% to
$16.3 million from $10.9 million for the first quarter of 2001. The increase was
due primarily to a $7.7 million increase in revenue from perpetual licenses,
which was partially offset by a decrease of $2.0 million in revenue from term
software license renewals.
Of the increase in revenue from perpetual licenses, $7.0 million was due to
the sale to First Data Resources ("FDR") of a perpetual non-exclusive license
that replaced the existing exclusive term license which was due to expire in
December 2002. Absent this incremental revenue, operating expenses described
below when expressed as a percentage of revenue would have been higher. Under
the FDR perpetual license, FDR is obligated to pay $1.95 million per month from
March 2002 through December 2002 and $1.18 million per month in 2003 (the
"perpetual license fees"). FDR also paid a signing bonus of $0.94 million in
March 2002. In the first quarter of 2002, our license revenue includes the March
payments and $5.85 million, representing the perpetual license fees due for the
months of April, May and June 2002. We expect to recognize, with respect to
the perpetual license fees, license revenue of $5.85 million in each of the
second and third quarters of 2002 and $3.54 million in the fourth quarter of
2002 and each of the first three quarters of 2003; provided, however, that FDR
has the right to terminate the license for convenience on 90 days' notice. The
agreement also provides for the possibility of additional revenue from FDR in
future years related to their re-licensing of our software to FDR customers, and
for incremental Pegasystems revenue from the elimination of previous exclusivity
restrictions on Pegasystems sales activities.
In the future, we expect to enter into more perpetual license transactions,
the effect of which may be to increase our license revenue and cash flow in the
short term and to decrease the amount of revenue and cash flow from the renewal
of term software license agreements. Historically, a significant portion of our
license revenue has been from renewals of term software license agreements. In
addition, license transactions with new customers have slowed significantly
since the latter part of 2001.
Services revenue for the first quarter of 2002 decreased 38% to $7.9
million from $12.7 million for the first quarter 2001. The decrease was due
primarily to delayed customer spending and a decrease in new customer license
transactions, which we believe were caused by the current generally weak
economic conditions. Typically, we derive a substantial portion of our service
revenue from services provided in connection with the implementation of software
licensed by new customers.
Deferred revenue at March 31, 2002 consisted primarily of billed fees from
arrangements, for which acceptance of the software license or service milestone
had not occurred, the unearned portion of service revenue and advance payment of
maintenance fees. Deferred revenue balances increased to $8.5 million as of
March 31, 2002 from $6.2 million as of December 31, 2001, due to advance payment
of maintenance fees and software licenses.
14
International revenues were 20% of total consolidated revenues for the
first quarter of 2002 and 27% for the first quarter of 2001. Our international
revenues may continue to fluctuate in the future because such revenues generally
result from a small number of product acceptances during a given period.
Historically, most of our contracts have been denominated in U.S. dollars.
However, we expect that more of our contracts in the future may be denominated
in foreign currencies, thereby exposing us to increased currency exchange risk.
Cost of revenue
Cost of software license revenue for the first quarter of 2002 was $0.6
million, the same as for the first quarter of 2001. Costs of software license
includes the amortization associated with stock purchase warrant we issued in
September 1997 under an agreement with FDR and the amortization of the
intellectual property we purchased from 1mind. Costs of software license as a
percentage of license revenue decreased to 4% for first quarter of 2002 from 6%
for the first quarter of 2001, due to the increase in software license revenue.
Cost of services consists primarily of the costs of providing
implementation, consulting, maintenance, and training services. Cost of services
for the first quarter of 2002 decreased 29% to $7.3 million from $10.2 million
for the first quarter of 2001, due to reduced staff costs including
compensation, travel and facilities expense. Cost of services as a percentage of
service revenue increased to 92% for the first quarter of 2002 from 81% for the
first quarter of 2001. The percentage increase was primarily due to reduced
services revenue partially offset by reduced staff costs. Our services
management will continue to review the resource requirements to ensure they are
appropriately aligned with revenue expectations.
Operating expenses
Research and development expenses for the first quarter of 2002 increased
15% to $5.8 million from $5.0 million for 2001. As a percentage of total
revenue, research and development expenses increased to 24% for the first
quarter 2002 from 21% for the first quarter of 2001. These increases were the
result of growth in staffing costs including compensation and benefits, and
increased use of third party consultants.
Selling and marketing expenses for the first quarter of 2002 increased 17%
to $5.7 million from $4.9 million for the first quarter of 2001. As a percentage
of total revenue, selling and marketing expenses increased to 24% for the first
quarter of 2002 from 21% for the first quarter of 2001. The increases were due
to increased spending on staff related costs and marketing programs.
General and administrative expenses for the first quarter of 2002 decreased
19% to $2.4 million from $3.0 million for the first quarter of 2001. As a
percentage of total revenue, general and administrative expenses decreased to
10% for the first quarter of 2002 from 13% for the first quarter of 2001. These
decreases were due primarily to reduced incentive compensation and depreciation
expense.
Installment receivable interest income
Installment receivable interest income, which consists of the portion of
all term license fees under software license agreements that is attributable to
the time value of money, decreased 13% in the first quarter of 2002 to $1.3
million from $1.5 million for the first quarter of 2001. The decrease was due to
a lower average discount rate for our portfolio of term software licenses. A
portion of the fee from each term license arrangement is initially deferred and
recognized as installment receivable interest income over the remaining term of
the license. For purposes of the present value calculations, the discount rates
used are estimates of customers' borrowing rates, typically below prime rate,
and have varied between 3.5% and 8.0% during the past few years.
Other interest income, net
15
Other interest income, net decreased 33% to $0.1 million for the first
quarter of 2002 from $0.2 million for the first quarter of 2001. The decrease
was due to lower interest rates, partially offset by larger invested cash
balances.
Other expense, net
Other expense, net, which consists primarily of currency exchange losses
and reseller development funds received from third-party vendors of computer
hardware products, was essentially unchanged from the first quarter of 2001.
Income before provision for income taxes
Income before provision for income taxes increased to $3.6 million for the
first quarter of 2002 from $1.3 million for the first quarter of 2001. This $2.3
million improvement was due primarily to a $5.4 million improvement in software
license gross margin from increased revenues, partially offset by a $1.8 million
reduction in service gross margin due to lower service revenues, increased
operating expenses of $1.0 million and a reduction in installment receivable
interest income.
Provision for income taxes
The provision for the first quarter of 2002 is for current taxes on
foreign subsidiary income. We have made minimal provisions for United States
federal and state income taxes due to the availability of reserved loss carry
forwards to offset current period income tax provision.
Liquidity and Capital Resources
We have funded our operations primarily from cash flow from operations and
the proceeds of our public stock offerings. At March 31, 2002, we had cash and
cash equivalents of $41.3 million and working capital of $66.5 million.
Net cash provided by operations for the first quarter of 2002 was $8.5
million compared with $3.1 million for the first quarter of 2001. Of the $5.4
million improvement, $1.3 million was due to improved profitability and $3.0
million was due to improved collections of accounts receivable, primarily from
perpetual licenses. Billings during the first quarter include annual license and
maintenance amounts for some customers, typically resulting in greater cash
collections in the first quarter than in other quarters of the year. The
remaining improvement was due to net changes in deferred revenues, accounts
payable and accrued expenses. We, like many companies, are beginning to see
longer payment cycles from some customers, which has increased the percentage of
our trade accounts receivable that are over ninety days past due.
Net cash used in investing activities for the first quarter of 2002 was
$0.7 million compared with $0.1 million for the first quarter of 2001. The
increased use of cash was due to the transaction costs associated with the 1mind
acquisition.
On February 6, 2002, we acquired substantially all of the assets of 1mind
for initial consideration valued at $3.7 million, consisting of 569,949 shares
of our common stock and warrants to purchase for nominal consideration 83,092
shares of our common stock. Depending upon the achievement of specified
milestones by the acquired business in 2002 and validation of the negotiated
value of 1mind, we may pay up to approximately $6 million in additional
consideration substantially in the form of shares of our common stock. (See note
3 of notes to condensed consolidated financial statements).
16
Net cash provided by financing activities for the first quarter of 2002 was
$0.6 million compared with $27 thousand used in the first quarter of 2001. The
increase was primarily due to the proceeds from stock option exercises.
We believe that current cash, cash equivalents, and cash flow from ongoing
operations will be sufficient to fund our operations until at least the end of
2002. Material risks to additional cash flow from operations include, but are
not limited to continued under-utilization of our service personnel and our
possible inability to enter into license transactions with new customers to
offset the adverse impact on our long term liquidity arising from entering into
more perpetual software licenses. There can be no assurance that changes in our
plans or other events affecting our 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 we require. We have commitments under non-cancelable
leases.
Inflation
Inflation has not had a significant impact on our operating results to
date, and we do not expect it to have a significant impact in the future. Our
unbilled term license and maintenance fees are typically subject to annual
increases based on recognized inflation indexes.
Forward-looking statements
This Report contains certain forward-looking statements. For this purpose,
any statements contained herein that are not statements of historical fact may
be deemed to be forward-looking statements. Without limiting the generality of
the foregoing, the words "believes", "anticipates", "plans", "expects", and
similar expressions are intended to identify forward-looking statements. There
are a number of important factors that could cause our actual results to differ
materially from those indicated by forward-looking statements made in this
report and presented elsewhere by management from time to time. Some of the
important risks and uncertainties that may cause our operating results to differ
materially or adversely are discussed below.
Our stock price has been volatile. Quarterly results have fluctuated and
are likely to continue to fluctuate significantly. The market price of our
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, and overall market performance,
will have a significant effect on the price for shares of our 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. We plan 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 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
we 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, we are more focused on closing larger
but fewer license transactions than in the past. This may increase the
volatility
17
in our quarterly operating results. Risks over which we have 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.
We 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 our markets. As a result,
success in current markets and new markets will depend upon our 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 we will have sufficient resources to make necessary product
development investments. We 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. Our
products are complex and may contain errors. Errors in products will require us
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 our reputation, or increased service and
warranty costs which would have an adverse effect on financial performance.
We have historically sold to the financial services market. This market is
consolidating rapidly, and faces uncertainty due to many other factors. We have
historically derived a significant portion of our revenue from customers in the
financial services market, and our 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 our
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
our future financial performance.
If existing customers do not renew their term licenses, our financial
results may suffer. A significant portion of total revenue has been attributable
to term license renewals. While historically a majority of customers have
renewed their term licenses, there can be no assurance that a majority of
customers will continue to renew expiring term licenses. A decrease in term
license renewals absent offsetting revenue from other sources would have a
material adverse effect on future financial performance. In addition, transition
to prepaid perpetual licenses may have a material adverse impact on the amount
of term license renewal revenues in future periods.
We depend 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, our Chief Executive Officer. The loss of key
personnel could adversely affect financial performance. We do not have any
significant key-man life insurance on any officers or employees and do not plan
to obtain any. Our success will depend in large part on the ability to hire and
retain qualified personnel. The number of potential employees who have the
extensive knowledge of computer hardware and operating systems needed to
develop, sell and maintain our products is limited, and competition for their
services is intense, and there can be no assurance that we will be able to
attract and retain such personnel. If we are unable to do so, our business,
operating results, and financial condition could be materially adversely
affected.
The market for our 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. We currently encounter
18
significant competition from internal information systems departments of
potential or existing customers that develop custom software. We also compete
with companies that target the customer interaction and workflow markets and
professional service 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 we will be able to compete successfully
against current or future competitors or that the competitive pressures faced by
us will not materially adversely affect our business, operating results, and
financial condition.
We must manage increased business complexity and growth effectively. Our
business has grown in size, geographic scope and complexity and we have expanded
our product offerings and customer base. This growth and expansion has placed,
and is expected to continue to place, a significant strain on management,
operations and capital needs. Continued growth will require us to hire, train
and retrain many employees in the United States and abroad, particularly
additional sales and financial personnel. We will also need to enhance our
financial and managerial controls and reporting systems. We cannot assure that
we will attract and retain the personnel necessary to meet our business
challenges. Failure to manage growth effectively may materially adversely affect
future financial performance.
We rely on certain third-party relationships. We have a number of
relationships with third parties that are significant to sales, marketing and
support activities and product development efforts. We rely 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 our products through
the use of industry-standard tools and utilities. We also have relationships
with third parties that distribute our products. In particular, we rely on our
relationship with First Data Resources for the distribution of products to the
credit card market and with PFPC Inc. for distribution of products to the mutual
fund market. 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 ours in the future or will not otherwise end
their relationships with or support of us.
We may face product liability and warranty claims. Our license agreements
typically contain provisions intended to limit the nature and extent of our 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 our licenses
with our customers are governed by non-U.S. law, and there is a risk that
foreign law might give us less or different protection. Although we have 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 our
resources.
We face risks from operations and customers based outside of the U.S. Sales
to customers headquartered outside of the United States represented
approximately 23%, 26% and 21% of our total revenue in 2001, 2000 and 1999,
respectively. We, in part through our wholly-owned subsidiaries based in the
United Kingdom, Singapore, and Australia, market products and render consulting
and training services to customers based in Canada, the United Kingdom, France,
Germany, the Netherlands, Belgium, Switzerland, Austria, Ireland, Sweden, South
Africa, Mexico, Australia, Hong Kong, and Singapore. We have established offices
in continental Europe and in Australia. We believe that our continued growth
will necessitate expanded international operations requiring a diversion of
managerial attention and financial resources. We anticipate hiring additional
personnel to accommodate international growth, and we may also enter into
agreements with local distributors, representatives, or resellers. If we are
unable to do one or more of these things in a timely
19
manner, our growth, if any, in our foreign operations will be restricted, and
our business, operating results, and financial condition could be materially and
adversely affected.
In addition, there can be no assurance that we will be able to maintain or
increase international market demand for our products. Most of our 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
we distribute our products may place us at a competitive disadvantage by
effectively making our products more expensive as compared to those of our
competitors. Additional risks inherent in our 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 our
foreign operations, and, consequentially, our business, operating results, and
financial condition.
We face risks related to intellectual property claims or appropriation of
our intellectual property rights. We rely primarily on a combination of
copyright, trademark and trade secrets laws, as well as confidentiality
agreements to protect our proprietary rights. In October 1998, we were granted a
patent by the United States Patent and Trademark Office relating to the
architecture of our systems. We cannot assure that such patent will not be
invalidated or circumvented or that rights granted there under or the
description contained therein will provide competitive advantages to our
competitors or others. Moreover, despite our efforts to protect our proprietary
rights, unauthorized parties may attempt to copy aspects of our products or to
obtain the use of information that we regard as proprietary. In addition, the
laws of some foreign countries do not protect our proprietary rights to as great
an extent as do the laws of the United States. There can be no assurance that
our means of protecting our proprietary rights will be adequate or that our
competitors will not independently develop similar technology.
We are not aware that any of our products infringe the proprietary rights of
third parties. There can be no assurance, however, that third parties will not
claim infringement by us with respect to current or future products. We expect
that software product developers will increasingly be subject to infringement
claims as the number of products and competitors in our 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 us to enter into royalty
or licensing agreements. Such royalty or licensing agreements, if required, may
not be available on terms acceptable to us or at all, which could have a
material adverse effect upon our business, operating results, and financial
condition.
We face risks related to the acquisition of 1mind. On February 6, 2002, we
acquired substantially all of the assets and specified liabilities of 1mind
Corporation and its wholly owned subsidiary (collectively, "1mind"). Following
the acquisition of 1mind, we intend to intensify our focus on marketing and
selling our products and services within the healthcare market. We face risks in
connection with integrating 1mind's technology and personnel into the combined
company. Additionally, we face risks involved with integrating and retaining key
former 1mind personnel. Overcoming these risks may result in undue cost or delay
and may require us to divert management time and attention from our primary
business operations. The result could be an adverse effect on our financial
results.
20
PEGASYSTEMS INC.
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 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.
We derived approximately 20% of our total revenue in the first quarter of
2002 from sales to customers based outside of the United States. Certain of our
international sales are denominated in foreign currencies. The price in dollars
of products sold outside the United States in foreign currencies will vary as
the value of the dollar fluctuates against such foreign currencies. Although our
sales denominated in foreign currencies in the first quarter of 2002 were not
material, there can be no assurance that such sales will not be material in the
future and that there will not be increases in the value of the dollar against
such currencies that will reduce the dollar return to us on the sale of our
products in such foreign currencies.
We believe that at current market interest rates, the fair value of license
installments receivable approximates carrying value as reported on our balance
sheets. However, there can be no assurance that the fair value will approximate
the carrying value in the future. Factors such as increasing interest rates can
reduce the fair value of the license installments receivable. The carrying value
reflects a weighted average of historic discount rates, and moves with market
rates as new license installment receivables are added to the portfolio, which
mitigates exposure to market interest rate risk.
Part II - Other Information:
Item 1. Legal Proceedings
In the Matter of the Arbitration Between Pegasystems Inc, et al., and Ernst &
Young, LLP, et al. On June 9, 2000, the Company and two of its officers filed a
complaint against Ernst & Young, LLP and Alan B. Levine (a former partner of
Ernst & Young) in Massachusetts state court. The Complaint alleges that the
defendants committed professional malpractice, breached contractual and
fiduciary duties owed to the Company, and issued false and misleading public
statements, in connection with 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 complaint sought compensatory
damages, including contribution for losses and other costs incurred in
connection with certain class action securities litigation, which have been
settled. 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. The parties have agreed to
arbitrate this dispute. An arbitration hearing has tentatively been scheduled
for June 2002.
SEC Investigation. The Company previously disclosed that in May 1999 the Boston
Office of the Securities and Exchange Commission's Division of Enforcement
("SEC") issued a Formal Order of Private Investigation of the Company and
certain individuals, currently or formerly associated with the Company, related
primarily to past accounting matters, financial reports, other public
disclosures and trading activity in the Company's securities during 1997 and
1998. On March 28, 2002 the Company was advised by the staff of the SEC that the
staff had terminated its investigation of the Company and such individuals, with
no enforcement action being recommended.
Qwest Arbitration. On January 17, 2002, the Company filed a demand for
arbitration with the American Arbitration Association in Denver, Colorado
against Qwest Corporation, successor in interest to US West Business Resources,
Inc. ("Qwest"). The Company is seeking monetary damages in the arbitration
relating to
21
Qwest's termination of a software license and service agreement between the
parties. On February 8, 2002, Qwest filed a counterclaim against the Company
seeking monetary damages for alleged breach of that agreement by the Company.
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
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
See Exhibit Index attached hereto
(b) Reports on Form 8-K:
(1) On February 6, 2002, we filed a report on Form 8-K with the Securities
and Exchange Commission reporting the acquisition of 1mind
Corporation.
(2) On April 9, 2002, we filed a report on Form 8-K with the Securities
and Exchange Commission reporting the termination by the Commission of
its investigation of the Company and certain individuals.
22
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: April 23, 2002 /s/ Alan Trefler
-----------------------------------
Chairman and Chief Executive Officer
/s/ Christopher Sullivan
---------------------------------------
Treasurer and Chief Financial Officer
(principal financial officer and chief
accounting officer)
23
Exhibit Index
10.1 Refreshed Software License and Support Agreement dated March 1, 2002 by and
between the Registrant and First Data Resources Inc. (confidential
treatment requested as to certain portions).
24