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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 1997
Commission File No. 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)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $.01 par value per share
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
As of March 20, 1998, the aggregate market value of the Registrant's voting
stock held by non-affiliates of the Registrant was approximately $487.1 million
(without admitting that any person whose shares are not included in determining
such value is an affiliate).
There were 28,545,100 shares of the Registrant's common stock, $.01 par
value per share, outstanding on March 20, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Definitive Proxy Statement for its 1998 Annual
Meeting of Stockholders to be held on May 6, 1998 (the "1998 Proxy Statement")
are incorporated by reference into Part III of this Form 10-K and portions of
the Registrant's Annual Report to Stockholders for the Registrant's fiscal year
ended December 31, 1997 (the "1997 Annual Report") are incorporated by reference
into Part II and Part IV of this Form 10-K. With the exception of the portions
of the 1998 Proxy Statement and the 1997 Annual Report expressly incorporated
into this Form 10-K by reference, such documents shall not be deemed filed as
part of this Form 10-K.
TABLE OF CONTENTS
PART 1
Item Page
- ---- ----
1 Business 3
2 Properties 16
3 Legal Proceedings 16
4 Submission of Matters to a Vote of Security Holders 16
Executive Officers of the Registrant 17
Certain Statements for Purposes of the "Safe Harbor" Provisions
of the Private Securities Litigation Reform Act of 1995 18
PART II
5 Market for Registrant's Common Stock and Related 24
Stockholder Matters
6 Selected Consolidated Financial Data 24
7 Management's Discussion and Analysis of Financial 24
Condition and Results of Operations
7A Quantitative and Qualitative Disclosure About Market Risk 24
8 Financial Statements and Supplementary Data 25
9 Changes in and Disagreements with Accountants on 25
Accounting and Financial Disclosure
PART III
10 Directors and Executive Officers of the Registrant 25
11 Executive Compensation 25
12 Security Ownership of Certain Beneficial Owners and 25
Management
13 Certain Relationships and Related Transactions 25
PART IV
14 Exhibits, Financial Statement Schedules, and Reports on 26
Form 8-K
Page 2
PART I
Item 1 BUSINESS
Pegasystems develops customer relationship management software to automate
customer interactions across transaction-intensive enterprises. Many of the
world's largest organizations in banking, mutual funds and securities, mortgage
services, card services, insurance, healthcare management, and
telecommunications use the Company's solutions to integrate, automate,
standardize, and manage a broad array of mission-critical customer interactions,
including account set-up, record retrieval, correspondence, disputes,
investigations, adjustments, and sales. The Company's solutions can be used by
thousands of concurrent users to manage customer interactions and to generate
billions of dollars a day in resulting transactions. Work processes initiated by
the Company's solutions are driven by a highly adaptable "rule base" defined by
the user-organization for its specific needs. The rule base facilitates a high
level of consistency in customer interactions in call centers, over the
Internet, and other delivery channels, yet drives different processes depending
on the customer profile or the nature of the request. The Company's open,
multi-tiered, client/server solutions operate on a broad variety of platforms,
including UNIX, Windows/NT, and IBM/MVS. The Company offers consulting,
training, and support services to facilitate the use of its solutions.
Industry Background
Intensifying competition is forcing businesses to reduce costs while
focusing on customer relationship management as the most important means of
differentiation. Many types of businesses are increasingly recognizing customer
interactions as a critical opportunity to solidify and expand customer
relationships. Due to the volume and precise nature of customer transactions, it
is especially critical for organizations to implement cost-effective systems
that manage customer interactions accurately and efficiently and capitalize on
that interaction to cross sell and up sell additional products and services.
Providing high-quality, cost-effective customer relationship management is
complex. Organizations with global operations must be able to manage customer
interactions in different languages, time zones, currencies, and regulatory
environments. The challenge is magnified as the product offerings of an
organization increase and when organizations are combined. Work processes
occasioned by a single customer interaction often involve multiple departments
within an organization, which may have different priorities and service
standards, and may involve a variety of different computer systems. Customers
may contact an organization through various means, including telephone,
facsimile, the Internet, or in person. The organization must be able to respond
in a timely, accurate, and consistent fashion or risk customer defection.
Historically, in attempting to meet demand for new customer management
software systems, organizations have faced a choice between building custom
systems or purchasing third-party systems. Building custom systems or modifying
third-party systems can be slow and costly and has often led to isolated,
departmentalized solutions. Traditional third-party systems are often
inflexible, requiring organizations to conform their work processes to the
system, rather than vice versa. Neither custom nor third-party solutions have
generally accommodated an organization's need to evolve or expand operations
without significant programming effort. Moreover, neither has had the
high-volume transaction processing or integration capabilities necessary to
support the comprehensive customer interaction requirements of large
organizations. Today, organizations need flexible, scalable customer
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relationship management solutions that can be implemented on an enterprise-wide
basis to facilitate consistent, cost-effective customer relationship management.
The Pegasystems Solution
The Company's solutions integrate, automate, standardize, and manage on an
enterprise-wide basis a broad array of mission-critical customer interactions
for organizations, including account set-up, record retrieval, correspondence,
disputes, investigations, adjustments, and sales. Pegasystems' solutions provide
an architecture that drives intelligent processing and seamlessly integrates an
organization's geographically dispersed and product specific service operations
and isolated computer systems. By bridging these "islands of automation" within
large organizations, the Company's solutions increase the efficiency of sales
and service representatives and enable organizations to address multiple
customer needs during a single contact.
The Company's customer service management solutions offer the following
advantages:
Flexibility and Consistency. The Company's solutions are based on rules
defined by the user-organization which drive various types of processing
depending on such factors as the content of the customer request, the profile of
the customer, the organization's policies and procedures, and the authority or
qualifications of the customer sales and service representatives. By modifying
its rule base, an organization can evolve its processing to address the
competitive requirements of its business without costly and time consuming
reprogramming. Significantly, the rule base feature of the Company's systems
permits an organization to establish consistent standards yet interact
differently with different segments of its customer base and thereby "mass
personalize" its services.
Scalability and Robust Functionality. The scalability of the Company's
multi-tiered client/server architecture allows an organization to add
departments easily to new or existing servers without performance degradation.
Organizations currently entrust the Company's systems with the storage and
management of data relating to hundreds of millions of financial transactions.
The Company's systems can be used by several thousand concurrent users to manage
customer interactions and to process accurately and securely transactions
involving billions of dollars a day that result from those interactions.
Ease-of-Use. The Company's client software applications increase the
effectiveness and productivity of customer sales and service representatives by
providing them with a flexible graphical user interface and processing
capabilities that leverage the power of client/server desktop computers or the
Internet/intranet. The Company's solutions allow customer sales and service
representatives to focus on delivering superior customer management, rather than
on mastering the protocols and procedures of multiple applications.
Integration Capabilities. The Company's open architecture permits its
solutions to be integrated with a wide variety of other applications and
technologies, including industry-standard relational database management
systems, advanced telephony equipment, and diverse storage media (including
magnetic, optical, tape, and microfilm). The Company's solutions also support
the message formats of major financial transaction networks such as the SWIFT
international funds network, the Federal Reserve's Fedwire system, and the VISA
and MasterCard networks.
Page 4
Multi-Platform Server Support. The Company's solutions feature a common
software code base which, in addition to facilitating maintenance and
enhancement development efforts, simplifies the support of multiple platforms.
The Company's solutions are designed to run on a broad range of computer
operating systems including IBM's MVS/CICS and AIX/UNIX systems, Digital
Equipment Corporation's VMS system, Microsoft's Windows/NT system, Sun
Microsystems' Solaris UNIX system, and Hewlett-Packard Corporation's HP-UX UNIX
system.
Improved Efficiency of Customer Management. Pegasystems' solutions actually
perform work, rather than simply track a customer management professional's
tasks. Variable data elements (e.g., date, amount, customer, account)
automatically route service requests and invoke system processes, depending on
an organization's rule base. This feature allows customer sales and service
representatives to focus on revenue enhancing opportunities, such as cross
selling, and other matters requiring personal attention. During a customer
interaction, the Company's solutions provide pertinent, consolidated information
to guide the service representative. Savings are realized through reduced talk
time, fewer manual processes, and less rework.
Business Strategy
Pegasystems' objective is to become the leading provider of
mission-critical client/server customer relationship management software to
organizations performing a high volume of complex interactions with demanding
customers. To achieve this objective, the Company is pursuing the following
strategies:
Leverage Strength in Financial Services Market. Pegasystems provides
customer relationship management solutions to many of the largest financial
services organizations in the world. The Company is seeking to expand its
business with these organizations through sales efforts focused on marketing the
Company's products and services to other business operations of these
organizations. The Company is also leveraging its relationships and expertise
with large financial services organizations to penetrate the medium-sized
financial services market.
Leverage Early Endorsement in Other Markets. In 1997, Pegasystems
successfully penetrated and delivered its solutions to the insurance,
telecommunications, healthcare management, and public utilities markets. Like
the financial services industry, these markets have customer relationship
management needs, and the Company's core technology is readily adaptable to
these markets. During 1997, the Company hired personnel with expertise in these
markets.
Increase Sales and Support Efforts. Pegasystems intends to establish
additional sales and support offices, increase significantly its domestic and
international direct sales forces, and provide enhanced service to customers. In
addition, the Company plans to develop further its relationships with technology
partners and consulting firms to gain introduction into significant business
opportunities.
Develop Standard Product Templates. The Company commenced licensing
standard product templates that give organizations an advanced starting point
for configuring their work processes.
Page 5
The Company intends to continue to develop and market standard product
templates. The Company believes that these templates will facilitate more rapid
implementation of the Company's solutions and will be a cost-effective way to
address the needs of smaller organizations.
Reduce Implementation Time. The Company is continuing to refine its
PegaSTAR consulting methodology, an approach to the reengineering of an
organization's work processes that facilitates more rapid implementation of the
Company's customer management systems and continued evolution of such systems by
an organization's personnel after initial implementation. This methodology
complements the Company's standard product templates in reducing the time
required to implement the Company's systems.
Strategic Relationships. The Company has actively developed a partner
strategy to increase market penetration at several levels. It has developed a
formal PegaCSP (Pegasystems' Certified Solutions Provider) program to recruit
Systems Integrators to allow and enable them to develop active Pegasystems
practices. The Company is continuing with its strategy of leveraging dominant
players in certain markets to sell and support its products. Financial
transaction processors such as First Data Resources, for example, provide access
to key customers and significant insight into the product requirements of the
card market. The Company also continues to leverage relationships with
technology companies to jointly bring best-of-breed solutions to market in a
timely fashion.
Maintain Technological Leadership Position. Pegasystems is continuing to
develop and invest in its technology. Current development efforts include the
development of tools to facilitate the use of its customer management system,
the integration of the Company's products with additional databases,
interoperability with Internet and intranet systems, and support of emerging
technical and workflow standards.
Technology
The Company's technology is designed to provide Technology Enabled
Relationship Management (TERM) over a variety of delivery channels including
call centers, branch offices, and the Internet. Pegasystems' solutions have the
following key technological attributes:
Information Management. Effective customer response requires up-to-date
information about the customer relationship, regardless of how, why, when, or
where the customer contacts the organization. Pegasystems' customer relationship
management solutions organize core customer information to facilitate global
access.
Multi-tiered, Dynamic Distributed Processing. The Company's systems are
designed to run in an advanced, highly scalable multi-tiered environment. In
traditional three-tiered client/server environments, the user interface, the
application code, and the data are segregated onto separate tiers. In the
Pegasystems three-tiered client/server environment, the application code, the
rule base, and selected data are replicated on both the central and satellite
tiers so that processing may occur on either the central server or the
distributed satellite servers to minimize network traffic and enhance
performance. The rule base determines the optimal location for processing to
occur based on the nature of the work required and the data involved. Rule base
changes are replicated across the organization's central and satellite servers
to facilitate consistent processing by all parts of the organization.
Page 6
Inherited Workflow. Pegasystems solutions maintain organizational
consistency while providing the flexibility needed for mass personalization. The
rule base of the Company's systems may be defined so that certain processes are
standardized across an organization while others may be superseded or
supplemented by "local" rules tailored to the specific requirements of groups
within the organization.
Platform Independence. Recognizing that organizations often use a variety
of computer platforms, Pegasystems provides technology alternatives by
supporting a range of mainframes, minicomputers, PC networks, and interface
devices. While the Company offers an advanced 32-bit Windows-PegaREACH
application for the desktop, the Company's server applications can also drive
"dumb terminals," allowing organizations to preserve their investments in legacy
networks.
Internet and Intranet Access. Pegasystems' solution PegaREACH uses the
Internet-based HTML (Hypertext Markup Language) to define display attributes for
its graphical user interface, leveraging logic and presentation rules between
PegaReach and Internet/intranet workflows. With PegaWEB, these workflows can be
accessed over the Internet or intranet using standard web browsers with no
change to core application rules. Pegasystems' rules dynamically create HTML
forms, menus, and displays, thereby facilitating interaction with the Internet.
Interfacing With Other Systems. Pegasystems' open architecture permits
integration with a wide variety of other applications and networks, including
relational databases, legacy systems accessed through IBM 3270 emulation, and
messaging protocols. The Company offers a Universal Application Programming
Interface (API) that allows an organization's custom software to be integrated
with the Company's applications without the need to modify the Company's core
application code. Pegasystems' PegaCONNECT components also support interfaces to
IBM's MQSeries, CORBA, 3270-based mainframe applications, and major relational
database systems. Pegasystems' solutions also integrate with other applications,
accounting systems, and imaging products
Storage Options. Data storage flexibility is important to the Company's
customers, and the Company's software uses an innovative object-oriented
approach that dynamically maps data according to the type of workflow. Versions
of the Company's systems can store customer service request data in the
Microsoft SQL Server, Oracle, Informix, and Sybase relational databases.
Functionality
The Company's solutions employ a consistent architecture and support the
following customer relationship management functions across call centers and
other service delivery operations:
Receiving. An organization's customer contact center receives requests by
telephone, mail, facsimile, or personal contact. Customer service
representatives and agents may enter details of incoming requests into
PegaREACH, the Company's easy-to-use, 32-bit graphical user interface.
Alternatively, electronic service requests are received from various networks or
messaging interfaces such as MQSeries, the SWIFT network, the Internet, or the
VISA/MasterCard network. The Company's systems also support direct electronic
access by customers through PCs, Internet
Page 7
browsers, and voice response units. In all cases, the service request
automatically initiates appropriate processing based on the rule base.
Routing. As processing steps are completed, the Company's systems
categorize and queue the request for appropriate automatic or manual processing.
Productivity-based load leveling and dynamic prioritization ensure high
performance and responsiveness. As work is processed, each customer
representative's "work list" is automatically updated in real time. The systems
monitor each customer request for conformance to the organization's timeliness
standards, automatically increasing priority and generating warnings based on
the service standards of the organization.
Researching. The Company's systems determine when more information is
needed and how to retrieve it from databases or other repositories. Pegasystems'
rule-driven processing automatically extracts relevant data, directs it to the
customer service representative or customer, links it to the work, and keeps it
readily accessible. The Company's systems can access information from multiple
data sources, whether maintained by the Company's systems or third-party
systems.
Responding. The Company's systems facilitate communications by an
organization with its customers by combining user-defined templates and specific
customer information to create personalized correspondence. When appropriate,
service representatives may further refine message content before forwarding by
mail, facsimile, or electronic transmission, and may attach images of
statements, checks, and other data. Follow-up communications are automatically
composed, customized, and sent. Sensitive correspondence can be queued for
online review before release, and the systems create a permanent audit trail of
customer communications.
Resolving. Concluding a piece of work involves application of the
organization's rules for resolving a request or stepping the customer service
representative through the process when human judgment is required. Resolution
also includes the creation of transactions, transmission to production systems,
management of financial adjustments, posting of service charges, updating of
general ledger accounts, and synchronization of multiple item requests.
Pegasystems' solutions improve efficiency and reduce effort and errors.
Reporting. Data automatically collected by a Pegasystem enables an
organization to analyze service representative efficiency and determine needs
for service representative training or changes to work processes. The systems
produce reports, graphical output, and feeds to spreadsheets illustrating the
volume and status of customer requests, the productivity of customer service
representatives, and service levels with specific customers.
The Company offers a number of different products with components and
features designed to address particular business areas while sharing core
technology and adaptable rule-driven processing. The Company intends to continue
to develop and market standard packaged solutions targeted at traditional and
new markets. The Company is moving toward product sets and brand identities
associated with each market.
Page 8
The Company offers industry specific solutions for:
Commercial Banking. The Company provides commercial banking solutions that
automate payments research, money transfers, and other "cash management' service
functions. These solutions improve the quality, accuracy, and efficiency of
customer interactions, making it easy for commercial banking organizations to
support their offerings a wide variety of services, including funds transfers,
account reconciliation, lock-box services, controlled disbursement accounts, and
account analysis.
Consumer Banking. The Company provides consumer banking solutions that automate
customer sales and service initiatives across diverse delivery channels, such as
Internet self-service, call centers, and branch networks. Targeted functions
within consumer banking include customer-contact adjustments, sales-campaign
management, and correspondence.
Securities and Mutual Funds. The Company services the mutual funds industry
through an agreement with First Data Investor Services Group, Inc. (FDI), a
subsidiary of First Data Corporation. The integrated product--marketed by FDI
under the name IMPRESS Plus--offers mutual fund institutions a comprehensive
service solution.
Card Processing. The Company's products are offered to the card processing
market through a relicensing agreement with First Data Resources (FDR)--the
largest card processor in the world. A jointly developed solution combines
Pegasystems' workflow and service delivery technology with First Data's
servicing functionality and on-line interfaces. It gives clients a flexible,
user-friendly solution that can be quickly and easily adapted to meet evolving
business needs without costly programming.
Insurance. The Company's insurance solutions integrate disparate back-end
systems to ensure that when calls, letters, or faxes reach representatives, they
have easy access to all the information they need to handle policyholder
requests. The Company's solutions position insurance organizations to provide
highly personalized customer service and increase profitability through
cross-selling.
Healthcare. The Company's healthcare solutions enable healthcare organizations
to more efficiently coordinate care. This allows health maintenance
organizations, healthcare providers, pharmacists, laboratory clinicians, and
health insurers to access integrated patient information over a network of
previously disconnected systems. Personalized data presentation provides
meaningful views of a patient's history, giving users easy access to just the
information they need to quickly respond to requests including referrals,
benefits verification, and claim status.
Telecommunications. The Company's flexible rule-base solutions can be configured
to automate a telecommunications service provider's interactions with its
customers and other providers. The Company provides workflow management
solutions which integrate disparate information systems--a capability of
importance to telecommunications providers facing competition due to
deregulation.
Utilities. The Company offers solutions that unite departmental or
organizational `islands of information' that may have evolved over years of
internal systems development. They retrieve customer information from numerous
legacy systems, identify cross-selling opportunities personalized to the
individual needs of each customer, and provide convenient service alternatives.
These solutions optimize customer service representative talk time and ensure
consistently high-quality service. They can also be adapted for a wide variety
of plant monitoring, management, and maintenance functions and can be configured
to track and document authorizations, and to enforce adherence to regulated
response times.
Page 9
Product Pricing
The Company's systems are licensed to organizations under agreements
requiring the payment of fees, typically in monthly installments, over the term
of the agreement. The amount of the license fee is based on various factors,
including the number of concurrent users, the functionality of the system, the
number of servers on which the product is installed, and the scope of business
usage. Typical recent individual system licenses have provided for the payment
of monthly fees of between $10,000 and $100,000 for an initial implementation.
Some organizations receive discounts for licensing multiple systems. The monthly
license payments generally begin once a system is installed and its capabilities
are accepted. The term of such licenses is typically five years, subject to
automatic renewal at the organization's option.
Services
Consulting Services. The Company supports its customers' reengineering
efforts during and after system installation with the PegaSTAR (the Pegasystems
Structured Technique for Analysis and Reengineering) installation methodology.
The Company encourages team building and transfer of knowledge from its
consultants to an organization's staff through an interactive co-production
methodology. Pegasystems and its customers work together to design, document and
tailor the system's rule base to the customer's organization. Pegasystems' goal
is to empower its customers' staffs with the knowledge and confidence to
operate, refine, and evolve their systems. The Company's new PegaCSP program
provides customers with the option of using third-party Systems Integrators'
analytical, technical, and managerial expertise to assist in Pegasystems'
implementation projects. Pegasystems Client Services Group, which as of December
31, 1997 was comprised of approximately 125 people located in the Company's
twelve offices, provides consulting, training, and customer support.
Training. The Company offers training programs for its customers'
operations staff and "Workflow Architects," who are responsible for evolving the
rules that drive the various processes related to customer interactions.
Pegasystems also organizes an annual PegaVISION Customer Conference and periodic
Advisory Board meetings, which enable its clients to exchange ideas, learn about
product directions, and influence Pegasystems' development process. Pegasystems
has training centers in Cambridge, MA; San Francisco, CA; and Reading, U.K.
Maintenance and Support. Pegasystems provides comprehensive maintenance and
support services, which may include 24 hours a day, 7 days a week customer
service, periodic preventative maintenance, documentation updates, and new
software releases.
Organizations that license the Company's systems may enter into a
maintenance contract providing for the payment to the Company of a monthly
maintenance fee over the term of the related license agreement generally equal
to approximately 18% of the monthly license fee. Organizations seeking
consulting and support services are generally charged an incremental fee ranging
between $70 and $220 per hour.
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Customers
Pegasystems provides robust and scalable customer service management
solutions that can support thousands of concurrent users based in multiple
countries, speaking different languages, and working with different currencies.
A representative list of the Company's major customers and the uses to which
they apply the Company's products is shown below:
Banco Popular de Puerto Rico -- Retail service center automation, check
research, and consumer loan inquiry and service.
Bank of America -- Retail/check customer service and research, automation
of branch support centers. Institutional funds transfer and foreign exchange
customer service for U.S. and European operations. Credit and debit card
correspondence, and dispute and chargeback service processing.
Bank of Ireland -- Retail/check clearings and research, automation of
branch support centers, and exception/credit item review and verification.
Banque Nationale de Paris -- Institutional funds transfer service,
research, and archive.
Barclays Bank PLC -- Institutional funds transfer and foreign exchange
customer service for international operations. Merchant credit card service
including telephony center, correspondence, and dispute and chargeback
processing.
Cedel Bank -- Global custody and securities movement customer service.
Central Vermont Public Services Corp. -- Customer service management,
providing call center representatives with access to consolidated customer
information.
Citibank -- Global funds transfer and foreign exchange customer service.
Check-related customer service and research. Domestic MasterCard and Visa
service including image integration, correspondence, and dispute and chargeback
processing.
Colonial Group -- Mutual fund customer service supporting telephony center
and correspondence.
Federal Reserve Banks of Boston and San Francisco -- Check processing
customer service, suspense ledger management, research, adjustment, and archive.
Fidelity Investments -- Mutual fund customer service supporting telephony
center and correspondence.
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First Chicago NBD -- Retail/check customer service and research. Wholesale
banking, funds transfer, check, corporate lockbox, and interbank compensation
service for global operations.
Franklin Templeton Group -- Mutual fund customer service supporting
telephony center, correspondence, and research.
Homeside Lending -- Escrow analysis and payment processing.
Household Credit Services -- Credit card service including telephony
center, correspondence, dispute, and chargeback processing. Private label
customer service for major retailers.
Kaiser Permanente -- Automating healthcare member, patient, provider, and
payer interactions.
Marine Midland Bank -- Institutional funds transfer customer service.
Mellon Bank Corporation -- Retail/check customer service, research, and
archive. Wholesale, institutional, cash management, and corporate lockbox
customer service.
Sears -- Customer service and authorizations at the Regional Credit Card
Operations Centers of Sears Credit, the consumer credit division of Sears,
Roebuck, and Co.
Trans Union Corporation -- Credit bureau data-management customer service
for institutional customers and real estate property appraisal processing.
In 1995, Chemical Bank accounted for 12.6% of the Company's consolidated
revenue and Citibank and Household Credit Services accounted for 16.2% and
14.9%, respectively, of the Company's consolidated revenue. In 1996, Bank of
America, Chase Manhattan Bank, and Fleet Bank accounted for 14.5%, 11.4% and
10.5%, respectively, of the Company's consolidated revenue. In 1997, Kaiser
Permanente and First Data Resources Corporation accounted for 13.7% and 10.0%,
respectively, of the Company's consolidated revenue.
Sales and Marketing
The Company markets its software and services primarily through a direct
sales force. As of December 31, 1997, the Company's sales force consisted of
approximately 40 salespersons in the Company's domestic and foreign offices. The
Company intends to continue to increase substantially the size of its sales
force. In addition, the Company is seeking to enhance the productivity of its
direct sales force by hiring additional support personnel to assist with the
sales, marketing, and technical requirements of the Company's complex and
lengthy sales cycle. To achieve significant revenue growth in the future, it
will be necessary for the Company both to increase the size and to enhance the
productivity of its direct sales force. Competition for qualified sales
personnel is intense and there can be no assurance that the Company will be able
to attract such personnel. If the Company is unable to hire additional qualified
sales personnel on a timely basis, the Company's business, operating results,
and financial condition could be materially and adversely affected.
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Pegasystems entered into a strategic relationship with First Data
Corporation which includes an agreement with First Data Resources (FDR) that
gives FDR -- the largest card processor in the world -- world wide rights to use
and re-license Pegasystems' solutions in the card issuing market. The Company
has evolved its indirect distribution channel by entering into an agreement with
First Data Investor Services Group, Inc., under which the Company's PegaSHARES
product is distributed by First Data. In addition, the Company has established
joint marketing relationships with Sun Microsystems, Hewlett-Packard Company,
Oracle Corporation, Informix, and Sybase. Recently, the Company entered into a
joint marketing agreement with Management Data, which develops solutions for
reconciliation and exception management for financial transactions. In the
future, the Company may also market and sell its products through value added
resellers (VARs) and Systems Integrators. There can be no assurance, however,
that the Company will be able to attract and retain VARs, Systems Integrators,
and other third parties that will be able to market and sell the Company's
products effectively.
To support its sales force, the Company conducts marketing programs which
include trade shows, public relations, and seminars. Sales leads are also
generated by the Company's consulting staff, partners, and other third parties.
In 1995, 1996, and 1997, international sales represented 10.5%, 17.7%, and
16.5%, respectively, of the Company's total revenue. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations" incorporated herein by reference from the
1997 Annual Report. See Note 11 of Notes to Consolidated Financial Statements
contained in the 1997 Annual Report.
Product Development
Since its inception, the Company has made substantial investments in
product development. The Company believes that its future performance depends on
its ability to maintain and enhance its current products and develop new
products. The Company's product development priorities include (1) creating
tools to enable organizations to configure more easily their customer service
management systems; (2) integrating the Company's products with the Internet for
customer self-service and with intranet systems for departmental service; and
(3) developing standard Application Programming Interfaces that allow other
client workstation and server applications to interoperate with the Company's
systems.
In 1995, 1996, and 1997 the Company's research and development expenses
were approximately $7.1 million, $8.2 million, and $15.1 million, respectively.
Competition
The customer service management software market is intensely competitive
and subject to rapid change. Competitors vary in size and in the scope and
breadth of the products and services offered. The Company encounters competition
primarily from internal information systems departments of potential or current
customers that develop custom software. The Company also competes with: (1)
software companies that target the customer interaction or workflow markets such
Page 13
as Remedy Corporation, Scopus Technology, Inc., Siebel Systems, and The Vantive
Corporation; (2) companies that target specific service areas such as DST
Systems Inc.; and (3) professional services organizations such as Andersen
Consulting that develop custom software in conjunction with rendering consulting
services. In addition, the Company expects additional competition from other
established and emerging companies, including Oracle Corporation and SAP AG, as
the market continues to develop and expand. Increased competition may result in
price reductions, less beneficial contract terms, reduced gross margins and loss
of market share, any of which could materially and adversely affect the
Company's business, operating results, and financial condition.
The Company believes that the principal competitive factors affecting its
market include product features such as adaptability, scalability, ability to
integrate with other products and technologies, functionality and ease-of-use,
the timely development and introduction of new products and product
enhancements, as well as product reputation, quality, performance, price,
customer service and support, and the vendor's reputation. Although the Company
believes that its products currently compete favorably with regard to such
factors, there can be no assurance that the Company can maintain its competitive
position against current and potential competitors.
Many of the Company's competitors have greater resources than the Company,
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. Many of the Company's competitors can devote
greater managerial or financial resources than the Company can to develop,
promote and distribute customer service management software products and provide
related consulting, training, and support services. There can be no assurance
that the Company's current or future competitors will not develop products or
services which may be superior in one or more respects to the Company's or which
may gain greater market acceptance. Some of the Company's competitors have
established or may establish cooperative arrangements or strategic alliances
among themselves or with third parties, thus enhancing their abilities to
compete with the Company. It is likely that new competitors will emerge and
rapidly acquire market share. There can be no assurance that the Company will be
able to compete successfully against current or future competitors or that the
competitive pressures faced by the Company will not materially and adversely
affect its business, operating results, and financial condition.
Intellectual Property and Licenses
The Company relies primarily on a combination of copyright, trademark and
trade secrets laws, as well as confidentiality agreements to protect its
proprietary rights. The Company also has one patent application pending in the
United States relating to the architecture of the Company's systems. While the
Company believes that its pending patent application relates to a patentable
invention, there can be no assurance that such patent application or any future
patent application will be granted or that any patent relied upon by the Company
in the future will not be challenged, invalidated or circumvented or that rights
granted thereunder will provide competitive advantages to the Company. Moreover,
despite the Company's efforts to protect its proprietary rights, unauthorized
parties may attempt to copy aspects of the Company's products or to obtain the
use of information that the Company regards as proprietary. In addition, the
laws of some foreign countries do not protect the Company's proprietary rights
to as great an extent as do the laws of the United States. There can be no
assurance that the Company's means of protecting its proprietary rights will be
adequate or that the Company's competitors will not independently develop
similar technology.
Page 14
The Company is not aware that any of its products infringes the proprietary
rights of third parties. There can be no assurance, however, that third parties
will not claim infringement by the Company with respect to current or future
products. The Company expects that software product developers will increasingly
be subject to infringement claims as the number of products and competitors in
the Company's industry segment grows and the functionality of products in
different industry segments overlaps. Any such claims, with or without merit,
could be time-consuming, result in costly litigation, cause product shipment
delays, or require the Company to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, may not be available on terms
acceptable to the Company or at all, which could have a material adverse effect
upon the Company's business, operating results, and financial condition.
From time to time, the Company licenses software from third parties for use
with its products. The Company believes that no such license agreement to which
it is presently a party is material and that if any such license agreement were
to terminate for any reason, the Company would be able to obtain a license or
otherwise acquire other comparable technology or software on terms and on a
timetable that would not be materially adverse to the Company.
Employees
As of December 31, 1997, the Company had approximately 400 employees, of
whom approximately 325 were based in the United States, 65 were based in Europe,
and 10 were based in Asia Pacific. Of the total, approximately 100 perform
research and development, 160 perform consulting and customer support, 100 were
in sales and marketing, and 40 were in administration and finance. The Company's
future performance depends in significant part upon the continued service of its
key technical, sales and marketing, and senior management personnel and its
continuing ability to attract and retain highly qualified technical, sales and
marketing and managerial personnel. Competition for such personnel is intense
and there can be no assurance that the Company will be successful in attracting
or retaining such personnel in the future. None of the Company's employees is
represented by a labor union or is subject to a collective bargaining agreement.
The Company has not experienced any work stoppages and considers its relations
with its employees to be good.
Backlog of License and Maintenance
As of December 31, 1997, the Company had software license and maintenance
agreements with customers expected to result in approximately $26 million of
revenue in 1998. As of December 31, 1996, the Company had software license and
maintenance agreements with customers expected to result in approximately $8.0
million of revenue in 1997.
Page 15
Item 2 PROPERTIES
Pegasystems' principal administrative, sales, marketing, support, and
research and development operations are located in a 50,000 square foot leased
facility in Cambridge, Massachusetts. The lease for this facility expires in
March 1999, subject to the Company's option to extend the term for up to eight
additional years. The Company also leases space for its other offices in the
United States, Australia, France, and the United Kingdom. These leases expire at
various dates through 2005. The Company believes that additional or alternative
space will be available in the future on commercially reasonable terms as
needed.
Item 3 LEGAL PROCEEDINGS
Actions Arising under Federal Securities Laws
In November 1997 and in early January 1998, two separate complaints
purporting to be class actions were filed with the United States District Court
for the District of Massachusetts alleging that the Company and several of its
officers violated section 10(b) of the Securities Exchange Act of 1934, as
amended, Rule 10b-5 promulgated by the Commission thereunder, and section 20(a)
of the Securities Exchange Act of 1934, as amended. The two actions were
consolidated by order of the Court and with the parties' consent, and a
Consolidated Complaint in the case captioned Joseph Chalverus, et al. v.
Pegasystems, Inc., et al. was filed in late-March, 1998. The complaint names the
Company itself and Alan Trefler, Ira Vishner, and Kenneth W. Olson, three
officers of the Company, as defendants.
The Consolidated Complaint alleges that certain of the defendants made
materially false and misleading statements concerning the Pegasystems-First Data
Resources transaction in the Company's filings with the Commission, analysts'
reports, press releases, media reports, and in connection with the Company's
financial results for the quarter ended June 30, 1997. The Consolidated
Complaint also alleges that one of the defendants sold shares of the Company
stock during the period between the date the transaction was first publicly
announced and the date the Company announced that it and its former certifying
auditor disagreed on the accounting treatment of the transaction. The
Consolidated Complaint seeks certification of a class of persons who purchased
Pegasystems' Common Stock between July 2, 1997 through October 29, 1997, and
does not specify the amount of damages sought.
The defendants have not filed any answers, motions to dismiss or other
responsive pleadings in this litigation, but anticipate filing a motion to
dismiss in the near future. The Company intends to defend this matter
vigorously.
Item 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of fiscal 1997 there were no matters submitted to
a vote of security holders.
Page 16
EXECUTIVE OFFICERS OF THE REGISTRANT
The names of the Company's executive officers and certain information about
them are set forth below as of December 31, 1997:
Name Age Position(s) and Office(s) Held
- ---- --- ------------------------------
Alan Trefler ................................ 41 President, Clerk and Director
Eugene A. Bonte ............................. 47 Vice President of Market Strategy and
Delivery
Joseph J. Friscia ........................... 42 Vice President of Sales and Marketing
Kenneth W. Olson ............................ 47 Vice President of Technical Development
Michael R. Pyle ............................. 43 Vice President of Applications
Development
Ira Vishner ................................. 44 Vice President, Corporate Services,
Treasurer, Chief Financial Officer
and Director
Executive officers of the Company are elected by the Board of Directors on
an annual basis and serve until the next annual meeting of the Board of
Directors and until their successors have been duly elected and qualified. There
are no family relationships among any of the executive officers or directors of
the Company.
Alan Trefler, a founder of the Company, has served as President and Clerk
and has been a director since the Company's organization in 1983. Prior thereto,
he managed an electronic funds transfer product for TMI Systems Corporation, a
software and services company. Mr. Trefler holds a degree in economics and
computer science from Dartmouth College.
Eugene A. Bonte joined the Company in April 1996 as Vice President of
Market Strategy and Delivery. He was a founder of Object Design, Inc., a
developer of object database management systems and tools, where he served as
Vice President from August 1988 through September 1995 and was responsible, at
different times, for marketing, corporate development and product management.
Mr. Bonte holds a B.A. from The Johns Hopkins University and an M.B.A. from the
Harvard Business School.
Joseph J. Friscia joined the Company in 1984 to establish its New York
office. Mr. Fiscia has served as Vice President of Sales and Marketing since
1987 and has recently undertaken responsibility for delivery of consulting and
installation services. Prior to joining the Company, he worked as a money
transfer operations manager with Bankers Trust Company and J. Henry Schroder
Bank and Trust Company. Mr. Friscia holds a B.A. from Long Island University and
an M.B.A. from Adelphi University.
Kenneth W. Olson, a founder of the Company, has served as Vice President of
Technical Development since 1983. Prior thereto, he managed the development of
specialized computer systems for large-volume transaction processing for TMI
Systems Corporation. Mr. Olson holds an S.B. in Humanities and Sciences from the
Massachusetts Institute of Technology.
Michael R. Pyle joined the Company in 1985 as an application development
manager and has been Vice President of Applications Development since 1990. Mr.
Pyle holds a B.C.S. from the CS College in London. Prior to joining the Company,
Mr. Pyle worked in Europe and the United States
Page 17
developing and deploying large-scale communications systems for the financial
and commercial sectors.
Ira Vishner, a founder of the Company, has served as Vice President of
Corporate Services, Treasurer, and Chief Financial Officer of the Company since
1983 and has been a director since 1994. Prior to 1983, he worked in the
executive offices of TMI Systems Corporation where he was responsible for
corporate planning, financial analysis, and product marketing. Mr. Vishner holds
an S.B. in Mathematics from the Massachusetts Institute of Technology.
CERTAIN STATEMENTS FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF
THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company, desiring to avail itself of the "safe harbor" provisions of
the Private Securities Litigation Reform Act of 1995, wishes to caution readers
that the following important factors, among others, in some cases have caused
and in the future could cause the Company's actual results to differ materially
from those expressed in forward-looking statements made by or on behalf of the
Company in filings with the Securities and Exchange Commission, press releases
and oral statements.
Words such as "expects," "anticipates," "intends," "plans," "believes,"
"estimates," "should," and similar words and expressions are intended to
identify the forward-looking statements contained in this Form 10-K Report.
These statements are based on estimates, projections, beliefs, and assumptions
of the Company and its management and are not guarantees of future performance.
Potential Fluctuations in Quarterly Results; Seasonality
The Company's revenue and operating results have varied considerably in the
past, and are likely to vary considerably in the future. Such fluctuations may
be particularly pronounced because a significant portion of the Company's
revenue in any quarter is attributable to product acceptances or license
renewals by a relatively small number of customers, and reflecting the Company's
policy of recognizing license fee revenue upon product acceptance or license
renewal in an amount equal to the present value of the total committed license
payments due during the initial license term or renewal period, as the case may
be. Product acceptance is generally preceded by an implementation period,
typically ranging from one to six months but in some cases significantly longer,
and by a lengthy sales cycle. The Company's sales cycle is subject to a number
of significant risks over which the Company has little or no control, including
customers' budgeting constraints and internal authorization reviews. Product
implementation may be delayed for a variety of reasons including unforeseen
technical problems and changes dictated by the customer in the scope or schedule
of the implementation. Other factors contributing to fluctuations in the
Company's revenue and operating results include changes in the level of
operating expenses, demand for the Company's products and services, the
introduction of new products and product enhancements by the Company and its
competitors, competitive conditions in the industry, and general economic
conditions. The Company budgets its product development and other expenses
anticipating future revenue. If revenue falls below expectations, the Company's
business, operating results, and financial condition are likely to be materially
and adversely affected because only a small portion of the Company's expenses
vary with its revenue. As a result, the Company believes that period-to-period
comparisons of its operating results are not necessarily meaningful and should
not be relied upon to predict future performance. There can be no assurance that
the Company will be able to maintain profitability on an annual or quarterly
basis.
Page 18
The Company's business has experienced and may continue to experience
significant seasonality. In recent years the Company has recognized a greater
percentage of its revenue in its third and fourth quarters than in the first and
second quarters due to the Company's sales commission structure and the impact
of that structure on the timing of product acceptances and license renewals by
customers. This pattern has been reinforced by the Company's maintenance
contracts, some of which entitle customers to, among other things, a fixed
number of hours of service per calendar year. Once the annual allotment of
service hours is exhausted, customers pay for additional services on an hourly
basis, typically resulting in higher services revenue in the Company's second,
third, and fourth quarters.
Due to the foregoing factors, it is possible that in some future quarters
the Company's operating results will fall below the expectations of the Company,
market analysts, and investors. In such event, the price of the Company's Common
Stock would likely be materially and adversely affected.
Dependence on New Products; Rapid Technological Change; Product Development and
Implementation Risks
The market for customer relationship management software and related
consulting and training services is subject to rapid technological change,
changing customer needs and preferences, frequent new product introductions, and
evolving programming languages and industry standards that may render existing
products and services obsolete. The Company's position in its current market or
other markets that it may enter could be eroded rapidly by product advances. The
life cycles of the Company's products are difficult to estimate, and the
Company's growth and future performance will depend in part upon its ability to
enhance existing products, and to develop and introduce new products that keep
pace with technological advancements, meet changing customer requirements,
respond to competitive products, and achieve market acceptance. The Company's
product development efforts require, and are expected to continue to require,
substantial investments by the Company for research, refinement, and testing,
and there can be no assurance that the Company will have the resources
sufficient to make such investments. The Company has in the past experienced
developmental delays, and there can be no assurance that the Company will not
experience difficulties which would delay or prevent the successful development,
introduction or implementation of new or enhanced products. In addition, there
can be no assurance that such products will meet the requirements of the
marketplace and achieve market acceptance, or that the Company's current or
future products will conform to changing industry requirements. If the Company
is unable for technological or other reasons to develop, introduce or implement
new or enhanced products in a timely and effective manner, the Company's
business, operating results, and financial condition could be materially and
adversely affected.
Products as complex as the Company's may contain errors that may be
detected at any point in the products' life cycles. In the past, the Company has
discovered certain errors in its products and has experienced shipping delays
while such errors were corrected. Such errors have also required the Company to
ship corrected products to existing customers. There can be no assurance that
errors will not be found in the future resulting in the loss of, or delay in,
market acceptance and/or sales and revenue, diversion of development resources,
injury to the Company's reputation, or increased service and warranty costs, any
of which could have a material adverse effect on the Company's business,
operating results, and financial condition.
Page 19
Computing Platform Shift; Compatibility with Third-Party Relational Databases
The Company commenced efforts in 1992 to evolve versions of its products to
use the C++ programming language and run on a variety of open platforms. In
December 1995, for the first time one of the new C++ versions of the Company's
products was used in production by a customer of the Company. The Company has
since shipped new C++ versions of its products for use on RS 6000/AIX, Digital
OpenVMS, Sun Solaris, Hewlett-Packard, and Windows/NT platforms. The Company is
actively working with customers to bring additional installations of these
products into production. There can be no assurance that the new versions of the
Company's products will meet the requirements of the marketplace and achieve
market acceptance, or that organizations will not migrate to other computing
platforms not supported by the Company. Moreover, there can be no assurance
that, notwithstanding the benefits of the new versions of the Company's
products, some of the Company's existing customers may choose not to migrate to
UNIX and Windows/NT systems. In such event, the Company may be required to
support both the old and new versions of its products, which could have a
material adverse effect on its business, operating results, and financial
condition.
The Company believes that the compatibility of customer relationship
management software systems with popular relational databases is an important
factor in the purchase decision of many organizations. Consequently, the Company
recently developed and shipped versions of its software capable of storing work
items in Oracle, Informix, Sybase, and Microsoft SQL Server relational
databases. However, the Company's existing and potential customers may demand
that the Company's systems be compatible with other relational databases and
there can be no assurance that the Company will not experience difficulties
which would delay or prevent the successful development or introduction of these
additional capabilities. Any such difficulty could have a material and adverse
effect on the Company's business, operating results, and financial condition.
Dependence on the Financial Services Market; Industry Consolidation
The Company has derived a significant portion of its revenue to date from
customers in the financial services market, and the Company's future growth
depends, in part, upon increased sales to this market. The financial condition
of the Company's customers and their willingness to pay for the Company's
products and services are affected by competitive pressures, decreasing
operating margins within the industry, currency fluctuations, active geographic
expansion, and deregulation. The Company believes that its customers' purchasing
patterns are somewhat discretionary. As a result, demand for the Company's
products and services could be affected by the condition of the markets the
Company serves or a deterioration in economic or market conditions generally.
The financial services market is undergoing intense domestic and
international consolidation. In recent years, several customers of the Company
have been merged or consolidated out of independent existence, and there is no
assurance that the Company will not experience declines in revenue occasioned,
in whole or in part, by future mergers or consolidations. Any decline in the
demand for the Company's products would have a material, adverse effect on the
Company's business, operating results, and financial condition.
Page 20
Uncertainty of Growth into other Markets
As part of its growth strategy the Company believes that it is critical to
continue selling its products to markets other than financial services, such as
insurance, telecommunications, healthcare, public utilities, and retail. The
Company believes that in connection with such efforts it will be necessary for
the Company to continue to hire additional personnel with expertise in these
other markets. There can be no assurance that the Company will continue to be
successful in selling its products to these other markets or in continuing to
attract and retain personnel with the necessary industry expertise. The
inability of the Company to succeed in its penetration of these other markets
could have a material adverse effect on its business, operating results, and
financial condition.
Risks of Customer License Non-Renewal
Revenue attributable to license renewals has historically accounted for a
significant portion of the Company's total revenue. While historically a
substantial number have been renewed, there can be no assurance that a
substantial majority of the Company's customers will continue to renew expiring
licenses, and any such non-renewal would require the Company to obtain revenue
from other sources in order to achieve its revenue targets. A decrease in the
Company's license renewal rate without offsetting revenue from other sources
would have a material adverse effect on the Company's business, results of
operations, and financial condition.
Dependence on Key Personnel
The Company's future success depends to a significant extent on Mr.
Trefler, its other executive officers, and certain technical, managerial,
consulting, and sales and marketing personnel The loss of the services of any of
these individuals or group of individuals could have a material adverse effect
on the Company's business, operating results, and financial condition. None of
the Company's executive officers has entered into an employment contract with
the Company, although each is subject to a non-disclosure and non-competition
agreement with the Company. The Company does not have, and is not contemplating
securing, any significant amount of key-man life insurance on any of its
executive officers or other key employees. The Company believes that its future
success also will depend significantly upon its ability to attract, motivate,
and retain additional highly skilled technical, managerial, consulting, and
sales and marketing personnel. In particular, delays in hiring and training
qualified sales personnel would adversely affect the Company's operating results
due to the substantial time period between the identification of new customers
and the successful implementation and acceptance of the Company's products by
those customers. Because developing, selling, and maintaining the Company's
products requires extensive knowledge of computer hardware and operating
systems, programming languages, and application software, the number of
qualified potential employees is limited. Moreover, competition for such
personnel is intense, and there can be no assurance that the Company will be
successful in attracting and retaining the personnel it requires to continue to
grow and operate profitably.
Intense Competition
The market for customer relationship management software and related
consulting and training
Page 21
services is relatively new, intensely competitive and highly fragmented. The
Company encounters significant competition from internal information systems
departments of potential or existing customers that develop custom software. The
Company also competes with companies that target the customer interaction or
workflow markets, and professional services organizations that develop custom
software in conjunction with rendering consulting services. Such competitors
vary in size and in the scope and breadth of products and services offered. The
Company anticipates increased competition for market share and pressure to
reduce prices and make sales concessions, which could materially and adversely
affect the Company's business, operating results, and financial condition.
Many of the Company's competitors have greater resources than the Company,
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. Many of the Company's competitors can devote
greater managerial or financial resources than the Company can to develop,
promote, and distribute customer service management software products and
provide related consulting and training services. There can be no assurance that
the Company's current or future competitors will not develop products or
services which may be superior in one or more respects to the Company's or which
may gain greater market acceptance. Some of the Company's competitors have
established or may establish cooperative arrangements or strategic alliances
among themselves or with third parties, thus enhancing their abilities to
compete with the Company. It is likely that new competitors will emerge and
rapidly acquire market share. There can be no assurance that the Company will be
able to compete successfully against current or future competitors or that the
competitive pressures faced by the Company will not materially and adversely
affect its business, operating results, and financial condition.
Management of Growth
The growth in the size, geographic scope and complexity of the Company's
business and the expansion of its product offerings and customer base have
placed, and are expected to continue to place, a significant strain on the
Company's management, operations, and capital needs. The Company's continued
growth, if any, will require it to hire, train, and retain many employees both
in the United States and abroad, particularly additional sales and financial
personnel, and will also require the Company to enhance its financial and
managerial controls and reporting systems. There is no assurance that the
Company can manage its growth effectively or that the Company will be able to
attract and retain the necessary personnel to meet its business challenges. If
the Company is unable to manage its growth effectively, the Company's business,
operating results, and financial condition could be materially and adversely
affected.
Risks Associated with International Operations; Currency and Other Risks
Sales to customers headquartered outside of the United States
represented approximately 17.7% and 16.5% of the Company's total revenue in 1996
and 1997, respectively. The Company, in part through its wholly-owned subsidiary
based in the United Kingdom, markets products and renders consulting and
training services to customers based in Canada, the United Kingdom, France,
Switzerland, Ireland, Luxembourg, Mexico, and Sweden and is in negotiations with
potential customers based in other foreign countries. The Company established
additional offices in continental Europe and the Pacific Rim. The Company
believes that its continued growth will necessitate expanded international
operations requiring a diversion of managerial attention and financial
resources. The Company anticipates hiring additional personnel to accommodate
international growth, and the
Page 22
Company may also enter into agreements with local distributors, representatives,
or resellers. If the Company is unable to do one or more of these things in a
timely manner, the Company's growth, if any, in its foreign operations will be
restricted, and the Company's business, operating results, and financial
condition could be materially and adversely affected.
In addition, there can be no assurance that the Company will be able to
maintain or increase international market demand for its products. Most of the
Company's international sales are denominated in U.S. dollars. Accordingly, any
appreciation of the value of the U.S. dollar relative to the currencies of those
countries in which the Company distributes its products may place the Company at
a competitive disadvantage by effectively making its products more expensive as
compared to those of its competitors.
Additional risks inherent in the Company's international business
activities generally include unexpected changes in regulatory requirements,
increased tariffs and other trade barriers, the costs of localizing products for
local markets and complying with local business customs, longer accounts
receivable patterns and difficulties in collecting foreign accounts receivable,
difficulties in enforcing contractual and intellectual property rights,
heightened risks of political and economic instability, the possibility of
nationalization or expropriation of industries or properties, difficulties in
managing international operations, potentially adverse tax consequences
(including restrictions on repatriating earnings and the threat of "double
taxation"), enhanced accounting and internal control expenses, and the burden of
complying with a wide variety of foreign laws. There can be no assurance that
one or more of these factors will not have a material adverse effect on the
Company's foreign operations, and, consequentially, the Company's business,
operating results, and financial condition.
Impact of Year 2000 Issue
The "Year 2000 Issue" refers to the problems associated with computer
programs having been written using two digits rather than four to define the
applicable year. The Company has performed an assessment of the software it uses
internally and the software it licenses to customers and such assessment has not
revealed any major outstanding problems in this regard. There can be no
assurance that such problems will not develop or be revealed in the future which
could materially and adversely affect the Company's business, operating results,
and financial condition.
Reliance on Certain Relationships
The Company has a number of third party relationships that are significant
to its sales, marketing and support activities and product development efforts.
The Company relies upon relational database management systems applications and
development tool vendors, software and hardware vendors, and consultants to
provide marketing and sales opportunities for the Company's direct sales force,
and strengthen its product offerings through the use of industry-standard tools
and utilities. The Company has also recently begun establishing relationships
with third parties that will distribute the Company's products. In particular,
the Company's relationship with First Data Corporation is central to its
distribution of products to several markets. The Company's strategy in entering
into these relationships is to keep pace with the technological and marketing
developments of major software vendors, to acquire technical assistance for the
Company's product development efforts, and to leverage the Company's sales and
marketing capabilities. There can be no assurance that these companies, most of
which have significantly greater financial and marketing resources than the
Page 23
Company, will not develop or market software products which compete with the
Company's products in the future or will not otherwise discontinue their
relationships with or support of the Company. The failure of the Company to
maintain its existing relationships, or to establish new relationships in the
future, because of a divergence of interests, acquisition of one or more of
these third parties, or for any other reason, could have a material adverse
effect on the Company's business, results of operations, and financial
condition.
PART II
Item 5 MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The information required by this item may be found in the section entitled
"Stock Price History and Related Stockholder Matters," in the Company's 1997
Annual Report to Stockholders and is incorporated herein by reference.
Initial Public Offering Proceeds
The Company completed an initial public offering of 3.4 million shares of
its common stock on July 24, 1996 at a price to the public of $12.00 per share,
pursuant to a registration statement on Form S-1 (SEC File No 3313-3807)
declared effective by the Securities and Exchange Commission on July 18, 1996.
The managing underwriters for the offering were Goldman Sachs & Co., Cowen and
Company, and Montgomery Securities. Of the 3.4 million shares of common stock
sold in the offering, 2.7 million were sold by the Company and 0.7 million were
sold by stockholders of the Company, resulting in net proceeds to the Company
and selling stockholders of $29.4 million and $7.8 million, respectively. None
of the expenses incurred by the Company in connection with the offering (which
expenses including the underwriting discount totaled approximately $3.5 million)
were paid, directly or indirectly, to directors or officers of the Company or
their associates, to persons owning 10% or more of any class of equity
securities of the Company or to affiliates of the Company. The proceeds have
been used to fund the Company's working capital and asset purchase requirements
as shown in the Company's Consolidated Statement of Cash Flows for 1996 and 1997
contained in the 1997 Annual Report to Stockholders.
Item 6 FIVE YEAR COMPARISON OF SELECTED CONSOLIDATED FINANCIAL DATA
The information required by this item may be found in the section entitled
"Five Year Comparison of Selected Consolidated Financial Data," in the Company's
1997 Annual Report to Stockholders and is incorporated herein by reference.
Item 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Item 7A QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not Applicable
The information required by this item may be found in the section entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," in the Company's 1997 Annual Report to Stockholders and is
incorporated herein by reference.
Page 24
Item 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements and supplementary data
appear in the Company's 1997 Annual Report to Stockholders and is incorporated
herein by reference. Financial statement schedules are set forth in Item 14,
"Exhibits, Financial Statement Schedules, and Reports on Form 8-K" of this Form
10-K and are filed herewith.
Item 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Reference is made to the Company's report on Form 8-K filed with the
Securities and Exchange Commission (the "Commission") on November 6, 1997 (as
amended by the Company's report on Form 8-K/A filed with the Commission on
November 18, 1997) and to the Company's report on Form 8-K filed with the
Commission on December 16, 1997.
PART III
Item 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to the Directors of the Company is set forth in the
section entitled "Election of Directors" in the 1998 Proxy Statement, which
section is incorporated herein by reference. Information relating to the
executive officers of the Company is set forth in Part I, immediately following
Item 4, of this Report under the caption "Executive Officers of the Registrant."
Information relating to compliance with Section 16(a) of the Securities Exchange
Act of 1934 is set forth in the section entitled "Section 16(a) Beneficial
Ownership Reporting Compliance" in the 1998 Proxy Statement, which section is
incorporated herein by reference.
Item 11 EXECUTIVE COMPENSATION
Information relating to executive compensation is set forth in the sections
entitled "Director Compensation," "Executive Compensation," "Option Grants,"
"Aggregated Option Exercises and Year-End Option Table," and "Compensation
Committee Interlocks and Insider Participation" in the 1998 Proxy Statement,
which sections are incorporated herein by reference.
Item 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information relating to ownership of equity securities of the Company by
certain beneficial owners and management is set forth in the section entitled
"Principal and Management Stockholders" in the 1998 Proxy Statement, which
section is incorporated herein by reference.
Item 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information relating to certain relationships and related transactions is
set forth in the section entitled "Certain Transactions" in the 1998 Proxy
Statement, which section is incorporated herein by reference.
Page 25
PART IV
Item 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
The following consolidated financial statements required by Item 8 of this
Form 10-K are incorporated by reference from the 1997 Annual Report.
Location in 1997
Item Annual Report
---- --------------
Consolidated Balance Sheets at
December 31, 1996 and 1997 Page 23
Consolidated Statements of Income for the years ended
December 31, 1995, 1996, and 1997 Page 24
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1995, 1996, and 1997 Page 25
Consolidated Statements of Cash Flows for the
years ended December 31, 1995, 1996, and 1997 Page 26
Notes to Consolidated Financial Statements Page 27 - 36
Reports of Independent Public Accountants Page 37 - 38
(2) Financial Statement Schedules
The following financial statement schedule as of December 31, 1996 and 1997
and for the years ended December 31, 1995, 1996, and 1997 is required to be
filed by Item 8 of this Form 10-K, and is filed herewith as noted below. The
financial statement schedule should be read in conjunction with the consolidated
financial statements of the Company.
Schedule II - Valuation and Qualifying Accounts Page 30
All other schedules are omitted because the required information is not
present or not present in sufficient amounts to require submission of the
schedule or because the information is reflected in the consolidated financial
statements or notes thereto.
(3) Exhibits
The exhibits filed as part of this Report are listed in the Exhibit Index
immediately following the financial statement schedule included in this Report.
(b) Reports on Form 8-K
On November 6, 1997, the Company filed a report on Form 8-K with the
Commission (which was amended by a report on Form 8-K/A filed by the Company on
November 18, 1997) in connection
Page 26
with the termination of the relationship with the Company's independent public
accountants. On December 16, 1997, the Company filed a report on Form 8-K with
the Commission in connection with its appointment of the successor independent
public accountants.
Page 27
SIGNATURES
Pursuant to the requirements to Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
PEGASYSTEMS INC.
Date: April 15, 1998
/s/ Ira Vishner
By: -------------------------------------------
Ira Vishner, Vice President, Corporate
Services, Treasurer, Chief Financial
Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report on Form 10-K has been signed below on April 14, 1998 by the
following persons on behalf of the Registrant and in the capacities indicated.
/s/ Alan Trefler
- ----------------------------
Alan Trefler President, Clerk and Director (principal
executive officer)
/s/ Ira Vishner
- ----------------------------
Ira Vishner Vice President, Corporate Services, Treasurer,
Chief Financial Officer and Director (principal
financial and accounting officer)
/s/ Edward A. Maybury
- ----------------------------
Edward A. Maybury Director
/s/ Edward B. Roberts
- ----------------------------
Edward B. Roberts Director
/s/ Leonard A. Schlesinger
- ----------------------------
Leonard A. Schlesinger Director
/s/ Thomas E. Swithenbank
- ----------------------------
Thomas E. Swithenbank Director
Page 28
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTARY SCHEDULE
To Pegasystems Inc.:
We have audited, in accordance with generally accepted auditing standards, the
consolidated statements of Pegasystems Inc. and have issued our report thereon
dated April 2, 1998. Our audit was made for the purpose of forming an opinion on
those consolidated financial statements taken as a whole. The schedule listed in
the financial statement schedule index is the responsibility of the Company's
management and is presented for the purposes of complying with the Securities
and Exchange Commission's rules and is not a part of the basic consolidated
financial statements. This schedule has been subjected to auditing procedures
applied in the audit of the basic consolidated financial statements and, in our
opinion, fairly states, in all material respects, the financial data required to
be set forth therein in relation to the basic consolidated financial statements
taken as a whole.
Boston, Massachusetts
April 2, 1998
Arthur Andersen LLP
Page 29
SCHEDULE II
PEGASYSTEMS INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Three Years Ended December 31, 1997
Balance Additions
at charged to Charged Balance
beginning costs and to other Deductions at end
Description of period expenses account (c) of period
- ---------------------------------------- ------------- ------------- ------------- --------------- -----------
Allowance for doubtful accounts:
Year ended December 31, 1995 $ -- $ 793,310 $ -- $359,423 $ 433,887
Year ended December 31, 1996 433,887 300,000 204,685(a) -- 938,572
Year ended December 31, 1997 938,572 1,938,148 284,781(b) 961,720 2,199,781
(a) Amount reclassified from liabilities during the year.
(b) Amount relates to service revenue reversed, which was previously charged
against the allowance for doubtful accounts.
(c) Deductions are related to accounts receivable write-offs.
Page 30
PEGASYSTEMS INC.
Exhibit Index
Exhibit No. Description
3.3.* Restated Articles of Organization of the Registrant.
3.4.* Restated By-Laws of the Registrant.
4.1.* Specimen certificate representing the Common Stock.
10.1.* Amended and Restated 1994 Long-Term Incentive Plan.
10.2.* 1996 Non-Employee Director Stock Option Plan.
10.3.* 1996 Employee Stock Purchase Plan.
10.4.* Loan Agreement dated as of December 16, 1993 between the Registrant and Fleet
Bank of Massachusetts, N.A.
10.5.* Loan Modification Agreement dated as of May 5, 1995 between the Registrant and
Fleet Bank of Massachusetts, N.A.
10.6.* Second Loan Modification Agreement dated May 15, 1996
between the Registrant and Fleet National Bank (successor by
merger to Fleet Bank of Massachusetts, N.A.).
10.11.* Promissory Note dated May 15, 1996 in the amount of $5,000,000 made by the
Registrant to the order of Fleet National Bank.
10.13.* Lease Agreement dated February 26, 1993 between the Registrant and Riverside
Office Park Joint Venture.
10.14.* Amendment Number 1 to Lease Agreement dated August 7, 1994 between the
Registrant and Riverside Office Park Joint Venture.
10.15. Warrant agreement dated June 27, 1997 by and between the Registrant and First Data
Resources Inc.
13.1. Portions of the 1997 Annual Report to Stockholders incorporated by reference
into this Report.
16.1.+ Letter of Ernst & Young LLP dated November 18,1997 to the Securities and Exchange Commission.
21.1.* Subsidiaries of the Registrant.
23.1. Consent of Arthur Andersen LLP.
23.2. Consent of Ernst & Young LLP.
27.1. Financial Data Schedule-1997.
27.2. Financial Data Schedule-1996.
- --------------
* Filed as an exhibit to the Registrant's Registration Statement on Form S-1
(Registration No. 333-03807) or an amendment thereto and incorporated herein
by reference to the same exhibit number.
+ Filed as an exhibit to the Registrant's report on Form 8-K/A filed with the
Securities and Exchange Commission on November 18, 1997 and incorporated
herein by reference.
Page 31