UNITED STATES
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 Period Ended September 30, 1996.
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
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PEGASYSTEMS INC.
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(Exact name of registrant as specified in its charter)
Massachusetts 04-2787865
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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101 Main Street
Cambridge, Massachusetts 02142-1590
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(Address of principal executive office) (Zip Code)
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(617) 374-9600
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(Registrant's telephone number, including area code)
Not applicable
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(Former name, former address and former fiscal year, if changed since
last report)
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 periods
that the registrant was required to file such reports), and (2) has been
subject to such reporting requirements for the past 90 days. Yes [ X ]
No [ ]
As of October 31, 1996, there were 26,382,200 shares of the registrant's
Common Stock, par value $.01 per share, outstanding.
Index to Form 10-Q
Pegasystems Inc. and Subsidiary
Page
Part I. Financial Information Number(s)
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Item 1. Financial Statements
Condensed Consolidated Balance Sheets -- September 30, 1996 and
December 31, 1995
Condensed Consolidated Statements of Income -- Three months ended
September 30, 1996 and September 30, 1995 and nine months ended
September 30, 1996 and September 30, 1995
Condensed Consolidated Statements of Cash Flow -- Nine months ended
September 30, 1996 and September 30, 1995
Notes to Condensed Consolidated Financial Statements --
September 30, 1996
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Part II. Other Information
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Signature(s)
-2-
Part I. Financial Information
Item 1. Financial Statements
Pegasystems Inc.
Condensed Consolidated Balance Sheets
(in thousands except share-related data)
December 31, September 30,
1995 1996
----------- -------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $511 $25,419
Trade and installment accounts receivable,
net of allowance for doubtful accounts
of $434 at December 31, 1995 and $839 at
September 30, 1996 8,896 12,701
Prepaid expenses and other assets 425 1,002
------- --------
Total current assets 9,832 39,122
Long-term license installments, net 13,399 18,032
Equipment and improvements, net 2,172 2,451
Software development costs, net 473 123
------- --------
Total assets $25,876 $59,728
======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $1,747 $1,549
Deferred revenue 114 263
Current portion of long-term debt 782 --
Deferred income taxes 2,796 2,789
------- --------
Total current liabilities 5,439 4,601
Deferred income taxes 4,947 6,991
Long-term debt 816 --
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;
23,494,200 shares issued and outstanding
at December 31, 1995 and 26,372,000 shares
issued and outstanding at September 30, 1996 235 264
Additional paid-in capital 106 29,994
Deferred compensation (91) (77)
Retained earnings 14,522 18,089
Cumulative foreign currency translation adjustment (98) (134)
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14,674 48,136
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Total liabilities and stockholders' equity $25,876 $59,728
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Pegasystems Inc.
Condensed Consolidated Statements of Income
(unaudited)
(in thousands)
except share-related data
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
1995 1996 1995 1996
---- ---- ---- ----
Revenue
Software license $3,624 $6,502 $8,414 $12,896
Services 2,032 3,064 5,941 8,060
------ ------- ------ ------
Total Revenue 5,656 9,566 14,355 20,956
Cost of Revenue
Cost of software license 127 118 508 354
Cost of services 1,605 2,017 4,258 5,006
------ ------- ------ ------
Total cost of revenue 1,732 2,135 4,766 5,360
------ ------- ------ ------
Gross profit 3,924 7,431 9,589 15,596
Operating expenses
Research and development 1,871 2,361 4,949 5,883
Sales and marketing 878 1,614 2,542 3,870
General and administrative 381 541 1,088 1,329
------ ------- ------ ------
Total operating expenses 3,130 4,516 8,579 11,082
------ ------- ------ ------
Income from operations 794 2,915 1,010 4,514
License interest income 384 381 1,122 1,127
Other interest income 6 273 16 296
Interest expense (33) (16) (68) (85)
------ ------- ------ ------
Income before provision for
income taxes 1,151 3,553 2,080 5,852
Provision for income taxes 437 1,386 790 2,285
------ ------- ------ ------
Net income $714 $2,167 $1,290 $3,567
====== ======= ====== ======
Net income per common and
common equivalent share $0.03 $0.08 $0.05 $0.14
====== ======= ====== ======
Weighted average number of
common and common
equivalent shares outstanding 25,600 26,991 25,600 25,952
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Pegasystems Inc.
Condensed Consolidated Statements of Cash Flow
(unaudited)
(in thousands)
Nine Months Ended September 30,
-------------------------------
1995 1996
Operating activities
Net income $1,393 $3,567
Adjustments to reconcile net income to
net cash provided (used) by operating
activities:
Provision for deferred income taxes 819 2,037
Depreciation and amortization 975 1,152
Provision for doubtful accounts -- --
Change in operating assets and liabilities:
Decrease (increase) in trade and
installment accounts receivable (3,240) (8,438)
Decrease (increase) in prepaid
expenses and other assets (206) (116)
Decrease (increase) in inventory -- --
Increase (decrease) in accounts
payable and accrued expenses (895) (198)
Increase (decrease) in deferred
revenue 769 149
------ -------
Net cash provided (used) by operating
activities (385) (1,847)
Investing activities
Purchase of equipment and improvements (851) (1,067)
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Software development costs -- --
------ -------
Net cash used in investing activities (851) (1,067)
Financing activities
Repayment of note payable to shareholder (50) --
Proceeds from issuance of long-term debt 1,347 --
Repayments of long-term debt (299) (1,598)
Issuance of common stock -- 29,396
Exercise of stock options -- 60
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Net cash provided (used) by financing
activities 998 27,858
Effect of exchange rate on cash (17) (36)
------ -------
Net increase (decrease) in cash (255) 24,908
Cash and equivalents at beginning of year 456 511
------ -------
Cash and equivalents at end of period $ 201 $25,419
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PEGASYSTEMS INC.
NOTES TO CONDENSED CONSOLIDATED
INTERIM FINANCIAL STATEMENTS
(unaudited)
September 30, 1996
Note A -- Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the three- and nine-month
periods ended September 30, 1996 are not necessarily indicative of the results
that may be expected for the year ending December 31, 1996. The registrant
suggests that these interim condensed consolidated financial statements be read
in conjunction with the audited consolidated financial statements and footnotes
thereto included in the registrant's Registration Statement on Form S-1, as
amended (the "Registration Statement") originally filed on May 15, 1996 and
declared effective on July 18, 1996. A copy of the Registration Statement may be
obtained from the Securities and Exchange Commission from its Public Reference
Section, 450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of
prescribed fees.
Note B -- Subsequent Events
None
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Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The Company was founded in April 1983 to develop, market and support customer
management software solutions for financial services organizations. Product
development began immediately and by the end of the year the Company had
secured its first customer. The Company has been profitable in each fiscal
quarter since the first quarter of 1985.
The Company's revenue is derived from two sources: software license fees
and services revenue. License fees, which have historically represented the
majority of the Company's total revenue, are generally payable on a monthly
basis under license agreements which typically have a five-year term and are
subject to renewal at the customer's option for an additional fixed period.
Such license agreements are generally non-cancellable, although some may be
terminated by the licensee for a fee prior to the expiration of the initial
term but after a minimum specified period. The Company's licenses generally
provide for annual license fee increases (the "inflation adjustments") based
on recognized inflation indexes (sometimes subject to maximums). The Company
believes that both it and its customers derive substantial benefits from the
recurring fee model because it encourages the Company to be responsive to
customer needs and provides the Company with additional revenue opportunities
through license renewals.
License revenue is recognized upon product acceptance. In the case of
license renewals, revenue is recognized upon execution of the renewal
agreement or if, as is generally the case, renewal is automatic unless the
customer gives notice of termination, at the expiration of the period during
which the customer has the right to terminate. The inflation adjustments are
recognized ratably over the months to which they apply. In accordance with
Statement of Position No. 91-1 issued by the American Institute of Certified
Public Accountants, the amount of software license revenue recognized upon
product acceptance or license renewal is equal to the present value of the
payments due during the minimum initial or renewal term, as the case may be,
plus the present value of any early termination fee. In 1993, 1994 and 1995
and the three months ended March 31, 1996, the discount rate for purposes of
the present value calculation was 7%; for the three months ended June 30,
1996 and September 30, 1996, such discount rate was 6.75%. Commencing with
the three months ended March 31, 1996, the Company has established and
intends to continue to establish the discount rate quarterly based on the
Company's then current marginal borrowing rate, reduced, with respect to
licenses which provide for inflation adjustments, by 1.5%, reflecting the
Company's estimate of the benefit of future inflation adjustments during the
minimum license term. The imputed interest portion of the license fees, which
is reported as license interest income in the Company's consolidated
statements of income, is recognized over the minimum initial or the renewal
term, as the case may be. To date, a substantial majority of the Company's
software licenses have been renewed upon expiration. License renewals
accounted for 32%, 26% and 28% of total revenue in 1993, 1994 and 1995,
respectively. The fact that a significant portion of the Company's revenue is
derived from the renewal of license agreements with fixed expiration dates
assists the Company in anticipating future revenue.
The Company's services revenue is comprised of fees for implementation,
consulting, maintenance and training services. All software license customers
are required to enter into a maintenance contract requiring the customer to
pay a monthly maintenance fee over the term of the related license agreement
equal to approximately 18% of the license fee. Maintenance fees are
recognized ratably over the term of the maintenance agreement. The Company's
software license agreements typically require the Company to provide a
specified level of implementation services for a fixed fee, typically with
additional implementation services available at an hourly rate.
Implementation fees are payable upon the achievement of specified milestones.
The Company generally recognizes implementation as well as consulting and
training fees as the services are provided.
In accordance with generally accepted accounting principles, the Company
has capitalized certain software development costs which it has typically
amortized over two years. No such costs, however, were capitalized in 1995 or
in the nine months ended September 30, 1996. At September 30, 1996, the
Company carried $123,000 of capitalized software development costs. These
costs will be fully amortized by the end of 1996. As a result, the Company
expects that its cost of software license revenue will be lower in 1997 than
in 1996.
The Company's export revenue has fluctuated considerably in the past due
to the fact that such revenue has been largely attributable to a small number
of product acceptances during a given period. The Company's export revenue
increased from $1.0 million in 1993 to $3.9 million in 1994 due primarily to
product acceptance by a single customer in Ireland in 1994, the year in which
the Company organized its subsidiary in the United Kingdom. Export revenue
declined to $2.3 million in 1995 due to the lack of large product acceptances
during the year.
Most of the Company's contracts are denominated in U.S. dollars, although
several are denominated in other currencies, primarily British pounds
sterling. The Company expects that in the future more of its contracts will
be denominated in foreign currencies. The Company has not experienced any
significant foreign exchange gains or losses, and the Company does not expect
that foreign currency fluctuations will have a significant effect on either
its revenue or costs in the near term.
Nine Months Ended September 30, 1996 Compared to Nine Months Ended September
30, 1995
Revenue
Total revenue for the nine months ended September 30, 1996 (the "1996
Period") increased 46.0% to $21.0 million from $14.4 million for the nine
months ended September 30, 1995 (the "1995 Period"). The increase was
primarily due to an increase in software license revenue.
Software license revenue for the 1996 Period increased 53.3% to $12.9
million from $8.4 million for the 1995 Period. The increase in software
license revenue was primarily attributable to software license acceptances by
new customers, software license agreement renewals, expanded software usage
by existing customers existing customers, the licensing of standard product
templates and inflation-based increases in monthly license fees.
Services revenue for the 1996 Period increased 35.7% to $8.1 million from
$5.9 million for the 1995 Period. The increase in services revenue was
primarily attributable to increased demand for consulting and implementation
services, and to a lesser extent, increased maintenance revenue from a larger
installed product base.
Cost of Revenue
Cost of software license consists of amortization expense related to
capitalized software development costs, royalty payments to third party
software vendors and costs of product media, duplication and packaging. Cost
of software license for the 1996 Period decreased 30.3% to $354,000 from
$508,000 for the 1995 Period, and decreased as a percentage of total revenue
from 3.5% for the 1995 Period to 1.7% for the 1996 Period. As a percentage of
software license revenue, cost of software license decreased from 6.0% for
the 1995 Period to 2.7% for the 1996 Period. Such decreases were due to
decreased amortization expense related to capitalized software development
costs.
Cost of services consists primarily of the costs of providing
implementation, consulting, maintenance and training services. Cost of
services for the 1996 Period increased 17.6% to $5.0 million from $4.3
million for the 1995 Period mainly due to increased staffing in the Company's
Reengineering and Client Services group in the United Kingdom and in the
Company's domestic regional offices to meet growing client commitments. Cost
of services as a percentage of total revenue declined from 29.7% for the 1995
Period to 23.9% for the 1996 Period, and declined as a percentage of services
revenue from 71.7% for the 1995 Period to 62.1% for the 1996 Period, in both
cases due to the growth in the Company's total revenue and increased
utilization of service personnel.
Operating Expenses
Research and development expenses consist primarily of the cost of
personnel and equipment needed to conduct the Company's research and
development efforts. Research and development expenses for the 1996 Period
increased 18.9% to $5.9 million from $4.9 million for the 1995 Period. The
increase in research and development expenses was due to the hiring of
additional development personnel. As a percentage of total revenue, research
and development expenses declined from 34.5% for the 1995 Period to 28.1% for
the 1996 Period reflecting the Company's strategy of leveraging existing
product functionality by shifting its historical focus on research and
development to sales and marketing.
Sales and marketing expenses for the 1996 Period increased 52.2% to $3.9
million from $2.5 million for the 1995 Period. As a percentage of total
revenue, sales and marketing expenses increased from 17.7% for the 1995
Period to 18.5% for the 1996 Period. Such increases were attributable to the
hiring of additional direct sales and marketing personnel, increased sales
commission payments attributable to higher sales, and increased investment in
marketing support activities and materials.
General and administrative expenses consist primarily of the salaries of
the Company's executive, administrative and financial personnel, and
associated expenses. General and administrative expenses for the 1996 Period
increased 22.2% to $1.3 million from $1.1 million for the 1995 Period due to
increased investment in the infrastructure needed to support the Company's
growth. Such expenses declined as a percentage of total revenue from 7.6% for
the 1995 Period to 6.3% for the 1996 Period due to the growth in the
Company's total revenue.
License Interest Income
License interest income represents the portion of all license fees due
under software license agreements which was not recognized upon product
acceptance or license renewal. License interest income for the 1996 Period
and the 1995 Period remained constant at $1.1 million.
Provision for Income Taxes
The provisions for federal, state and foreign taxes were $790,000 and $2.3
million for the 1995 Period and the 1996 Period, respectively. The effective
tax rates were 38% for the 1995 Period and 39% for the 1996 Period. The
increase in the effective tax rate was primarily due to the reduced
availability of research and development tax credit carryforwards. At
September 30, 1996, the Company had $420,000 in research and development tax
credit carryforwards available to offset future federal taxable income.
Liquidity and Capital Resources
Since its inception, the Company has funded its operations primarily
through cash flow from operations and bank borrowings. In addition, in July
1996, the Company issued and sold 2,700,000 shares of Common Stock in
connection with its initial public offering. Net proceeds to the Company from
such offering were approximately $29.4 million. At September 30, 1996, the
Company had cash and cash equivalents of approximately $25.4 million and
working capital of approximately $34.5 million. The Company's approach of
charging license fees payable in installments over the term of its licenses
has historically deferred the receipt of cash and limited the availability of
working capital.
Net cash provided by operating activities for the years ended December 31,
1993, 1994 and 1995 was $1.6 million, $1.5 million and $830,000, respectively.
Such amounts were used to support the Company's working capital requirements.
During the nine months ended September 30, 1996, net cash used by operating
activities was $1.8 million, primarily due to an increase in accounts
receivable.
The Company used $890,000, $1.1 million, $1.4 million and $1.1 million of
net cash during 1993, 1994, 1995, and the nine months ended September 30,
1996, respectively, to purchase property and equipment, primarily computer
hardware and software, to support the Company's growing employee base and new
regional office and training facilities. The Company's capital commitments
consist primarily of operating leases for office space and equipment. At
December 31, 1995, the Company's commitments under noncancellable operating
leases for office space and equipment with terms in excess of one year
totalled $1.0 million, $1.1 million and $1.1 million for 1996, 1997 and 1998,
respectively. The Company's total payments under such leases was $800,000,
$860,000 and $1.1 million for 1993, 1994 and 1995, respectively. See Note 6
of Notes to Consolidated Financial Statements.
The Company has a $5.0 million revolving credit line, which is unsecured
and expires on June 30, 1997. At September 30, 1996, the Company had no
borrowings under its revolving credit line. The Company's credit agreement
prohibits the payment of dividends, has profitability requirements and
requires maintenance of specified levels of tangible net worth and certain
financial ratios. See Note 4 of Notes to Consolidated Financial Statements.
In 1993, the Company recorded bad debt expense in the amount of $326,000
as a result of certain specifically identified accounts receivable relating
primarily to services rendered by the Company. The Company recorded no bad
debt expense in 1994. In 1995, the Company recorded bad debt expense in the
amount of $793,000 as a result of indications in the fourth quarter of the
year that certain receivables relating primarily to services rendered by the
Company would not be collected in full. The receivables with respect to which
bad debt expense was recorded in 1993 and 1995 related primarily to
maintenance and installation services provided by the Company. At the time
such services were rendered (and the resulting revenue was recognized) there
was no significant uncertainty regarding the acceptance thereof and the
collectibility of the related receivables was probable.
The Company believes that the net proceeds from this offering and its
initial public offering together with cash generated by operations and
availability under its bank credit facility will be sufficient to fund the
Company's operations for at least one year following the completion of this
offering. However, there can be no assurance that additional capital beyond
the amounts currently forecasted by the Company will not be required or that
any such required additional capital will be available on reasonable terms,
if at all, at such time as required by the Company.
Inflation
Inflation has not had a significant impact on the Company's operating results
to date, nor does the Company expect it to have a significant impact in the
future due to the fact that the Company's license and maintenance fees are
typically subject to annual increases based on recognized inflation indexes.
Forward Looking Statements
To the extent that this report contains "forward looking statements,"
the registrant cautions that actual financial, market, and operating results may
vary materially and adversely from those predicted, and that the forward looking
statements are subject to a wide range of risks and uncertainties. Further
information regarding the various factors which could materially and adversely
affect the registrant's results is described in its Prospectus dated July 18,
1996 which was filed with the Securities and Exchange Commission on July 19,
1996.
Part II. Other Information
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Securities Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None
Signature
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: November 19, 1996 By:
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Ira Vishner
Chief Financial Officer and Vice President
of Corporate Services